Tuesday, June 24, 2008

A discussion on excess oil profits tax

The Becker-Posner blog is a collaborative blog that discusses a variety of issues, with two different views, from an economist and a tax lawyer/judge, supplied for each topic. Recently, I found there a good discussion on the excess profits tax on oil companies, which is currently being proposed by some government policy advisers.

Becker (the economist) argues rightly that an excess profits tax on oil companies will be an additional hurdle to solving the existing tight supply of oil:

The proposed excess profits tax on the earnings of oil companies would discourage the search for additional oil, and hence would have the opposite effects on this search from a relaxation of the moratorium on offshore drilling. An excess profits tax that is expected to persist for many years discourages further exploration for oil simply because much of the profits on new oil production would be taxed away….

Lower production by American companies would cause a rise in the world price of oil. Moreover, increased production by other countries would tend to offset reduced production by the United States, so that the effect on global warming and global pollution is likely to be modest. However, the increase in wealth transferred from the United States to the Middle East, Russia, Venezuela, and other oil-producing countries could be substantial.

Posner (the tax lawyer) agrees, but adds that a tax should be levied instead on its use, mainly for environmental protection reasons:

But given the high price of oil, increasing our oil production will increase total world production rather than just substitute for foreign production. So there will be more tanker spills and more carbon emissions if offshore and Alaska drilling is allowed, since the supply of oil will be greater….

The problems created by an increased supply of oil can be minimized by an increase in the federal gasoline tax … calibrated to prevent gasoline prices from declining as a consequence of increased production of oil and hence increased supply.

A gasoline or carbon-emissions tax must not be confused with a tax on the profits of oil companies, which, because of the uncertainties involved in exploring for oil, will, as Becker points out, reduce the incentive to find and exploit new domestic oil fields. (In contrast, a heavy tax on gasoline will increase the incentive to find energy substitutes for oil.) In addition, imposing excess profits taxes sends a bad signal to the business community: that success will be penalized.

All throughout, a good and thorough discussion. I encourage you to read their entire post. In addition, I would like to add my own thoughts.

Perhaps there should also be a mechanism to distinguish oil use for industrial and public use vis-a-vis individual private use. Industrial use that benefits a lot of people has a more attractive cost-benefit ratio than private use i.e. for private vehicles, homes, etc. I think more tax should be levied for the latter's use.

By industrial use, I mean oil’s use by business and economic entities that produce goods for the local economy and generate jobs for the local communities. Many of these businesses are already hurting from the high price of oil, and increasing this cost further by taxation will only further erode their business profitability and viability. Given that the economy is already weak at this point, losing additional businesses to bankruptcy through higher taxation will only put more people out of work, and further deteriorate the economic environment.

The continuous increase in oil price can and should be contained by demand destruction. But, in my opinion, destroyed demand should come from low to no value-added use, such as that for private conveniences. It should not come from productive initiatives, especially not from those that support an already floundering economy.

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