Here’s a summary of some of the recent discussion about the proposal of a tax on the windfall profits of oil producers.
it may seem like a free lunch to generate revenue from these profits because there is not a whole lot that the taxed companies can do to avoid paying the tax today. But if the impacted businesses anticipate that the tax will persist or be levied again in comparable future circumstances — and why wouldn’t they? — the end result will be a less than socially optimal level of investment.
Energy Outlook notes that the specifics of the senate’s proposal raise problems beyond these traditional concerns:
The proposed change would affect the way that oil companies account for the value of their inventories for tax purposes. Most companies use the Last-In/First-Out (LIFO) method of inventory accounting. Under this system, the cost of goods sold is determined by the most recent purchases, not by cheaper product already in inventory. If the Senate version of this bill passes, any oil company with more than $1 billion in sales would have to recognize 75% of the increased inventory value between year-end 2004 and year-end 2005. If that were done based on yesterday’s closing price on the NY Mercantile Exchange, it would amount to about $10.00/barrel of additional taxable earnings for every barrel of inventory held by these companies. In aggregate, the Senate expects this to generate approximately $5 billion in extra taxes from the affected companies.
The arguments against this are different from those against a simple surtax on oil company profits, which would act as a general deterrent to investment in the industry. In some respects, this kind of back-door tax is even worse, because it increases the existing disincentives for holding commercial oil inventories, while taxing income that hasn’t yet occurred and may never, if prices fall again. Lower inventories will increase oil market volatility and translate directly into reduced flexibility in operations. The less inventory a refinery carries, the less it is able to respond to sudden changes in the market or events that affect crude oil supplies, such as hurricanes or terrorist incidents. Hammering oil companies for the unrealized appreciation of their inventories–not unlike taxing you for the market appreciation of your house, even if you have no plans to sell it–sends a negative and unhelpful signal to an industry that has already seen its inventories decline from the equivalent of 27 days of average refinery throughput in 1990 to only 19 days in 2004.
Econlog argues that a simple gasoline tax or traffic congestion tax might make more sense.