Of windfall profits and oil companies (Or, a response to Scope, Barack Obama, and Sarah Palin)

With <a href=”http://www.redstate.com/erick/2010/01/11/im-afraid-sarah-palin-might-be-ruining-herself-unintentionally/”>Erick’s well-intentioned post</a> concerning National Tea Party Convention’s legitimacy raising ire among some Palin fans and <a href=”http://www.redstate.com/mbecker908/2010/01/11/sarah-palin-is-a-fox/”>Palin’s signing up with Fox News Channel</a>, it looks like Palin season is upon us. As a result, several comments and <a href=”http://www.redstate.com/scope/2010/01/13/in-search-of-facts-concerning-gov-palins-record-in-alaska”>a diary written by Scope</a> (which I recommend that you read) have been made in support of <a href=”http://gov.state.ak.us/aces/”>Alaska’s Clear and Equitable Share (ACES)</a>, a profits tax on oil companies in Alaska passed during Palin’s tenure as governor of AK. President Obama, and many Democrats, have toyed with the idea of levying a windfall profits tax similar to the ACES scheme on oil companies in the US, and despite support for such a tax having died down since the conclusion of the Bush Administration, it is still very much favored among many on the left. To that end, I have decided to respond to all of these disparate parties supportive of a 70’s-style profits tax on oil through a critique of the ACES tax scheme. Make no mistake: ACES is a profits tax, plain and simple, and while it may not have the “windfall” prefix, it is very similar in structure to many “windfall profits” taxes, including Obama’s proposed scheme. In AK’s special case, where the <a href=”http://ltgov.alaska.gov/services/constitution.php”>Alaskan Constitution</a> entrusts mineral rights to the state, the problem isn’t so much class warfare as it is that profits taxes are both economically inefficient, and an unstable form of revenue for the government. Moreover, they can, in extreme circumstances, create perverse incentives in government. Let me explain.

First of all, there is a significant difference between economic profit and accounting profit. While accounting profit is simply what’s left over when all accounts have been payed with incoming funds, economic profits include all costs, including labor and time, as best it can. (As an aside, Investopedia has a good definition here.) For example, let’s say that you spend $20 to set up a lemonade shop, and you get $30 after two days of working the lemonade stand. Accounting profits would be $10 ($30-20=$10). Now, let’s say that you could have made $35 mowing lawns with those inputs. In that case, your economic profit is negative ($30-20-35=-25)! Why is economic profit important? There are many reasons, but for our purposes, there can only be one [insert Highlander reference here]:

Economic profit, not accounting profit, is what companies are actually getting back for their efforts, because they are inclusive of resources that aren’t strictly monetary, such as time and labor. Therefore, moralistic endeavors to get a “Clear and Equitable share”, of a company’s profits, if that is the intention, should ideally be confined only to the actual “share” in question (which is whatever oil companies’ economic profit actually is, NOT accounting profits, which are much higher than economic profit).

Besides that concern, a tax on accounting profit isn’t very efficient for government: it’s very easy to hide profits in some account or other, and even easier to move profit from the US (or AK) to more favorable areas. A tax on production, OTOH, is difficult to escape: if the oil is produced in the US (or AK), oil companies have less options to escape taxation, and monitoring becomes much easier for the government. Even if all of the enforcement issues are dealt with adequately (and in a way that is more cost-effective than enforcing a tax on production), lower profits would mean less long-term investment in the oil industry wherever this holds true.

From the government’s viewpoint, there are also problems with the stability of such an arrangement as a form of revenue for AK long-term; profits throughout any stretch of time are far more variable than production. This means that incoming revenue is also going to be erratic in nature. Also, production comprises only a small part of what is involved in the overall profit of oil companies: refining, transportation, demand, etc. play a large role in those profits, and are largely dependent on factors outside of AK. Considering that fact, it’s a bit of a stretch to say that a windfall profits tax would fall under Article VIII of AK’s Constitution, though I’m sure AKSteve, Art, or one of our legal eagles would know more about that than me. All of this culminates to create a perverse incentive, wherein legislatures seek to increase oil company profits, instead of production, to increase incoming government revenue. Though both would be somewhat amoral, as we’ve already noted, profits have less to do directly with AK than production, so it is likely that measures to increase government revenue by increasing profits would benefit AK directly less than a production tax. Moreover, some of the indirect benefits of production in AK (workers spending their money on AK goods, company investment in AK, etc.) would also be redistributed away from the state, as the result of a profits tax. In a striking irony, you’re right back where you started: with corrupt politicians working with well-meaning pols and Big Oil to enrich their own coffers, while screwing over AK’s citizens and economy.

So, what were Palin’s motivations in all of this? If you subscribe to Public Choice Theory, or if you’re a cynic, you could make the case that Palin did it for her own benefit: profits were high and in plain view (eliminating the long-term problem of enforcement), and attacking the oil companies for “price gouging” is a time-tested strategy for electoral success. Certainly, I can think of a couple of politicians who would think, “Long-term policies be damned! I’m only in office for the next couple of years; let the next sucker who gets into office figure it out!” I’d bet that a large part of Democratic support originated from that motivation, and there are probably more than a few operatives who hope to characterize whoever is in office when this tax scheme comes under strain as “fiscally irresponsible” for political points, as they did with Bush and the mortgage crisis.

On the other hand, there are plenty of cases where a politician’s good intentions lead to unanticipated results: even Reagan, when he signed the Therapeutic Abortion Act, fell victim to this penchant. If it wasn’t below Reagan to fall privy to such vices, Palin is surely not exempt from the maxim, good intentions=bad policy.

In the end, it’s unlikely that we will ever really know the truth, just as it’s probable that both motivations were at play among the AK legislature. Whatever the case, profits taxes are no better when enacted by Republicans than when suggested by Dems, and we should take note that, regardless of motivations and intent, all that we’re left with at the end of the day are the results of policy, whether good or bad.