Normative Economics ~ Weighing-in On the Windfall Profits Debate

Politicians all want to do something for the economy in the worst way, and they usually do. Why?  They do so either because they want to get elected, get reelected, or make money for themselves and their friends. 

Perhaps a better title for this posting would be, Normative vs. Positive Economics ~ Why Politicians Aren’t Always the Best Deciders. But, because the windfall profits tax is a hot blog topic lately, I figured I’d get more hits on it with the title I chose.

Most economists, including those of us who, as teachers, just dabble at the edges of this “dismal science“, question the wisdom of imposing a windfall profits tax on big oil. We all teach that, ceteris paribus, when governments raise taxes on producers, much of that increased cost of production is simply passed-on to consumers. But if economics is only useful in the study of how things are (positive economics), then it truly is a dismal science. Fortunately, economics also involves consideration of the way things should be (normative economics).

Most Democrats in Congress, and the presumptive nominee of the Democratic Party for President, responding to the country’s desire for change, think that a windfall profits tax on big oil would be a “fair and reasonable” way to ease the pain and anxiety that Americans are feeling over rising fuel costs. They tend to believe that democracy should deliver the basics of life for all working Americans — normative economics.  Republicans, who are more resistant to change, tend to be more pragmatic. They believe in classic economics which teaches that government should get out of the way and let market forces do what they do — positive economics. 

I don’t recall for sure who said it first, but it certainly seems to be true: Politicians all want to do something for the economy in the worst way, and they usually do. Why?  They want to do so either so they can get elected, get reelected, or so they can make money for themselves and their friends. 

Here’s an interesting quote from the latest Sierra magazine: “Let us rid ourselves of the fiction that low oil prices are somehow good for the United States.” Who said this?  Then representative Dick Cheney in 1986 said this as he introduced a bill before Congress to impose a tax on imported oil. Gee – that was smart.

President Jimmy Carter, who has taken an awful lot of flak over the years from Republicans for the economic problems that persisted during his administration, may just be the exception to the rule for politicians. As President, responding to OPEC’s orchestrated reduction of output to punish the west for its support of Israel during the Yum Kippur War, Carter created the Depart- ment of Energy and established a national energy policy aimed at reducing our dependence on foreign oil. By personal example, he encouraged Americans to cut back on energy consumption and he removed price controls from domestic petroleum production.  As imports and oil company profits later began to grow, he tried a windfall profits tax anticipating big revenues. Instead, tax revenues declined and domestic oil production plummeted by an estimated 795 million barrels. So, we’ve been down this road before.

I personally believe that Carter was acting on the best advice of the economic advisors who had his ear at the time, and that he acted in the best interests of the nation as a whole. But one would think that we’d have learned our lesson by now.

Try as I may, I fail to find much convincing argument on the Internet currently to support Barack Obama’s pledge to impose a windfall profits tax on big oil. To the contrary, the blogosphere is filled with augments against it (good work McCain supporters). But Obama’s opponent this year isn’t making much economic sense either by advocating a federal gas tax holiday. So, why are they both making these kinds of promises? They are doing so because these things resonate with the voters, and the voters are very much in a populist mood this year. Only 47 percent of Americans are against nationalizing our oil companies, which most other nations have already done, oil being such a basic commodity to the livlihood and social welfare of a nation’s people.

A June 14th Rasmussen Report poll found that only 36 percent of voters believe that a windfall profits tax on big oil would cause fuel prices to go up. The rest, less 23 percent who said that they were not sure, said that prices would either go down or that they would stay the same. So, while the tax idea may be a loser in terms of offering a near-term solution to higher prices, it’s not necessary a looser politically, unless McCain supporters can successfully educate voters to the contrary before November.  Nor is the tax necessarily a looser in terms of contributing to a long-term solution. The same Rasmussen Report poll found that 76 percent of Americans believe that new energy technology developments are more likely to solve the problem than anything else, and the majority polled said that, given sufficient investment, private industry would be far more likely to succeed at this than government research programs.

Okay, you say, but you don’t believe in polls. Well, I do. I believe that, collectively, Americans are not dumb. It’s called, government of, by and for the people, not just for stockholders, but for people who must borrow from Peter to pay Paul on a monthly basis just to keep food on the table and their kids in school.

Now we get into the arguments about whether big oil’s profits are truly excessive and whether big oil is or is not already investing substantially in alternative energy technologies.

Exxon Mobil, the world’s largest oil company, reported last quarter a profit of $10.9 billion, up 17 percent from a year before. It was the second-most-lucrative quarter in the company’s history, after the record $11.7 billion pocketed in the previous three months. Chevron reported profit of $5.2 billion, up almost 10 percent from a year earlier. Europe’s Royal Dutch Shell said its quarterly profit jumped 25 percent to a record $9.1 billion, while British Petroleum said its profit soared 63 percent to a record $7.6 billion. Earlier, ConocoPhillips said its profit rose 17 percent to $4.1 billion, and Occidental Petroleum said its profit climbed 50 percent to a record $1.8 billion. But, is any of this excessive? What is a fair and reasonable profit? Should government ever set limits on how successful corporations can be in terms of profit, and should we not be able to compel businesses, by legislation, to act responsibly?  All these questions are in the realm of normative economics, so the answers tend to be subjective. 

Most of us would agree that 10 percent profit is fair and reason- able… but twice that much – seven times that much, especially when the average Joe can’t afford enough gas to just commute back and forth to work? Forget about that summer trip this year, kids. No wonder Americans are outraged. Even John McCain is outraged. On May 5, while campaigning in North Carolina, McCain said that he was willing to consider the windfall profits tax too. “I don’t like obscene profits being made anywhere,” McCain said, “I’d be glad to look not just at the windfall profits tax, that’s not what bothers me, but we should look at any incentives that we are giving to people – or industries or corporations – that are distorting the markets.”

On the score card for investments in alternative energy tech- nologies by U.S. oil companies, it seems to me that the picture is more objective. Speaking at a Houston energy conference last year, Exxon Mobil chairman and CEO Rex Tillerson said, “I don’t know much about farming, I’m not an expert on biofuels, and there’s not a lot of technology I can add to moonshine. There is really nothing we can bring to that whole issue. We don’t see a direct role for ourselves with today’s technology.” Obviously, he and the second largest corporation in the world after WalMart, are more interested in near term profits than into long term sustain- ability. Long term? Hey, that’s my grandkids we’re talking about now!

During their press conference last month, the founding family and self-billed longest continuous shareholders of Exxon Mobil, the Rockefellers, said that they think the oil giant should be investing more in clean energy — and that separating the chairman and CEO functions may put the company in a better position to face challenges in the future. Exxon Mobil’s competitors, they pointed out, like British Petroleum, Royal Dutch Shell, Conoco Phillips, and Chevron, have collectively invested billions of dollars in recent years in renewable, low carbon technology research to reduce emissions and integrate the cost of carbon into strategic planning and investments. But half of these companies are foreign, government-owned companies. So, no, I do not think that U.S. oil companies are adequately committed to the long term, best interests of the American people. They are concerned first and foremost about near term profit for their shareholders.

The problem of high fuel prices is basically an issue of supply and demand. The high and ever-growing global demand for oil and its limited supply, coupled with market uncertainty over the stability of its supply, is raising the price per barrel. At the same time, profit expectations of oil company stockholders stoke each company’s drive to seek ever higher profit margins. Obviously, these two factors are in tension. If economic theory holds, in time the market will find an equilibrium that suits both the consumer and the investor. But this begs the question:  will it happen soon enough?  As John Maynard Keynes said, “In the long run we are all dead.”

Fuel prices are less in the United States than they are in most of the rest of the world. However, Americans don’t care. Our economy and our standards of living, for as long as any of us can remember, have been based on the false assumptions of an unlimited and uninterrupted supply of oil. We complain about volatile prices for gas and diesel at the pump while, at the same time, we demand that our investments turn a profit.

A windfall profits tax, if implemented properly with incentives built-in to increase investment in capital to include new energy technologies, might help to regulate market volatility felt at the pump. But let me emphasize the underlined word, might; big oil moguls and large shareholders could just decide, as they have in the past, to just take their money and run. I’m sorry Barack, but I must conclude that it’s highly unlikely that a windfall profits tax will raise much revenue or ever bring prices down. To bring prices down, we must do some combination of the fallowing: reduce world demand for oil; restore the value of our dollar by reducing debt and the foreign exchange deficit; reduce or eliminate market anxieties concerning the flow of oil out of the Persian Gulf; and develop sustainable alternatives for it.

I invite your comments to this posting, whether pro or con.

Published in: on June 21, 2008 at 5:29 pm  Comments (6)  

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6 CommentsLeave a comment

  1. Whew! Kent, you have given us quite a bit to think about. But really, to put in my two cents worth, the best way to perhaps bring down the cost of fuel is to decrease our dependency on oil. There are ways we could do this: Make sure our airlines travel with a full load, stop wasting so much fuel on Nascar racing, walk more or stop making so many unnecessary trips by car. carpooling (for work and shopping), upgrade our railroads and reintroduce rail travel, and for goodness sake, stop using those plastic bags at the supermarkets & other stores. We need a department at the federal level to list all the ways we use oil responsibly. We need more fuel efficiency autos. And another thing, why are we in such a hurry to reach out destination?

    Of course, none of the above will happen overnight, so each of us must find ways to decrease our gasoline usage. One of the things we can do is to challenge ourselves. I donno know if any of this will work but it is worth a try. If anyone has any suggestions, I would welcome hearing them.

  2. Thank you, Nancy. I agree with everything you’ve said except one thing. I don’t think we need a new government agency to tell us how we’re wasting this precious resource — we’ve already got the Commerce Department and the Environmental Protection Agency. We just need an administration that will let them do their jobs.

  3. Kent, this was an interesting read. I agree the windfall profits tax will not fix anything. I do not think we have any choice but to explore alternative fuels and drill in the places all the environmentalists object to. My understanding is we can drill without disturbing the environment too much so not sure why all the objections. The environmentalists need to address all the natural gas drilling that is using up the water and ruining the roads with heavy equipment. All due respect to Nancy Coleman but all we need is another federal dept–I don’t think so!!!!!!!!!!

  4. Let us not forget that 76% of all “windfall profits” are put back into research and development. This is America and I firmly believe that energy solutions will come from entrepreneurs in this country motivated by profit even dare I say “windfall profits” not by Gov taxation or regulation. If the Gov gets their hands on this what is to stop them from getting their hands on “windfall profits” from corn which is on the rise and how does this solve the real problem which is alternative fuel sources? Companies are in oil to turn a profit and why shouldn’t they be. If these profits are taxed where is the motivation to make it cleaner or better? You can Nationalize oil which the Democrats and Obama are leaning toward but then that paves the way for us to follow the way of Socialism and do what China and Chavez have already done not a good idea in my book.

  5. I fully understand your argument, Douglas. Further, as an economics teacher I’m not entirely comfortable with the idea of imposing a windfall profits tax on big oil either. But government, in my opinion, has allowed big oil in this country to get too big. As privately-held corporations, there is now scant competition again; they’re acting as an oligolopoly. Further, I suspect your 76% figure is way out of line with what oil companies and Exxon/Mobile in particular are doing with their “after tax” revenues. Please get back to us with a source for your information.

  6. Politicians are catering to voters this year so any quick fix schemes are going to be questionable and most likely backfire. They seem to think that taxing windfall profits will gain a lot of votes and probably will, also they are saying that “yes we need to open up more drilling in Alaska and off shore places around our nation”..there again it is a useless quick fix for the voters and of course once they are elected they probably won’t do it anyway lol…The truth is and it has been said many times in the news we need refineries and as for more drilling what good would it do us if we added another zillion barrels a day from excessive drilling at the expense of our national forests…BECAUSE every barrel of oil produced in the USA will be a GLOBAL COMMODITY that means it will be sold mostly to Asian markets right now at high profits and very little if any oil produced in Alaska ever goes into a gallon of American gas why? because it can be sold at $143 a barrel to other countries (wow you say surely not) YES it is true even if we did have new refineries being built right now it would still be producing gas bought at the highest rate available from oil…so every time you hear politicians say yes lets DRILL DRILL DRILL then you are listening to LIE LIE LIE lol …Drilling new wells will NOT MAKE YOUR GAS ANY CHEAPER but only make the oil companies more richer lol..You see the government leases the land for peanuts to the oil companies so they can drill for oil but the oil once it reaches their barrels becomes a global commodity which means it don’t belong to the tax payer who really owns the land it is being taking out of.
    If our government took oil that was drilled on tax payer property and sold it to refineries in the USA And produced gasoline for the American working man then maybe gas would be cheaper but that’s not how things are done here…to many toes would have to be stepped on and seeing as how a whole crapload Of our leaders are on some kind of oil board or oil interest well they aint messing around with their bread and butter “aint going to happen” right now oil companies could spend a few billion here and there building new refineries and still have 4 or 5 billion left over to shoot a game of pool with but why should they..well they don’t have to they don’t have a shortage of oil and they are making money hand over fist and the share holders are making it hand over fist so why waste a billion or 2 here or there so that the average man can fill up his truck with $2 gallon of gas ..Our own government could have built refineries and let them be run by private companies to keep cost down and keep gas plentiful and cheap god knows they have wasted billions and zillions of dollars on other wasteful projects that don’t help us or do any good at all but that would also mess up the big feeding trough…Right now as things are the oil companies are not really making a fuss …But we are and ..what we are going to do is ruin what’s left of our oil supplies on a pipe dream of cheap gas.. So let them DRILL DRILL DRILL and when you see our gas prices..higher ..higher ..higher..then you can say well dammm we got drilled in the rear end again lol
    Anyway check this out and pass it around:

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