The Proper Take on Energy Profits

It often seems that the American public forgets that we live in a free market economy. Recent calls for taxes on 'windfall profits' demonstate just how little the average citizen understands the notion of supply and demand, well at least when it is removed from the ridiculous demand for SUVs or beanie babies. As usual, politicians sense an opportunity to spend other people's finances while currying voter support by seeking to take more than they are entitled to by changing the tax rules in the middle of the game. No one seemed to cry for oil companies when oil profits were in the dumpster in the 1990s. It's positively perplexing that people expect innovation to take place while simultaneously limiting the amount of profit after taxes that could then be used for that very purpose.

In today's Wall Street Journal, the editors do a nice job explaining why mucking around with profits is not just bad business, but bad in the long run as well. Here are some highlights:

Back when Jimmy Carter signed the windfall profits tax during the last oil crisis, the results were the opposite of what the politicians intended. The first adverse result, as recently documented by the Congressional Research Service, was that oil companies reduced their U.S. domestic production by 1.5 million barrels a day, or by almost 6%. Exploration for new supplies slowed because the tax, by design, snatched as much as a third of the profit from these investments.

The supertaxers claim oil companies are immorally profiting from the Katrina natural disaster and the global inflation in oil prices. But if governments make it illegal to make money from reserves when oil markets are squeezed, companies won't have the financial incentive to hold oil in reserve in the first place, and consumers will find themselves in even greater misery in the next supply shock. Where is the morality in that? What better serves consumers: the service station that has no gas at $2 a gallon, or the station with full tanks but which charges $3.19?

As recently as the late 1990s, oil prices fell below $20 a barrel. The "windfall profits" in boom years offset the down years in much the same way that restaurants make "windfall" profits on busy Saturday nights. Many Americans are selling their homes in this hot real estate market for two or three times what they paid for them. Does [Congress] want to slap a windfall profits tax on home sales?

A new report from the Tax Foundation finds that the biggest profiteers from oil aren't the companies that produce and deliver it to gas tanks, but are the federal and state governments that tax it. Between 1977 and 2004, total taxes on gasoline sales have been $1.34 trillion (thanks to average taxes at the pump of about 40 cents a gallon), or more than double the $640 billion of oil company profits -- and that's not including the taxes the companies also paid on their profits.

In Washington of late, the term profit has become synonymous with "greed." But it is the pursuit of profit that drives the technological progress that makes energy abundant and affordable -- and will drive down prices in the future, just as prices of electricity and gas have fallen throughout most of the last century.

If Americans want reliable supplies of oil and lower gas prices, they had better hope oil companies aren't prohibited from making money selling it. There's an estimated five trillion barrels of oil retrievable from the Earth. We can say with certainty that it will be entrepreneurs in the virtuous quest for profits, not gassy politicians or talk-show hosts, who will put that fuel in our gas tank.

Here here.