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Newsom Wants a Windfall Tax on Oil Profits. Ask Jimmy Carter How It Worked for Him.

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Gov. Gavin Newsom has called a special legislative session asking lawmakers to “deter price gouging by oil companies ..." (AP Photo/Nam Y. Huh)
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Gov. Gavin Newsom has more in common with former President Jimmy Carter than trademark hair and a toothy smile. Apparently, their understanding of economics and the energy market is equally poor. They both foolishly believe that financially punishing oil companies will ease consumers’ pain at the pump.

In what was an obvious effort to draw public attention away from decades of policy failure, Newsom began vilifying the oil industry a couple of months ago when he told Californians that “oil companies are ripping you off” and making “record profits” “at your expense.”

“I’m calling for a NEW windfall tax exclusively on oil companies,” Newsom tweeted in late September. “If they won’t lower their prices we will do it for them.

“The $$ will go directly back to you.”

Portrait of Kerry Jackson, a fellow with the Center for California Reform at the Pacific Research Institute

Kerry Jackson

Opinion

On Wednesday, Newsom issued a proclamation calling a special legislative session, asking lawmakers to “deter price gouging by oil companies by imposing a financial penalty on excessive margins” and empower state bureaucrats to “more closely review and evaluate costs, profits, and pricing” in oil production. He has yet to release any specific legislative proposals as of this writing.

Apparently, there are no economics refresher courses required to govern California. If there were, Newsom would know that higher prices are indications of scarcity, not corporate money-grubbing.

Maybe Newsom’s threat is nothing more than the “politicization of this issue,” as one refiner put it, and will go away in time. But there’s no doubt that the heat is stoked by an ignorance of – or indifference to – basic economics coupled with the hubris of elected office.

And there might even be some spite mixed in.

“Since taxing something more means a provider of goods and services to others keeps less of the value they create for others,” says Pepperdine University economist Gary Galles, “it is hard to see any way other than rhetorical misrepresentation that would make prices lower for consumers as a result of increased taxes. This seems more like government saying, ‘I will hurt you even more if you don’t comply with my demand to scapegoat you as causing what I have done’ to oil companies.”

The inescapable consequence of hiking corporate taxes is the increase in the cost of doing business that follows. (In a state where the cost of doing business is already punitive, it’s drop-dead foolish to crank up the pain.) Higher taxes will leave companies with two options: operate with smaller profits, or pass on higher costs to customers, which is almost a given because the demand for motor fuels tends to be inelastic – gasoline is almost as important as groceries in a modern economy.

Could be that Newsom is bluffing, hoping that in response to his threat oil companies will lower prices to avoid paying more to the government. If so, he’s again demonstrating a fundamental misunderstanding of economics. Even when passing on their tax burdens, companies can’t set prices at whatever levels they wish. This can happen only in monopolies, which exist only when the government erects barriers to entry. Businesses are bound by markets, their actions often determined in advance by the laws of economics.

History recalls that Congress passed Jimmy Carter’s windfall profits tax on oil companies in 1980, and the result was a ugly mess: domestic production fell, America’s reliance on imports increased, and revenues landed far short of projections. The law was eventually scrapped, but not before it had done eight years’ worth of damage.

If we were playing a board game, we’d find that the real villain behind California’s steep gas prices – a gallon of regular is almost $1.45 higher than the national average – sits in the State Capitol.

“​​California refineries,” says the Institute for Energy Research, “have been closing due to an onerous regulatory environment” as well as “rich inducements to switch to biofuels.” Newsom’s severely restrictive COVID lockdowns are yet another factor. When demand fell because driving decreased, there was a corresponding drop in refinery output, which has not returned to previous levels, and might not ever, since Newsom and other politicians have made it clear they want to put fossil fuel companies out of business.

Come Monday, lawmakers will gather in Sacramento to be sworn in and convene the special session. Not much else will happen until January, which is fortunate. That will give legislators an entire month to better understand the negative effects of windfall profits taxes.

About the Author

Kerry Jackson is a fellow with the Center for California Reform at the Pacific Research Institute.