On June 10, while visiting Los Angeles, President Biden pointed at big energy companies as the culprits for rising gasoline prices. He lambasted the industry by claiming they would rather use their record profits to buy back stock than to drill for oil. He also pressured domestic companies to ramp up production while simultaneously threatening them with a windfall profits tax. Pressure ramped up again on June 14 with a series of letters by the president to various companies asking for concrete solutions to increase supply.
Contrary to Biden’s claim that the industry isn’t developing domestic leases, some oil and gas companies are planning to boost output in the Permian Basin alone by 25 percent this year, while expanding refining capacity by 250,000 barrels per day. That’s equivalent to building a medium-sized refinery. Other major and independent domestic oil companies are also planning to boost production. But this won’t happen overnight, especially in a regulatory and policy environment that remains basically hostile to fossil fuels.
Recent examples include the curtailment of new leases for drilling; regulatory and legal obstacles for new pipeline development; increased mandates for ethanol blending; and environmental, social, and corporate governance (ESG) regulations designed to discourage new financing of fossil fuel projects. In addition, oil and gas companies face the same supply-chain constraints and rising costs as other industries.
Against this backdrop, on June 14, Senate Finance Committee Chair Ron Wyden (D-Ore.) announced he would soon introduce legislation setting a 21 percent surtax on the excess profits of oil and gas companies with more than $1 billion in annual revenue and use those revenues to provide a gasoline subsidy for American consumers. Proponents of the tax allege it’s time for the industry to pay its fair share of the nation’s tax bill. What’s more, argue supporters, the current windfall is the result of geopolitical events — e.g., Russia’s war in Ukraine — and not an outcome of strategic company investment decisions.
Those advocating for a windfall profits tax need to take a hard look at economic and fiscal realities. Forgotten in the debate is the fact that the oil and gas industry already contributes mightily to federal and state coffers. Prior to the pandemic, the industry paid $160 million in federal corporate income taxes along with another $4.2 billion in royalties from production on federal lands. That represented 19.3 percent of net income, compared to 10.6 percent on average for all industries. What is more, in some states the energy industry is the single largest taxpayer. For example, oil and gas companies paid $15.8 billion in state and local taxes and royalties to the state of Texas in 2021.
Here are some more inconvenient facts. In 2021, U.S. energy firms were the 10th most profitable sector of the U.S. economy out of 11, according to S&P Global IQ. Energy firms listed in the S&P 500 stock index posted an 8.3 percent profit margin in 2021. That was below the median for all 11 sectors, which was 10.6 percent. Furthermore, prior to the recent run-up in oil prices, the average net profit for oil and gas drilling was only 4.7 percent. In short, high profits are an exception, not the rule, for the oil and gas industry.
In practice, imposing a tax on the earnings of energy companies likely would backfire, leading to less — not more — oil and gas production.
This was the case after enactment of the Crude Oil Windfall Profit Tax Act in 1980 (U.S. Public Law 96-223), under the Jimmy Carter administration, in response to the OPEC oil embargo and the Iranian Revolution of the previous decade that led to sharply higher gasoline prices and growing profits for domestic and international oil companies. It went into effect at a time when the American economy was on the verge of a recession — much like today — and the law’s implementation was expensive and revenues proved to be well below expectations. Domestic production dropped from 8.7 million barrels per day in 1980 to 7.5 million barrels per day in 1988, proving that if you want less of something, tax it! The tax was repealed in 1988, by which time oil imports had risen by almost 1 million barrels per day.
After focusing for more than a decade on the need to reduce carbon emissions, we now face a new paradigm as the war in Ukraine has returned energy security to center stage. Though still pushing renewable energy and electric vehicles, Biden says he wants more domestic oil production while consumers and businesses are demanding lower energy prices. A revived windfall profits tax won’t get us there. Instead, it likely would raise prices, increase our reliance on imports, and do nothing to stimulate more domestic production. If the past is prologue, it will actually diminish America’s energy security.
Bernard L. Weinstein is emeritus professor of applied economics at the University of North Texas, former associate director of the Maguire Energy Institute at Southern Methodist University, and a fellow of Goodenough College, London.