United Nations chief Antonio Guterres says profits by oil companies are immoral and governments should institute windfall taxes. “This grotesque greed is punishing the poorest and most vulnerable people while destroying our only common home,” Guterres said.
Guterres does not understand common sense economic policy.
This should be clear from a cursory examination of his political record. Guterres, after all, is a career politician from Portugal, where he is a member of that country’s Socialist Party. Serving as prime minister from 1995, he resigned in 2002 after his party suffered stunning defeats in local elections. Portuguese voters were unhappy with poor economic growth. Indeed, Portugal’s per capita income is less than half that of the United States. In fact, Portugal’s per capita income is lower than Italy’s, the oft-noted sick man economy of Europe.
So a former prime minister of a poor European country has started to swim in the swirling waters of tax policy.
What Guterres and so many left-wing leaders fail to understand is that raising taxes on businesses reduces investment in future supply. Guterres does not connect the dots. He screams for a windfall profits tax. If he were to achieve his goal, in time, the world would again be in deficit with regard to the global supply/demand balance. Global oil prices would rise. Guterres would scream, “It’s not my fault.” Still, the global economy would suffer because of high energy prices. Some countries would ration demand. A negative feedback loop would be created. Guterres and other socialists like Sen. Bernie Sanders (I-VT) would blame the market.
For over two decades, economists have been studying the effects of windfall profits taxes.
To show the problems with a windfall profits tax, consider the most basic questions of investing: risk and reward. For an investor to make a risky investment, they need a higher expected reward. Energy is a high-risk sector. Even before the pandemic, energy was the most volatile sector of the stock market in the 2010s. And when the pandemic arrived, more than 100 oil companies went bankrupt, and the major producers significantly rolled back their operations.
The COVID-19 shock made oil companies more hesitant about major capital spending. During the pandemic, oil prices went below zero. Producers could not give oil away. Today, producers remember a lesson of the lockdowns: be prudent with capital investment.
If government shrugs its shoulders when oil companies lose money because of low prices but imposes taxes when prices are high, the risk for oil investment will be higher. Businesses will demand higher returns for higher risk. That is economics 101.
But let’s contemplate a little history.
In 1980, President Jimmy Carter introduced a windfall profits tax. The tax reduced domestic production and increased reliance on imports. A Congressional Research Service paper found that the tax reduced domestic oil production by between 1.2% and 8.0% and increased reliance on foreign oil by between 3% and 13% between 1980 and 1988 (when the tax was eventually repealed). A 2018 paper in the American Economic Journal found that the tax reduced domestic production, largely by reducing the total output of wells already in operation. The paper noted that such a tax could not be modeled as simply a tax capturing the rents (in layman’s terms, excess profits) of oil producers but rather would reduce incentives to produce at the margin.
Today, U.S. oil producers are slowly expanding production. Prior to the pandemic, U.S. daily oil production hit 13 million barrels a day, up from 5 million barrels in 2005, just as the shale oil revolution transformed the global oil market. The U.S. became the swing producer. OPEC was hobbled. At the moment, U.S. production is up to 12 million barrels a day. If the U.S. benchmark price of West Texas Intermediate remains elevated above $80 a barrel, currently WTI is at $91 a barrel, then U.S. production will continue to increase. With high prices and patience, the U.S. will again be the swing producer.
Ignore Guterres and other socialists; let the market work its magic and deliver shared prosperity for all.
James Rogan is a former foreign service officer who later worked in finance and law for 30 years. He writes a daily note on finance and the economy, politics, sociology, and criminal justice.
