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Should we tax oil company profits?
Forget about how much you like either oil companies or taxes. Let's boil down the comparison to either taxing profits or taxing gasoline prices.
Taxing profits will reduce the incentive to increase future supply, even if you think oil companies form a cartel. Fewer profits means less exploration and less incentive to develop new extraction technologies.
The weakening of supply responses is desirable only if you think we are approaching the "end of oil" -- and indeed all feasible substitutes -- and that we don't want to discover more oil right now. Perhaps it would be better to run out our string of doom more slowly. You also presumably would believe that more conservation, as would be induced by higher prices, won't much help. These views, taken together, are possible but I find them doubtful.
Alternatively, you might believe that our government can tax short-run profits that arise from supply kinks or slow-to-adjust refineries. Yet we will magically remove those taxes within a few months, so they do not discourage long-run elasticity of supply. That again strains the imagination.
Taxing gas prices puts an immediate burden on motorists, although the profits tax may bring higher prices in the longer run. But the gas tax encourages conservation and maintains the incentive for new supply. Surely that is the superior approach.
Addendum: Jane Galt and her readers have relevant thoughts.
Posted by Tyler Cowen on May 1, 2006 at 07:24 AM in Economics | Permalink
Comments
"But the profits tax encourages conservation and maintains the incentive for new supply."
Surely you meant to say that 'gas taxes' encourage conservation and maintain the incentive for new supply? Profits taxes don't do either.
Posted by: Slocum at May 1, 2006 7:56:40 AM
duh. You're preaching to the converted, man.
Posted by: joshg at May 1, 2006 8:15:40 AM
Thanks, I corrected the typing error.
Posted by: Tyler Cowen at May 1, 2006 8:15:56 AM
I would note that "reducing incentives to do X" is sometimes, but not always, the same as "reducing the incidence of X." In this particular case, I would find it at least somewhat surprising if the amount of exploration were affected all that much by a profits tax.
Posted by: alkali at May 1, 2006 10:02:15 AM
I'm not following the logic on the sales tax. We increase the sales tax to reduce gas consumption by X. Companies see demand permanently lower by X. Smaller market, smaller profit. The incentive to supply decreases.
I understand ideas concerning incidence and elasticity -- but that analysis looks at the incidence of a given tax rate. Here you are choosing a tax so as to decrease demand a given amount. No matter who pays the tax, you are shrinking the market by some fixed amount, by design. Presumably the tax isn't worth having if you just barely dent demand. But any large, permanent reduction in demand should affect the willingness to explore/innovate/supply.
That's not to say I dislike the idea of higher gas taxes. But I like the 'pure economics' idea of taxing until private cost equals social cost. I'm not persuaded that these punitive tax schemes to REALLY encourage conservation are optimal, or even better than what we have now.
Posted by: jack hayes at May 1, 2006 10:36:58 AM
An excellent argument for nationalizing the oil industry!
Posted by: Anderson at May 1, 2006 10:57:35 AM
Why not treat oil and gas companies no better than other industries? Why give them tax breaks that no other industries have?
I vaguely recall seeing a CBO document indicating that the tax burden on oil companies was a lot lower than the tax burden on other industries. I went to google and did a search for that CBO paper and did not find it. I did however find one of their papers flatly stating that "Through various tax preferences, the current tax system treats extractive industries (producers of oil, gas, and minerals) more favorably than most other industries". (I don't have the time to look for more - sorry.) The paper (http://www.cbo.gov/showdoc.cfm?index=2731&sequence=30) was written in 2001, but its hard to believe that with 2 oilmen in the White House the situation hasn't become even more favorable.
Posted by: cactus at May 1, 2006 11:09:02 AM
If you want to use taxes to raise the price of gasoline I think the tax should be on imports -- both crude and refined products. This raises the marginal price that domestic producers receive and consequently would encourage domestic production. A tax on the final product-- largely gasoline -- does nothing to encourage production -- it just provides a windfall to government.
Posted by: spencer at May 1, 2006 11:32:10 AM
It's obviously better to tax gasoline. Taxing specific goods to promote revenue collection and social engineering ends is generally preferable, and special taxes on oil companies come closer to being "bills of attainder" than my strict constitutionalist impulses prefer. Trouble is, taxes on gasoline and heating oil would be very regressive, like taxes on alcohol, cigarettes, cell phones etc already are. In theory it's important to seperate the distributive and efficiency benefits of proposed policies, but in practice it's not politically viable to even try to do so (mostly because the poor tend to be unaware of their own interests), so we have a long run, extremely slow improvement in policies where improved efficiency is also conductive to wealth inequality and no counterbalancing long run movement towards improved efficiency that is also conductive to wealth equality.
Posted by: michael vassar at May 1, 2006 11:34:59 AM
I think that what is being proposed is a one-time hit-and-run tax on oil companies. Such a tax, by itself, cannot affect incentives. It is only the expectation of such a tax in the future that could affect incentives. One argument is that these expectations are unaffected by what we do now so the incentive argument against a hit-and-run tax goes away.
Indeed, the oil companies may have always been expecting such a tax and already reduced their investments at the margin accordingly. If so, foregoing a tax now is like making your bed and not sleeping in it.
Posted by: jeff at May 1, 2006 12:58:20 PM
What about 'we should use less gas so we put less co2 in the atmosphere before we figure out alternative fuel sourcing?'
Posted by: Dan at May 1, 2006 1:28:38 PM
I think even a short run profits tax (presuming you coudl work out the details make it go away etc) woul acta as a significant deterent to investment. The simple reason is that the oil industry is highly volitile. If you have big declines at certain points you need big surges at times to make up for it. Unless you are going to ahve automatic subsidies that kick in whenever prices fall too much putting short run taxes (even if you administer them perfectly, is going to be highly problematic.
Posted by: mjw at May 1, 2006 2:05:54 PM
Oil companies should not have to pay a higher tax than other industries.
On the other hand, neither should they pay a lower tax than other industries.
Posted by: Half Sigma at May 1, 2006 3:32:15 PM
I second Jack's question above:
I'm not well versed in this stuff, and looking for an explanation of why this is wrong:
- If you expect a gas tax to decrease consumption, you thus decrease demand and thus profits.
- The decrease in demand and in profits acts as a disincentive to explore/improve, etc.
SO: a tax on gas has exactly the same bad effects as a tax on profits.
Also:
- if you tax profits, you increase prices
- increased prices lead to decreased consumption (increased conservation).
SO: a tax on profits has exactly the same good effects as a tax on gas.
What am I missing?
Posted by: Dan at May 1, 2006 5:42:28 PM
Dan, the biggest difference is in short run vs. long run impact. gas taxes affect consumption and profits now. profit taxes primarily affect investment decisions, which will affect gas supply in the long run more than today. One reason a profit tax is so popular in Congress is that politicians do not understand either the long run or time consistency.
Another difference is that a gas tax and a profits tax have a different incidence. a gas tax hits all the pumps, including non-US oil providers. I'm not sure how a profits tax can avoid disadvantaging US domestic producers vs. Petroleos de Venezuela, unless it is combined with an import tax.
Posted by: DK at May 1, 2006 6:12:52 PM
What explains the tax differential on gasoline between Europe and the US?
Posted by: bronxite at May 1, 2006 6:22:30 PM
The "hit and run" tax idea is an interesting way to think of it. Basically, we're asking them for a one-time lump sum payment, like a judgment in a lawsuit against tobacco companies. Have tobacco companies suffered (as opposed to farmers)?
Perhaps that's the model to think of: enter negotiations for a lump sum payment in lieu of an actual tax. It might sound like a bribe, but it's not really: the money would go into the Treasury rather than into the campaign funds of specific legislators. Still coercive, but it shakes up the incentive structure. Could we have an eBay for similar types of legislation? Like pollution-permit pricing, no?
Posted by: RSaunders at May 1, 2006 6:32:03 PM
What explains the PRICE differential between the US and Europe? Price in the UK is more than twice as expnensive than the US East coast.
Posted by: William Holt at May 2, 2006 8:22:10 AM
Oil companies make an average profit of nine cents a gallon on gasoline. Government takes average taxes of forty-four cents a gallon. And someone thinks reducing the profits of the companies who are finding, refining and marketing the gas is going to help gas customers? How will the government use the money from that tax increase to help anyone but itself? How about reducing the "windfall taxes" of the government that does nothing to find, refine or market gasoline, but imposes drastic regulatory and liability barriers on the industry that far outweigh any tax breaks it may afford? I won't even get into the double taxation of dividends and profits and capital gains - Aargh!
Posted by: Robert Speirs at May 2, 2006 10:53:06 AM
"Oil companies make an average profit of nine cents a gallon on gasoline."
Surely this refers only to downstream profits.
Upstream profits have to be a lot greater than that with the higher price of oil these days.
Posted by: Half Sigma at May 2, 2006 11:10:36 AM
I find it interesting that noone has talked about the externalties that the consumers of oil and gas and the producers of oil and gas do not pay for. If the oil producers and consumers (yes I know I am a consumer of oil)had to pay the full freight for what oil really costs us, the prices would at least double. Government subsidizes heavily our use of oil (foreign wars, roads, etc). What we should do is double the tax on oil products and to help the lower income people is lower the taxes on the lower part of income. Say gasoline tax is projected to bring in $100 Billion. Then figure out how much higher we can place the level at which someone begins to pay taxes on their income and reduce income tax intake by $50 Billion. Lower income taken care of somewhat, deficit reduced and some of the externalities are properly paid for.
Posted by: Murphy at May 3, 2006 10:40:30 AM
Gax taxes are better, and I support them -- and every time somebody mentions "global warming" without supporting gas taxes, I know they're not serious.
Of course, politicians who DO support gas taxes usually find out their voters do NOT, and in fact become ex-supporters.
Gas taxes in Europe are MUCH higher (I'm in Slovakia, over $4/gal; $1.30/liter).
Pres. Bush should have put a $0.10/gal tax sometime after 9/11 (perhaps Dec. 2002, after elections?), with the goal to reduce imports and stabilize prices. Then, increase it by $0.01 (a penny) every month, unless the spot price goes up by "too much" (20% in a month), at which time, no tax increase. Or, if "way too much", even a 1 penny tax decrease; for slower, but increasing tax revenue.
To pay down the deficit and to reduce "global warming" -- and to blame the gas taxes on those who fear global warming and who spend tax dollars.
Posted by: Tom Grey - Liberty Dad at May 4, 2006 10:04:12 AM
So, there's a leviathan and an eagle and a glass of milk (with a straw), which they are going to share. The leviathan tells the eagle:
"you can have the top half"
and then proceeds to drink the whole glass. The eagle, perplexed, asks the leviathan:
"why didn't you share that milk with me, like you promised?".
The leviathan answers, in a matter-of-fact tone:
"I only drank from my half".
Posted by: Jonathan Katcher at May 9, 2006 6:40:29 AM
Set the taxes aside for a moment and look at the impact of having a futures market on the raw material (oil) and on the finished product (gasoline, heating oil, etc.). Couple that with people's ability to instantly communicate on every nuiance in the geo-political landscape which drives futures prices up and prices at the pump up, but what are the oil companies paying? Their costs do not really change but their profits soar. Get rid of the futures on the finish good and see what happens.
Posted by: Tom Madden at May 11, 2006 5:04:56 PM
Is it true Brazil has a sugar cane based fuel for around a dollar a gallon?(after conversion rate)Why can't we have cleaner, alternative fuels? Why does the governmnet care more about business than people. And businesses aren't people!
Posted by: Joshua at May 31, 2006 9:37:15 PM
