Oil Profit Tax

Every day in the news, there’s more discussion about oil and the price of gasoline. With the upcoming election, there will certainly be lots of campaigning and discussion around this issue. The usual rhetoric of wealth distribution and trickle down economics begin making their rounds. Obama would have a taxation of the oil companies and then reallocate these funds to decrease the price of oil for poorer Americans. McCain opposes this taxation stating that this will hinder investment going forward in Oil and Gas exploration and drilling. Unfortunately, both of these plans are dangerously foolish.

 

The real issue here is oil and energy. Oil, and more broadly hydrocarbons, will remain the most influential and also detrimental factor for the world. Hydrocarbons still provide the majority of energy needs in the world today. Renewables have not found a viable option for storing energy and thus have remained only a small portion of energy production (except for dams, very few renewable sources comprise a portion of energy in the US). One of the greatest challenges humanity will face, besides global warming, will be how to move energy away from hydrocarbons and towards other sources.

 

Obama’s plan for taxing oil companies and using that money to lessen the price at the pump is at best foolish and at worst dangerous. Taxing profits of large oil companies certainly would not be in anyway viable. In many cases, oil companies will in some way pass this tax on to the consumer. McCain is correct in that this will hinder investment and in the long run increase the price of energy. With the lower profitability, companies will either pass the tax onto the consumer or lower their cost basis. Either way, the end result will be a future rise in the price of gasoline as money that would have been used for investment would be in the short run allocated to consumers by a lowering of the price of gasoline at the pump. More dangerous would be the subsidizing of a very influential commodity in the economy. By artificially depressing the price of gasoline, these taxes would hinder investment into other areas (such as renewable) by causing demand for gasoline to rise. As the general public is satisfied with gasoline, the demand for other forms of transportation and renewables technology will decline.

 

In some ways, it seems only natural that while the rest of the US suffers high gas prices, oil companies should not be making exorbitant profits. The fact, however, is that profits represent the spread between a firms inputs and their outputs. While commodity markets do not operate in the same way that a manufacturing market might, the general business concept is to turn your costs into higher revenues. Companies as economic agents fulfill this role surprisingly well. Mostly, a group of individuals could never be as efficient as a market—often times individuals destroy value in the market. If we were to take profits from oil companies and give them to the general American public, we would be artificially hindering investment and development in this market.

 

These economic agents help society quickly and safely adjust to the environment. The rise in the price of oil has helped a lot of competitors to oil develop other technologies to compete. However, given that this is a market for addicts (no one can operate without oil), there are many reasons why government intervention may be necessary. In many cases, oil companies can sell oil for whatever price since people need it to travel. At the same time, it is detrimental to divert resources into the renewables as these companies will often lose money on renewable forms of energy. The government should make a concerted and strong step towards encouraging renewable energy through research and development. At the same time, oil companies should begin pursuing diversification into other markets. Many mining companies will purchase mines containing different metals in order to insulate the company from shocks in commodity pricing. Oil will always be in demand, but going forward the prices will continue to rise and often squeeze the margins at refineries. Many oil producers would do well to begin diversifying their revenue streams while helping to develop a better market for energy.