November 07, 2005, 9:10 a.m.
A Windfall of Bad Economics
Federal meddling in the gasoline market has never helped anyone.

By Paul J. Gessing

Bill Frist and Judd Gregg are the latest Republican senators to accuse oil companies of “gouging” consumers and to call for new tax or regulatory clampdowns as “remedies.” Although the populist stance against “big oil” might appeal to some beleaguered motorists, these Republicans — and most congressional Democrats — are dead wrong on the economics of proposals that would increase the level of federal intervention in the gasoline market.

One need only look to President Nixon’s price controls of the early 1970s to see the damage that such meddling can do to an economy. Herbert Stein, who headed Nixon’s Council of Economic Advisers, observed that the Nixon price controls on domestic oil, rather than reducing gas prices, had the effect of “encouraging oil imports, increasing our dependence [on foreign oil] and making it easier for OPEC to charge us a high price.”

Senators today are proposing that domestic oil companies be subject to a windfall profits tax, as these companies have benefited from the high barrel-price of oil. But like price controls, windfall profits taxes have only resulted in failure. This backward policy was concocted in 1980, when it was billed as a “temporary” excise tax that would supposedly prevent oil companies from benefiting “too much” from fluctuating crude oil prices. In an open letter to lawmakers that was recently published by the National Taxpayers Union, 257 of the nation’s leading economists, including two Nobel Prize laureates, argued that,

According to analysis by the Congressional Research Service, the windfall profits tax reduced domestic oil production in an estimated range of between 3 percent and 6 percent annually and it increased annual oil imports from between 8 percent and 16 percent. The tax, which created large compliance costs, but by 1987 and 1988 yielded almost no government revenue, was finally repealed by Congress in 1988 — a goal that had been sought by President Reagan since the 1980 Presidential campaign.

If the windfall tax is enacted again it will undoubtedly hurt domestic energy production, increase American dependence on foreign oil, and reduce overall energy supplies available to consumers. Considering the fact that many in Congress have misguidedly, yet simultaneously, endorsed the concept of government-directed “energy independence,” it is plain to see that anti-corporate rhetoric does not make for coherent public policy.

One reason why gasoline and heating oil is expensive today is that these commodities became far rarer when refinery production was shut down and damaged during the recent Gulf Coast hurricanes. In addition, the nation had already been dealing with high gas prices in part because of growing demand in China and elsewhere around the world. Given these circumstances, not to mention the fact that gas stations in the U.S. compete almost exclusively on price, the scenario of oil companies successfully colluding to control prices seems far-fetched. Even OPEC, one of the few remaining cartels in the world, has consistently seen member countries “cheat” by producing more than their allotted amount of oil. Of course, there is no room for such “cheating” now because OPEC and other producers are already at peak production.

Prices change all the time for all manner of goods. That is the nature of markets. If you bought a house ten years ago and sold it for double, or even triple, its previous value (as seems to be common these days), are you guilty of price gouging, or are you simply asking fair market value? It is somehow hard to believe that homeowners who so intuitively understand and even expect tremendous gains in housing prices could be demanding windfall profits taxes.

Sure, oil companies are earning record profits, but should we really expect anything else given the fact that these complex and incredibly large firms are charged with finding, accessing, refining, and delivering to market the single most important natural resource to the modern economy? Combine that with instability in the Middle East, an ongoing insurgency in Iraq, and the recent hurricanes, and it becomes more difficult to argue that oil companies do not deserve to be handsomely compensated for keeping the fuel flowing.

Hopefully, lawmakers will find no trumped-up examples of “gouging,” or will find that their pleas for an investigation of oil prices have fallen on deaf ears. If Congress does choose to act, the historical evidence already predicts the outcome: economic harm. This is exactly opposite of what policymakers are expecting.

— Paul J. Gessing is director of government affairs for the National Taxpayers Union.