A Tax on Oil Profits That Would Be ‘Efficient and Progressive:’ Analysis

Even though gasoline prices have come down slightly in the last few days, they remain quite high by historical standards and Democrats headed into what could be a tough election this fall are looking for ways to ease the pain at the pump.

As we told you last week, one of the options Democrats are discussing is a special tax on windfall profits earned by the major oil firms, with the revenues being used to provide refunds to low- and middle-income consumers. But economist Thornton Matheson of the Urban-Brookings Tax Policy Center says that lawmakers should be careful as they approach this idea.

Structured the wrong way, a tax on “excess” oil profits could backfire, reducing output and raising prices as companies attempt to pass along their higher costs. Matheson argues that the proposals from Sen. Sheldon Whitehouse (D-RI) – which would impose a tax of 50% on the price of oil sold by large producers above its 2015-2019 average – and Rep. Peter De Fazio (D-OR) – which would impose a 50% tax on excess earnings relative to a 2014 to 2019 baseline – run the risk of distorting the oil market while failing to achieve the goal of lower costs for consumers.

Instead, Matheson says that an oil tax should focus on the corporations and partnerships that produce petroleum and typically see ballooning profits when prices suddenly rise – and are overwhelmingly owned by upper-income households. Those excess profits are a kind of rent, Matheson says, which can be taxed efficiently without affecting output or prices. A natural resource rent tax, which has been deployed in oil-producing nations such as Norway and the United Kingdom, applies a special higher rate on elevated profits while leaving depreciation schedules in place, allowing producers to claim full deductions for the cost of their investments.

At the same time, the U.S. provides roughly $3.5 billion in subsidies for fossil fuel producers, which have not been shown to increase output and could be safely eliminated. “Instead of subsidizing petroleum profits, Congress could introduce a permanent petroleum profit surtax to raise revenue in an efficient and progressive manner,” Matheson says.

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