A Call to Inaction

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Friday, November 11, 2005

THE BOSSES of the major oil companies were summoned to Congress on Wednesday and asked to justify their windfall profits. "My constituents think someone rigged the price and someone -- them -- is getting ripped off," said Sen. Pete V. Domenici, a New Mexico Republican not hitherto known as a scourge of business. The scene recalled past oil shocks, when bosses were also summoned to Capitol Hill, accused of price gouging, and then hit with price controls and special windfall taxes.

Congress would do well not to repeat those "remedies," because both turned out to be disastrous. The case against price controls is especially powerful. When oil prices spike, it is because of scarcity -- for example, scarcity caused by hurricane damage to petroleum infrastructure on the Gulf Coast. The best way to manage that scarcity is for producers to make a special effort to get oil to the market and for consumers to make a special effort to cut back. Higher prices encourage both of those responses; rather than complain of price gouging, Congress should celebrate price signals. By contrast, controlled prices create no pressure for extra production or conservation. They just create gas lines: Witness the 1970s.

A tax on windfall profits is less counterproductive but still bad. For one thing, it's not as though the profits are socially useless. Even in the absence of a special tax, they generate regular tax revenue for both federal and state governments as well as dividends for retirement plans. For another, the profits are a spur to new investment; taxing them reduces the return that companies will expect to make on new oil finds or refineries, with the result that there will be less oil and gas available in the future and hence higher prices.

Moreover, taxes on windfall profits tend to exacerbate dependence on imports, because companies generally make windfall profits only from their U.S. drilling operations; contracts for drilling foreign oil are usually structured so that the windfall from high prices is captured by the foreign government. As a result, windfall taxes penalize oil drilled in the United States. A study by the Congressional Research Service found that the last such tax imposed on the oil industry, between 1980 and 1988, reduced domestic production 3 to 6 percent and increased imports between 8 and 16 percent.

For the past two decades, the United States has enjoyed cheap oil. Companies have reacted by building no new refineries and holding back on some exploration projects; consumers have reacted by buying ever-larger homes and cars and forgetting about conservation. Now, thanks to surging demand for energy in China and India, the era of cheap oil has ended, at least for the time being. Congress should play a role in the protection of vulnerable groups from the consequences, for example, by offering refundable tax credits to low-income families that depend on heating oil. But its main policy should be to stand back and let price signals do their work.


© 2005 The Washington Post Company

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