“Windfall” Taxes Not the Solution to Energy Challenges

High winter heating bills are hitting homeowners in their pocketbooks while analysts are warning motorists of $3-per-gallon gasoline next summer. At the same time, oil companies are reporting record profits amidst press accounts of low royalty payments to the government.

Everyone is taking this opportunity to make political hay. Democrats, wanting to use the issue to re-take control of Congress, call for taxing "windfall profits." Anxious Republicans press the oil companies to lower their costs. So-called consumer advocates urge increased federal oversight to end "price gouging."

Consumers should be concerned about this issue, but not because the oil companies are raking in profits. They should be concerned because of the danger that current energy prices may be used as an excuse to hike taxes and further increase energy prices. To understand why, it is helpful to examine the current situation.

There are many ways to measure the cost of energy. Since oil company profits are under attack, perhaps the best way is by looking at the price of oil. While the figures vary, the price of oil peaked in late 1979 or early 1980 at around $90 a barrel in 2005 dollars. This is compared to a price of $67.51 for a barrel of American light crude at the beginning of February 2006. Oil is cheaper today than it was 25 years ago.

Since so many of us depend on cars for transportation, gasoline might also serve as a good proxy for energy prices. In 1918, the price of a gallon of gasoline was about $3.20 in 2005 dollars. After trending downward for about 50 years, the price spiked again in 1981 at just under $3.00. This means that the recent price of gasoline didn't surpass the 1981 level until Hurricane Katrina crippled oil production and distribution along much of the Gulf Coast. Today's average price of around $2.35 is still well below the historical highs.

So while energy is not cheap today, it is still less expensive than it was 25 years ago. One reason for this is the energy industry has invested large portions of its sometimes substantial profits in technology to discover, produce, and deliver energy at ever increasing levels of efficiency.

While the reputation of profit-particularly in the energy business-has suffered lately, it has provided significant benefits to society. This is particularly true in Texas.

The Texas General Land Office reported that for fiscal year 2005, oil and gas revenues for the Permanent School Fund totaled over $345 million, up from $269 million in 2004. In the first four months of this fiscal year, approximately $142 million has been cleared, up from $98 million for the same period in 2005.

Oil and gas revenues, driven by the search for profits, help educate Texas schoolchildren, pave our roads, and provide for public safety. But while the free market has been paying for textbooks and delivering energy as efficiently as possible, poor government policies have been behind much of the increase in energy prices.

Over the last 30 years, U.S. energy and environmental policy has hindered the development of new oil and gas reserves, severely restricted new nuclear and coal-fired generation of electricity, and added significant costs to the production of gasoline by requiring additives like ethanol. Additionally, last year's energy bill poured almost $14 billion dollars of taxpayer subsidies into energy production.

It is policies like these that are driving up the price of energy because they are restricting supplies in a time of rapidly increasing global demand.

The last thing America needs to add to this mix is higher taxes on energy production-this would only further depress exploration and production. Yet this is a real possibility as many politicians are running for cover under a withering assault in the press over energy prices. Many of these are the same politicians who helped to create the problem in the first place.

To meet our future energy needs, energy companies will have to invest hundreds of billions of dollars in the coming years. The commitment to do this requires some certainty that these investments will yield future profits. While companies are used to taking business risks, the risk that profits could be confiscated should they exceed some arbitrary political comfort level reduces the possibility that necessary investments will be made. A windfall profits tax is not only unfair, it will lock Americans into years of higher energy costs.

To combat rising energy prices, we need to remove burdensome regulations that hinder domestic production and eliminate subsidies that distort consumer demand for energy products. In essence, we need to let the free market do its work. The free market, not higher taxes, will move America toward lower energy prices.

Bill Peacock is the director for the Center for Economic Freedom with the Texas Public Policy Foundation, an Austin-based research institute. He may be reached at [email protected].