Imposing a New Tax on Energy Producers Will Not Lower Gas Prices

Consumers nationwide are feeling a hit to their wallets thanks to surging energy prices. Due to extreme volatility in the per-barrel price of oil and the subsequent spike in gas prices (reaching an average of $4.32 per gallon), it's no surprise this kitchen table issue has attracted the attention of policymakers in Washington. Unfortunately, some lawmakers are proposing a disastrous new tax hike on American oil producers that would lead to higher consumer prices. Congress should bring forth policy solutions that will broadly lower prices instead of putting energy producers in the crosshairs of dangerous tax policy that would hurt, not help American families. Americans need relief, not more burdensome tax and regulatory policy out of Washington.

Despite the implementation of numerous policies that have hindered American fossil fuel production from the Biden administration, some members of Congress think this important sector that powers the American economy isn’t beaten down enough. Last week, Senator Sheldon Whitehouse (D-RI) and eleven additional Senators filed legislation to impose a windfall profits tax on oil companies that produce or import at least 300,0000 barrels of oil per day. If enacted, these companies would pay a “per-barrel tax equal to 50 percent of the difference between the current price of a barrel of oil and the pre-pandemic average price per barrel between 2015 and 2019.” Any revenue raised from this tax would be distributed via a quarterly rebate to individuals with an annual salary below $75,000. According to information provided by Sen. Whitehouse’s website, such a tax would generate about $45 billion per year.

The sponsors of this misguided legislation claim it’s needed in order to “curb” the profiteering of big oil who are raking in record profits by “price gouging” consumers. Of course, this is wholly inaccurate. Oil and gas prices are set by free market forces of supply and demand, and if there is an imbalance between these two factors the price will either rise or fall. In this real world example, due to strong economic growth there is increased demand for oil, but on the supply side, foreign conflicts and stagnant domestic production have limited the amount of oil in the global marketplace. According to Economics 101, when demand exceeds supply there is always an inevitable increase in prices. Ultimately, there is little the federal government can do that would meaningfully lower energy prices in the short-term. Over time, producers and consumers will adjust their behavior to lower prices: either consuming less oil or producers expanding the oil supply.

It is for this reason that a substantial tax on oil producers is a disastrous idea. As the old adage goes: “when you tax something, you get less of it.” In this case, imposing an additional targeted tax on oil, the main ingredient for gasoline, you will get less oil production. Less oil production will hamper the future production of gasoline and ultimately lead to higher gas prices down the road. It’s also likely that producers will pass along a portion of this tax burden onto consumers through the form of higher prices.

Research from the eight years (1980-1988) a windfall profits tax was in effect shows it can significantly affect our economy. The Congressional Research Service notes in a comprehensive report from 2006 that the tax was widely considered unsuccessful, and if reinstated, would have “several adverse economic effects” such as reduced return on capital investments within the energy sector, increased foreign oil imports, reduced production of oil, and higher consumer prices over the long run. For the reasons described below, the tax was repealed by the Omnibus Foreign Trade and Competitiveness Act of 1988:

  • Failed to generate anticipated revenue. During its tenure, the tax generated gross revenue of about $80 billion, or 80 percent less than the projected amount of $393 billion.

  • Hurt domestic producers. When in effect, the tax reduced domestic oil production from between 320 million barrels (1.2% of domestic production) and 1.27 billion barrels (4.8% of domestic production). This resulted in an increase of oil imports to the United States.

  • Distorted business decisions. “Since the tax was imposed on oil production, extraction was penalized and other aspects of the business (refining and marketing, the downstream operations) became relatively favored. Thus it created financial incentives to shift resources from exploration and drilling to refining and marketing.”

  • Administrative headaches. A 1984 General Accounting Office report called the windfall profits tax “perhaps the largest and most complex tax ever levied on a U.S. industry.”

In the years after its repeal, NTU has always strongly advised against efforts to reinstate this poorly crafted tax. In fact, at NTU’s office, we have a framed letter signed by 250 economists sent to Congress urging against the adoption of such a tax. As written in that letter “if it is enacted again, a windfall profits tax can be predicted to result in a diminution of domestic energy production, an increase in American dependence on foreign oil, and a reduction in the overall supplies available to consumers.” 

These economists are right. While data is murky on the short-term impacts of a windfall profits tax, it is certainly likely to lead to price increases over the long term. Since the tax would reduce the incentive to sell oil, it would ultimately hamper capital investments today into oil exploration and extraction projects. So, in effect, a tax on profits today will lead to less exploration, less drilling, and less oil in the future. Since this tax is aimed at corporate drillers and importers, the consequences are likely to be felt all the way through the supply chain and on consumers. 

The senators supporting this tax also ignore the basics of tax policy. Since high prices will ultimately lead to greater corporate profits, much of this “windfall” will eventually find its way into government coffers; the more corporate profit the companies earn, the more corporate income tax they pay. 

Enacting a windfall profits tax would just be the latest assault on American energy producers from each end of Pennsylvania Avenue. At the White House, President Biden canceled the Keystone XL Pipeline, suspended oil and gas leases in Alaska, delayed the issuance of new leases, nominated anti-fossil fuel officials, and may be in the process of raising drilling rates. Down the street in Congress, they’ve advanced legislation to soak drillers with higher taxes, new fees, and even more restrictions on producing energy. No doubt, this blatant hostility towards domestic energy producers increases costs on businesses, and by extension, raises prices that consumers pay. 

The best way to help consumers is to encourage more competition and allow companies to build greater production capacity. Instead of using the power of the federal government to single out unfavored energy types, lawmakers should employ an “all of the above'' strategy. Letting the market choose which types of energy to use is the fairest and most effective way to lower prices and protect jobs. The issue of energy prices is a pressing one, but raising tax burdens on energy producers that would ultimately reduce the supply of energy through a windfall profits tax is an unserious solution to a serious problem. A windfall profits tax is a tried-and-failed policy that deserves to be put in the shredder.