Windfall Profits Tax

A lot of talking has been going on about placing a windfall profits tax on large oil companies. Presidential candidate Barack Obama had this up on his website, as part of his proposed energy policy:

Enact a Windfall Profits Tax on the Top Grossing Oil Companies and Ease the Burden on American Families: The oil industry has profited greatly—over $150 billion in 2007—due to global instability fueled by conflict in Iraq, failing domestic fiscal policies that have weakened the U.S. dollar and skyrocketing global demand resulting from a lack of investment in alternatives. Barack Obama supports imposing a windfall profits penalty on oil selling at or over $80 per barrel. Revenue from the proposal will be invested in a number of measures to reduce the burden of rising prices on families.

The problem with imposing any tax on a company is that the tax will immediately be passed on to the customer. This means that the ultimate goal of saving the consumer money will go right out the window. Another problem with this plan is that it will only cause companies to change their definition of profits. If $80/barrel is the limit, then the only thing that will happen is that companies will charge $79/barrel and have another $30 in associated fees and surcharges. Don’t believe me? Check your cell phone statement. Here is a section from my cell phone bill from Sprint:

Sprint Surcharges $9.44

Sprint Surcharges are rates we choose to collect from you to help defray costs imposed on us. Surcharges are not taxes or amounts we are required to collect from you by law. Surcharges may include: Federal USF, regulatory charges, administrative charges, gross receipts charges, and other charges incurred to recover costs associated with governmental programs. The amounts, and the components used to calculate Surcharge amounts, are subject to change.

Federal-Univ Serv Assess Non-LD $2.42
Texas State-Infrastructure Reimburse $1.30
Texas State-Margin Fee Reimbursement $1.00
Texas State-Univ Serv Assessment $3.77
Administrative Charge $0.75
Regulatory Charge $0.20

If the cell phone companies impose surcharges to “defray costs” that are “associated with governmental programs,” then that means that it doesn’t matter how much the government wants to charge the companies, they will always pass it on to the consumer.

Any student who has had a basic economics course will know that taxing something is the worst way to lower the cost of that item. There are only two ways to lower the cost of an item: raise the supply of that item or lower the demand for it.

Here's a graph from this site to help illustrate my points:

As you can see, the dotted green line represents the supply of a given item while the solid red lines indicate the demand for that item. When the demand for this product increases from D1 to D2, the price of the item increases from P1 to P2. While it is basic economics, this graph is helpful in explaining the situation with oil because OPEC has said that it will not increase production, therefore we have a fairly static supply.
If we were to increase the supply of oil by drilling, it would move the supply line to the right, causing the points where it meets with the demand curve to be lower than they are now. This would cause the price to be lower.
If there is one thing that I want you to take away from all of this, it is:
"Placing a tax on something only increases the price of that item."

Posted byJ. R. Guinness at 7:37 AM  


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