Analysis | Should oil firms be forced to share windfall?

Warren Aakervik Jr. has been in business long enough that his customers don't blame him for high oil prices.

"I'm literally sitting on no oil right now," he says from his office at Ballard Oil, which his father started in 1937. "When prices go down, you try to sit with the least amount of inventory possible," so you don't get stuck with higher-priced oil.

"When prices go up, I try to hold on to as much inventory as I can, so I can delay price increases as long as I can."

But Aakervik, whose firm supplies marine fuel and home-heating oil, wouldn't mind seeing a tax on all the profits oil companies have been distilling over the past few years.

"Would you rather see the money go to the oil companies, or to the government?" he asks.

It's a billion-dollar question on which few people agree.

Proponents of a windfall-profits tax say the money could be used for low-income energy-assistance programs, hurricane repair or the search for cleaner, renewable sources of energy.

Opponents say taxing the oil companies' good fortune merely punishes them for being in the right place at the right time and robs money from other things they could be doing, such as finding and making more oil and gas.

Commodity prices are cyclical — they rise and fall due to changes in supply and demand. New supply comes on line, and prices fall; old supply dries up and prices rise until substitutes become available. Consumers decide they want more or less of a product, and prices swing up and down accordingly.

Markets also tend to sort out higher prices. When commodity prices rise, consumers use less of that commodity, and substitutes become more attractive. If you're General Motors and you decided to build Hummers instead of hybrids, that's not good news as gas prices rise. Markets are efficient, but the players in them are not always very smart.

Price gouging?

The run-up in oil prices isn't necessarily evidence of price gouging, as some have charged. Oil prices were at about $12 barrel in early 1999, then began to climb as the economies of India and China began to surge and they started using more oil. China went from an oil exporter to one of the world's largest importers, and demand drove the price up. By the end of the year, oil prices had more than doubled.

Supplies have been adequate in this country, but with no new refining capacity in decades, any rise in demand was bound to result in higher prices.

Only in the case of oil do consumers and politicians vent such anguish and anger over rising prices. For example, steel prices have been rising, but nobody's clamoring for an excess-profits tax on rebar.

Perhaps it's the importance of oil (though some of us might have a more difficult life without coffee); perhaps it's the sharp price spikes to which oil is periodically subject. Perhaps it's the record profits.

Whatever the reason, in no other commodity market do people so often assume that the suppliers are artificially raising the cost of the end product.

It's hard to tell how much of the current oil chatter in Congress is serious concern and how much is grandstanding for the home folks. But we ought to at least think this through before we go jumping on (or off) the oil tanker.

First, these aren't the highest gasoline prices on record. When you factor in inflation, the highest recorded prices were in 1918, when gasoline cost about $3.20 a gallon in current dollars. In recent times, we've only matched the second-highest average prices, from 1981, when we paid around $3 a gallon.

Second, we had a windfall-profits tax from 1980-1988. It generated $79 billion in revenue but may have cut domestic oil production by around 1 billion barrels, according to a congressional study. That meant higher prices at the pump, and more imports of foreign oil.

Dean Baker, economist and co-director of the Washington, D.C.-based Center for Economic Policy, is skeptical of that study, however. He notes that domestic oil production rose during the 1980s, and that new oil was not subject to the tax.

"It's not clear that it had much impact," he says of the old tax. Baker recently proposed a 40 percent tax on oil-company profits above any firm's five-year average profit, adjusted for inflation.

The oil industry has alternative explanations for its profits.

Previous losses

Oil producers were losing money and going out of business in 1999, says Mark Kibbe, senior tax-policy analyst at the American Petroleum Institute, the industry's lobbying arm. And even at today's healthy profits, the industry average is 7.2 cents of profit per $1 of sales, versus 7.8 cents for U.S. industry as a whole in the second quarter of this year. (Exxon's profit was 9.8 cents per dollar.)

"We're not making windfall profits," he says.

An excess-profits tax would make U.S. firms less competitive globally, he says. "You could see further consolidation if the tax laws become too overbearing."

Where does the profit go? Some of it goes into new exploration and development; some of it goes to shareholders in the form of dividends.

If we tax those profits, consumers should recognize that the tax isn't going to be paid by ExxonMobil Chairman Lee R. Raymond, despite the more than $7 million he makes every year. It's going to be paid by consumers.

ExxonMobil claims a windfall-profits tax will take money away from finding and refining more oil. But by the same token, the tax breaks found in the 2003 Energy Policy Act haven't all gone to encourage exploration and development. ExxonMobil spent $3.7 billion in the second quarter of this year on buying its own stock.

And that's probably where the windfall tax has its greatest appeal. Markets allocate resources efficiently; they don't always provide other things we need, such as a strategy for dealing with global warming.

A lot of the talk about a windfall-profits tax probably is just talk.

"Congress wouldn't pass it without a gun to its head," says Amy Isaacs, national director of Americans for Democratic Action, a liberal lobby in Washington, D.C. "But we're going to ask them to do it and keep on asking."

The challenge, of course, is ensuring that the windfall-profits tax would be used for something other than more tax breaks for people who don't need them. And if you can't guarantee that, you don't have much argument for the tax.

T.M. Sell, Ph.D., is professor of political economy at Highline Community College.