Windfall Profits? Spare Me

Lynne Kiesling

Like “price gouging”, “windfall profits” is an economic non-concept that rears its ugly head in the political machinations surrounding exogenous economic dislocations like national disasters. Senators Cantwell and Dorgan, who are sensible on some other, electricity-related, energy issues, really get it wrong here. Steve Chapman’s column on the topic points out the economic fallacy of such political machinations:

Sen. Byron Dorgan (D-N.D.), meanwhile, was outraged by the thought of giant oil companies making money merely for supplying the nation’s energy needs. He claimed they will reap $80 billion in “windfall profits” and wants the government to confiscate a large share of that sum through a special federal tax.

But the prospect of occasional “windfall” profits is one reason corporations are willing to risk their money drilling wells that may turn out to be drier than Alan Greenspan’s reading list. Take them away, and investors may decide they’d rather speculate in real estate.

Speaking of real estate, Americans seem to feel no moral compunction about getting rich from unforeseen increases in the price of another vital necessity. You think home sellers in Baton Rouge haven’t raised their asking prices in the last 10 days? You think Dorgan wants to tax their windfall?

It’s hard to see why oil companies shouldn’t make a lot of money when the commodity they provide is suddenly in short supply. After all, they are vulnerable to weak profits or even losses during times of glut. Back when Americans were enjoying abundant cheap gasoline, the joke was that the surest way to make a small fortune in the oil industry was to start with a large fortune.

Oil companies are also subject to the whims of nature. No one is holding a charity fundraiser for the businesspeople whose rigs and refineries were smashed by Katrina. No one will come to their aid if prices drop by half.

I encourage you to read the whole thing; the excerpt does not do it justice. Chapman makes the right point: in risky businesses like petroleum refining, firms risk losses when there are plentiful supplies. They try to manage production to increase their profits, but every other firm is doing the same thing. When a natural disaster strikes, it strikes the supplies of all (although not uniformly), but the profits accrue to the firms because of the scarcity, not because of some conscious choice of firms to withold production to raise prices. Thus I would go so far as to argue that a windfall profits tax is not just economically inefficient, it’s unfair and immoral.

3 thoughts on “Windfall Profits? Spare Me

  1. I’m sure Senators Dorgan and Cantwell are far less outraged at the increase in federal revenues resulting from the growth of our “sick” economy. Maybe they would consider a “windfall rebate” to those of us who are providing those additional federal revenues. Right!!!!!

  2. Um, doesn’t it just make sense to use LIFO accounting in a time when raw materials prices are volatile? The companies can’t switch because of SEC rules, so they have to report “windfall profits” based on FIFO records, at a time when they are paying through the nose for crude and have to pay overtime at their facilities to make up for the refineries that are shut down.

    I wonder if any reporters out there ever took a micro-econ class OR an accounting class? We already know that the Senate only allows lawyers who majored in poli-sci.

  3. But suppose the tax is on refined gasoline, in which extra profits accrue no matter the underlying barrel price of crude? While energy companies need to have financing to rebuild and bring their facilities back on line, the temporary (?) shortage of gas causes its price to swing to a level based on its short supply rather than an increase in demand. With a clear need for raising more than the voluntarily given $2B for Hurricane Katrina, a Windfall Profits Tax on gasoline is a responsible way to both raise the necessary funds and to steer demand towards other, less bloody and dirty sources.

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