Sunday, May 29, 2011

Democrats use oil profits as a campaign device

Published in The Tennessean, Sunday, May 29, 2011

by Richard J. Grant

History is easier to understand when we remember that the interests of individual politicians regularly differ from those of their constituents. This helps explain the recent grandstanding by Senate Democrats when they summoned oil-company executives to act as political punching bags to help distract attention from the Obama administration's abysmal record on energy supply.

This show trial was the centerpiece for hearings in support of the Democrats' “Close Big Oil Tax Loopholes Act,” which purports to eliminate oil-industry subsidies. The show-trial format fit well with the political exploitation of public distress over rising gasoline and oil prices. The Senators made wild and misleading insinuations in the form of marketable soundbites while the oil executives had to respond in the longer paragraphs that are usually needed to explain reality.

Passive listeners were led to believe that oil companies were making rapacious profits at the expense of consumers and not paying their fair share of taxes. In truth, the profitability rates of the major oil companies are unexceptional and the industry is taxed quite heavily.

Perhaps the Senators who sponsored the bill believe, as the president does, that profits are a cost and impose a burden on customers. They seem to believe that profits should be redistributed to the people through the U.S. Treasury.

Whatever revenue the proposed bill might initially deliver to the Treasury would decrease over time as the industry adjusted. Ironically, the higher tax burden would lead to higher pre-tax rates of profitability in the oil industry as capital allocations shrink and adjust to reflect the new tax structure and to preserve after-tax profitability rates comparable to those in other industries.

If the Senators were successful in passing this bill, the result would be the same as most of their previous interventions. It would drain capital away from domestic energy production, reduce total oil supplies, and increase the demand for imported oil. That means that oil prices will be higher than they would have been otherwise. The Senators will once again hurt their constituents.

Those who do not understand the nature of capital and profits are likely to believe that profits are just a surplus that can be harmlessly redistributed. The presidential candidate, Barack Obama, supported a “windfall-profits tax” on oil companies for just this purpose. Such taxes are a perennial campaign device.

In 1980, Congress enacted a so-called windfall-profits tax, that was really an excise tax, to capture for the Treasury a portion of oil-company profits that rose with high imported-oil prices. The 1970s were years of high inflation and domestic-oil price ceilings that forced U.S. oil producers to sell their product at below-market prices. It is no wonder that these were also the years of energy crises.

The windfall-profits tax reduced the competitiveness of the American oil industry relative to the OPEC producers. American producers had less revenue, a significant portion of which was diverted to the U.S. Treasury leaving less capital for reinvestment in domestic oil production. The relative lack of internally generated funds needed for reinvestment and expansion caused many firms to turn to outside funding sources and increase their debt. Heavier debt loads made more companies vulnerable to bankruptcy when oil prices later dropped.

In the wake of the recent financial crisis and the recent volatility in oil prices, these unhappy consequences of government intervention should sound very familiar.


Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com

Copyright © Richard J Grant 2011