Windfall Profits Tax: Bad Politics and Bad Policy

The reason that Ronald Reagan was such a believer in tax cuts actually went back to his time as an actor. When he was an actor, his colleagues told him to do everything he could to only make two movies per year. The reason was that if he made three he would wind up in the bigger tax bracket. Because taxes were so high in that bracket, he would wind up taking less home than if he only made two movies. Reagan was just stunned that anyone would encourage someone not to work. That's how Reagan became such a believer in tax cuts because he saw taxes as an incentive not to work.



That is what I thought of when I read analysis of Barack Obama's proposal for a windfall profits tax on oil companies. I have no use for the oil companies and I have stated my disgust toward them. That said, taxing a company more for being more successful only discourages companies for being successful. The reason everyone is in business is to maximize their profits. Now, Barack Obama is telling not just oil companies but all companies that if you are too successful you will be punished. Philosophically, that makes no sense. We want all companies to be as motivated as possible to make as much profit as possible. Imposing so called windfall profits tells companies that at some point they need to stop making money.



Beyond that, the Wall Street Journal raises an excellent point...what exactly is a windfall profit...

Mr. Obama didn't bother to define "reasonable," and neither did Dick Durbin, the second-ranking Senate Democrat, when he recently declared that "The oil companies need to know that there is a limit on how much profit they can take in this economy." Really? This extraordinary redefinition of free-market success could use some parsing.

Take Exxon Mobil, which on Thursday reported the highest quarterly profit ever and is the main target of any "windfall" tax surcharge. Yet if its profits are at record highs, its tax bills are already at record highs too. Between 2003 and 2007, Exxon paid $64.7 billion in U.S. taxes, exceeding its after-tax U.S. earnings by more than $19 billion. That sounds like a government windfall to us, but perhaps we're missing some Obama-Durbin business subtlety.

Maybe they have in mind profit margins as a percentage of sales. Yet by that standard Exxon's profits don't seem so large. Exxon's profit margin stood at 10% for 2007, which is hardly out of line with the oil and gas industry average of 8.3%, or the 8.9% for U.S. manufacturing (excluding the sputtering auto makers).

How will Barack Obama measure a so called windfall profit? Will he draw a line in the sand on a certain number? Wouldn't that merely discourage work like it did for Reagan and his colleagues? Barack Obama dismisses the number one rule of taxes. Taxes are a form of punishment. That which you want to punish you tax. By taxing windfall profits, what Barack Obama does is punish the maximization of profits. Now, I don't believe for one second that the oil companies are playing fair. Yet, the way to punish their behavior is not by taxing them.



Politically, this makes even less sense. That's because the folks want politicians to provide solutions that will lower the price of gasoline. They aren't looking for scapegoats or demons. They are looking for something, anything, that will tangibly decrease the price of gasoline. It is just that simple. In no way will taxing the oil companies even more lower the price of gasoline. In fact, it may lead to higher gas prices. This sort of demonization politics might work with other issues, but not on gas. The public is far too engaged to fall for the sort of class warfare that Barack Obama is practicing. The public is wholly unconcerned with what the oil companies make except as it relates to what they pay themselves. Unless Barack Obama can make the link between his windfall profits tax and lower gas prices, this is a failed political strategy. Giving a nebulous reference to alternative energy research, something we have been doing for decades, is not enough. The irony here is that Barack Obama is engaging in exactly the sort of political gimmicks that he accuses John McCain of engaging in. If Barack Obama insists on making windfall profits and forced conservation the centerpiece of his energy policy, he will hand that issue to McCain in the fall.