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Fringe Democrats’ Proposed Solution to High Gas Prices: Higher Taxes

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The recent wild price swings for crude oil have prompted allegations of price gouging from Democrats, many of whom asserted that if crude oil prices decline, gasoline prices should follow in lockstep. Academics, journalists, and policymakers quickly and universally debunked these claims.

However, some Democrats in Congress continue to push the fallacy that oil producers are unilaterally responsible for the price of crude oil, and consequently responsible for the price of gasoline – all while refusing to encourage domestic production to increase supply.

These fringe Democrats’ most recent “solution” to high energy prices is a windfall profit tax similar to the failed tax initiated by the Carter Administration in 1980. Legislative proposals introduced by Rep. Ro Khanna and Sen. Sheldon Whitehouse and Rep. Peter DeFazio aim to tax oil companies’ profits and redistribute those funds to American citizens.

Prominent voices in industry and in the media identified that these proposals rely on several faulty premises:

  1. A windfall profit tax does not address the root cause of high energy prices.

A windfall profit tax would be a band-aid fix – and an ineffective one, at that. Fundamentally, the current spike in gas prices is driven by multiple, interconnected factors. War in Ukraine has threatened the availability of oil and natural gas supplies across Europe. A lack of investment in oil and natural gas infrastructure, in the United States and abroad, has hampered efforts to replace Russian energy with alternative sources. The prospect of a nuclear deal with Iran, freeing up Iranian oil exports, lingers over supply projections. Reuters reports the geopolitical moves that resulted in a brief market correction this week:

“Oil prices fell more than 5 percent on Monday to the lowest in nearly two weeks amid hopes for progress toward a diplomatic end to Russia’s invasion of Ukraine – a development that would boost global supplies – while a pandemic-linked travel ban in China cast doubt on demand.”

Amidst all of this, the domestic oil and gas industry is attempting to respond to global demand needs while navigating the most challenging and antagonistic regulatory environment the industry has seen to date. On one hand, Secretary Granholm continues to ask oil and natural gas companies to increase production:

We need for everyone to step up. Whether it’s gas station owners, whether it’s oil companies… We need to all band together at this moment, against Russia, and increase supply.” (emphasis added)

But on the other hand, policy actions like the Department of Interior stalling on issuing new leases and permits are making it impossible to do so. The uncertain regulatory environment – made worse by proposals such as the windfall profit tax – discourages investment in energy companies at the exact moment companies need investment in order to accelerate production, as stated by the Financial Times editorial board:

Stability is key to promoting both investment and spending — both of which drive economic growth. … High profits are not guaranteed, and if they are taxed away investors may be reluctant to take on risk — especially in an already unstable, unpredictable environment.” (emphasis added)

  1. The price of oil is set by the global commodities market, not by oil producers.

Garrett Golding, an economist at the Federal Reserve Bank of Dallas, explains how the oil supply chain creates a gap between the price of oil and the price of gasoline. Costs are borne, and passed along, at every stage of the supply chain:

“Refiners acquire crude oil and turn it into the fuels we use. It’s then sent by pipeline, truck, railcar, and vessel to distribution facilities and service stations. This process can take several days. Inherent to that is a time lag between what you see with daily oil prices and what service stations pay to fill up their underground tanks. While oil prices shot up immediately, it took almost two weeks for the full effect to be seen on the street. … It’s not price gouging or a grand plot by the industry. This is how the business functions.” (emphasis added)

Additionally, to lock down oil supply in a volatile market, businesses throughout the oil supply chain purchase crude oil with futures contracts. Consequently, the current price of gasoline reflects past purchases of oil.

  1. Historically, oil producers’ gross profits do closely not track the price of oil.

The windfall profit tax proposals in Congress presume that there is a “windfall profit” to tax. Analysis from Real Investment Advice shows that this is not actually the case. In fact, under pressure from shareholders, over the last decade, oil producers have structured their operations so that their profits do not fluctuate significantly with the price of oil:

“Below we share data comparing the gross profit margins of Exxon and Chevron versus the oil price. … As both graphs highlight, there is little to no correlation between profit margins and oil prices. … Energy companies hate volatility in oil prices because shareholders pay up for predictable profits and growth. To limit earnings volatility, all energy companies lock in future prices via contracts with buyers to sell oil in the future at specific prices. They also hedge with oil futures to further manage oil price volatility.” (emphasis added)

  1. A windfall profit tax would likely increase gas prices.

It’s highly unlikely that a windfall profit tax on oil producers would prompt the producers to artificially lower the price of the oil they sell. Speaking on CNBC, Austan Goolsbee, former Chairman of the Council of Economic Advisors under President Obama, argued that such a tax would cause oil and gas prices to go up as corporations throughout the oil supply chain attempt to recoup losses from the tax:

“I’m not a big fan. I don’t see what that’s going to solve. I think that there’s a high chance, the way they described it in that segment, that it would lead for oil and gas prices to go up.” (emphasis added)

Brian Brenberg, Associate Professor for Business at Kings College London, was harsher in his criticism of the proposal:

“We’ve heard a lot of bad ideas in recent years, but this might be the worst. We’ve got an oil and gas crisis, and these guys want to put basically a price control in. … It’s absolutely foolish and it will send energy markets into a tailspin.” (emphasis added)

A similar tax proposal was recently debated in the United Kingdom. Prime Minister Boris Johnson rejected calls from the opposing Labour Party to instate a windfall profit tax on oil companies, arguing that a windfall profit tax would result in even higher energy prices. UK Finance Minister Rishi Sunak stated that it would be unsustainable to hold the price of energy at “artificially low” levels.

Conclusion

A windfall profit tax has been tried before, to no avail. A post-mortem published by the nonpartisan Congressional Research Service in 2009 evaluated the Windfall Profit Tax of 1980 and found that it generated far less income than projected, while reducing domestic oil production and increasing reliance on imported oil. Additionally, in 1984, the U.S. Treasury Department urged Congress to repeal the tax since “the perceived ‘windfall’ for producers has generally vanished.”

These fringe Democrats’ perceived windfall could just as easily vanish weeks, or months, from today. As a reminder, nearly two years ago oil futures traded at negative prices. This anomaly occurred without any outcry from Congress about supposed market manipulation or concern for consumers. Rather, according to the Congressional Research Service, negative oil futures prices were simply a product of market forces:

“As a backdrop to negative futures prices is a large gap between supply and demand for crude oil. … The drop in overall crude oil prices, including the negative prices for the WTI May futures contract, indicates the market is working.” (emphasis added)

In order to fulfill the administration’s own requests to produce more oil and natural gas, the industry needs more stability and predictability from legislators and regulators, not less. Americans deserve better than fringe Democrats’ dishonest, politically driven campaign that would reduce U.S. oil production and further raise prices at a time of unprecedented uncertainty.

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