UMD Libertarians

What Is a ‘Windfall’ Profit?

August 4, 2008

The “windfall profits” tax is back, with Barack Obama stumping again to apply it to a handful of big oil companies. Which raises a few questions: What is a “windfall” profit anyway? How does it differ from your everyday, run of the mill profit? Is it some absolute number, a matter of return on equity or sales — or does it merely depend on who earns it?

Enquiring entrepreneurs want to know. Unfortunately, Mr. Obama’s “emergency” plan, announced on Friday, doesn’t offer any clarity. To pay for “stimulus” checks of $1,000 for families and $500 for individuals, the Senator says government would take “a reasonable share” of oil company profits.

Mr. Obama didn’t bother to define “reasonable,” and neither did Dick Durbin, the second-ranking Senate Democrat, when he recently declared that “The oil companies need to know that there is a limit on how much profit they can take in this economy.” Really? This extraordinary redefinition of free-market success could use some parsing.

Take Exxon Mobil, which on Thursday reported the highest quarterly profit ever and is the main target of any “windfall” tax surcharge. Yet if its profits are at record highs, its tax bills are already at record highs too. That sounds like a government windfall to us, but perhaps we’re missing some Obama-Durbin business subtlety.

Maybe they have in mind profit margins as a percentage of sales.

If that’s what constitutes windfall profits, most of corporate America would qualify. Take aerospace or machinery — both 8.2% in 2007. Chemicals had an average margin of 12.7%. Computers: 13.7%. Electronics and appliances: 14.5%. Pharmaceuticals (18.4%) and beverages and tobacco (19.1%) round out the Census Bureau’s industry rankings. The latter two double the returns of Big Oil, though of course government has already became a tacit shareholder in Big Tobacco through the various legal settlements that guarantee a revenue stream for years to come.

In a tax bill on oil earlier this summer, no fewer than 51 Senators voted to impose a 25% windfall tax on a U.S.-based oil company whose profits grew by more than 10% in a single year and wasn’t investing enough in “renewable” energy. This suggests that a windfall is defined by profits growing too fast. No one knows where that 10% came from, besides political convenience. But if 10% is the new standard, the tech industry is going to have to rethink its growth arc. So will LG, the electronics company, which saw its profits grow by 505% in 2007. Abbott Laboratories hit 110%.

If Senator Obama is as exercised about “outrageous” profits as he says he is, he might also have to turn on a few liberal darlings. Oh, say, Berkshire Hathaway. Warren Buffett’s outfit pulled in $11 billion last year, up 29% from 2006. Its profit margin — if that’s the relevant figure — was 11.47%, which beats out the American oil majors.

Or consider Google, which earned a mere $4.2 billion but at a whopping 25.3% margin. Google earns far more from each of its sales dollars than does Exxon, but why doesn’t Mr. Obama consider its advertising-search windfall worthy of special taxation?

The fun part about this game is anyone can play. Jim Johnson, formerly of Fannie Mae and formerly a political fixer for Mr. Obama, reaped a windfall before Fannie’s multibillion-dollar accounting scandal. Bill Clinton took down as much as $15 million working as a rainmaker for billionaire financier Ron Burkle’s Yucaipa Companies. This may be the very definition of “windfall.”

General Electric profits by investing in the alternative energy technology that Mr. Obama says Congress should subsidize even more heavily than it already does. GE’s profit margin in 2007 was 10.3%, about the same as profiteering Exxon’s. Private-equity shops like Khosla Ventures and Kleiner Perkins, which recently hired Al Gore, also invest in alternative energy start-ups, though they keep their margins to themselves. We can safely assume their profits are lofty, much like those of George Soros’s investment funds.

The point isn’t that these folks (other than Mr. Clinton) have something to apologize for, or that these firms are somehow more “deserving” of windfall tax extortion than Big Oil. It is in the eye of the political beholder, who is usually looking to soak some unpopular business.

It’s what politicians do in Venezuela, not in a free country.

They didn’t used to. Chavez seized them.

Pretty different from what essentially boils down to increasing income tax on the oil industry and introducing tax incentives to invest in alternative fuel sources. Clearly its diverging from free market ideals, but at least its still operating with in that framework unlike authentic nationalization of industry.

Obama’s idea of a windfall tax against Big Oil is a knee-jerk reaction to a rise in demand. Is he willing to punish equal and worse “offenders?” I doubt it. He’s pandering to people who whine about gas prices in hopes of winning a few votes. It’s sad.
They wrote this today? They just ripped off all my posts from that oil thread yesterday, WSJ douches. Real men read the Economist.

Are you bent out of shape at the theory of the windfall tax, or only that it could easily be leveled at your company?

it’s too bad the majority of people are too fucking stupid to comprehend this.

and with the horribly elastic demand for oil, i’m sure that oil companies couldn’t pass the burden back to consumers

My company won’t be involved. I don’t like windfall taxes in general. Why restrict any aspect of a free market economy? The only time the gov’t should even consider intervening is when a monopoly is involved or if someone is cooking the books.

Same people who get freaked out because the public debt is a huge number even though as a ratio to GDP the U.S ranks around 30th in public debt behind Japan,France,Germany,Canada…. etc etc.

OMG IT IS SOOOO MUCHHHH PROFITS OMMMGG BILLIONS OF DOLLARS I COULD BUY 6000 GOLD SPINNERS FOR THAT@@!!!

They very well may do that, but it wouldn’t be in their best interest.

What you might see is plenty of folks hitting the streets looking for work. Basically more folks for liberals to pander.

lol

honestly, i’d love to be the sole owner of a company with that much power. if the politicians try some bullshit, say fine. i’ve got enough money to live off of quite comfortably, i’ll just shut down and kill the countries fuel supply for a while and put tens of thousands of people out of work.

It has been done before. The difference was the companies were privately owned with a limited amount of owners.

It would be awesome to see big companies do this. I don’t see how Exxon can do that since it is on the public stock market. Then again, they can just raise their prices to account for tax increases.
I like that Obama supports it because it shows how he will be a modern day Jimmy Carter if allowed into office
You forgot to mention that a vast majority of the taxes paid by oil companies are paid to foreign countries that collect far more than the US 35% on income. The US is not to blame for the ridiculous amount of taxes that oil companies pay. Not to mention your article throws in sales taxes from the companies purchases throughout the year as well as excise and property taxes.

Fix the dollar.
I would like for a politician to come forward and DEFINE the “windfall profits tax” without picking on just one company or industry. Then, once they’ve defined it, make it applicable to EVERYONE. I’d like to see what Major Leage Baseball thinks of getting hit with it, or maybe some government pet corporation. Why should a windfall profits tax only affect one kind of company selling one kind of product?

What about public health and safety?
because oil is important for basic living standards, companies profiting from basic needs is unpatriotic

It’s nice to see how the slanted story omits that most industries average less than ~5% profit margins (AFTER TAXES). Cherry picking FTW
Windfall profits tax is pretty damn dumb, not gonna lie.

Won’t surprise me if Volcker and Buffet convince Obama to scrap the idea sooner rather than later.

Not gonna explain, either…?

Do you really not think Exxon isn’t going to pass that cost on to consumers?

I’m sure their board is going to say, “Ok, let’s keep the same revenue and willing give away more money to the government.” Hell no, they’re going to find someone else to incur the cost. The only people left are the consumers. I know they’re getting out of the retail business, but there are plenty of places where they can increase revenue at the general public’s expense.

I put my money in 6% CD’s last year. That is a very safe investment. I would expect that established companies make at least the rate of return on a CD. 8% is very modest.

Thank you.

A tax on profits alone doesn’t justify a price increase. Humungus has beaten the point many times …. if they could raise prices after the levy of a tax on profits, then they could just as easily do so right now with the exact same amount of success — as a theoretical exercise. Practical matters might make for certain differences.

And people think I’m an Obama-regurgitator
How is windfall supposed to affect stock value, if at all? I’d think it would drive it down.

That’s not necessarily true though. They walk a fine line between enterprise and government; I’m sure they’re satisfied making their record profits at the moment.

But a shareholder revolt would occur if the government went after their post-tax profit with a second tax. They’d find a way around it.

It would cut into dividends.

Profit is profit; less profit isn’t going to force prices down. Speculation may, sure, but less profit certainly won’t.

It’s sad but it works. And this is a prime example of his empty promises for change

Hope I can believe in

Give it up already. We get it.

It is not instant and wont be a simple price increase at the pump, they would for example cut spending on R&D to keep the same profit reducing efficiency and that would increase the price to consumer in the longer term.

Someone take a SS, because I agree with ACE.
today my poly sci proff and i discussed windfall taxs, no lie and also we talked about the president hopefules flip flopping…. it was like rl diac

I hope you didn’t discuss proper grammar and spelling.
I agree with A_C_E too! Considering that the demand for gasoline is extremely inelastic, consumers will have to grin and bear it (like they do now) when the oil companies raise prices to compensate for the additional taxation.

Problem is far to many think plans like Obama has proposed will actually work. His whole campaign is based on making people BELIEVE

Just the idea that the government is going to just arbitrarily come along and say “oh you make too much money in our opinion, so we’re going to take away everything above some percent” is .

Just the idea of corporate non-competitiveness taking away so much of the average American’s purchasing power is

gasoline may be inelastic but other goods associated with oil are more elastic.
The entire idea of a “windfall profit” tax is necessarily arbitrary since what constitutes a windfall profit is entirely subjective. Nonetheless, I think that Obama’s goal is not simply to pay for stimulus packages through taxation but to create a starker economic signal for the shift away from oil to alternative energies.

I agree with all that consumer demand is indeed inelastic for gas but I think that is simply due to the dearth of alternatives available. As consumer gas prices rise with increased taxation on an inelastic good (economics 101), there is a stronger economic signal to improve on other forms of alternative energy as they become more feasible in comparison to higher gas prices.

As more energy alternatives are advanced and an infrastructure is built, we will see gas prices becoming more elastic as it increases higher and higher. This change is based on the fact that consumers would now have an alternative to using gas.

If you look at European countries with very high gas prices (basically all of them), many of the Western ones have very good public transportation infrastructure. American states, too, can build good public transportation infrastructure if the demand was there. As gas prices rises, there is an economic signal for public transportation to better its infrastructure:

(”Mass transit systems around the country are seeing standing-room-only crowds on bus lines where seats were once easy to come by. Parking lots at many bus and light rail stations are suddenly overflowing, with commuters in some towns risking a ticket or tow by parking on nearby grassy areas and in vacant lots.”)

Obviously the article only relates to metropolitan areas and not rural areas (of which 21% of the population in America resides in:) but nonetheless, a larger shift to public transportation can occur if only the infrastructure is improved. Higher gas prices create a demand for such improvement.

Gas prices will no doubt rise from increased taxation but this is just the initial step in a calculated move to create economic signals for alternative energy and public transportation investment. To focus solely on the cyclical payments of stimulus package>consumer>higher gas prices ignores the more sophisticated economic issues surrounding the taxation policy.

Picking on someone’s disabilities now?

Nice mischaraterization anyways. They don’t take away “EVERYTHING” above X.

Over 5 years which comes to $13billion per year, or $3.2billion per quarter on average.

That is nothing when you consider $80-$100billion per year in income and close to $400billion in total revenue.

Why compare it to their income? Compare it to their profits. Nice way to spin things.

Company brings in ~$120 Billion. It pays $23-$33 billion in taxes. It makes $11 billion profit.

Hope shit, maybe you can become my CFO

And even with that applied to all of the oil companies, it is still an AFTER TAX profit margin for the oil industry that is nearly DOUBLE the average industry in this country.

All this simply HIGHLIGHTS the non-competitive pricing of the oil industry, which BOLSTERS the case to tax them further. Thanks for bringing it up.

So?

I made 6% in CD’s at my bank last year. How is 8% absurd? Shit, It is absurd that an established company is expected to make less than they could if they just put their money in the bank. (I know they can’t put it all in the bank, but I hope you are smart enough to get the point)
Why is everyone arguing about what constitutes a subjective “windfall profit”? Everyone has different interpretations and methodologies. There is no right answer to what a “windfall profit” is.

it would surprise me. a lot of people think (incorrectly) that it’s the oil companies’ profits that are driving up oil prices (and not the other way around), and that the solution is to tax those profits (again). it’s a good way to get votes, even if it’s a shitty economic policy.

It’s like people have never heard of a government setting a lower limit for money and then taxing a percentage above that….

Income taxes are applied to income, not profit, that’s why.

Here is a point where you and I agree. The cost to create something does not determine the value of that object. If it was industry wide there could be impact due to the demand inelasticity of oil, but a single company would not be able to raise prices themselves.

That being said, I am against windfall profit taxes, but not because I think it would inherently raise prices.

A windfall tax was imposed on oil companies by Jimmy Carter late in his presidency. It prompted oil companies to cut back on production and was repealed by Ronald Reagan in 1988.

I know. I was agreeing with Karnejj in response to the post that said that the oil companies would just directly pass on the cost to the consumer, they can’t.

So, you’re implying that the oil companies can do nothing to affect their profits that would have any effect on prices.

yes. the price is determined by the market; if they’re pumping it at $50 a barrel, they’re still going to sell it on the market, and so they’ll make $70 per barrel of profit.

So ….. oil companies are independent/external to this “market” in your conception of things……..? Somehow, “The Market” comes up with a price for oil and then just, uhhh….. tells these oil companies what it should be. Only then do the oil companies know what to sell oil for. And thus, it becomes obvious that the oil companies’ profits end up being LOCKED IN, eh? That is really what you’re trying to convince us of, here?

Summer vacation seems to have addled your poor, developing mind. Next time your friends pressure you to take drugs, Just Say ‘No’…

what the fuck are you talking about? the oil companies can drive down prices by producing more, so they’re obviously involved in the market, but that’s not going to change the fact that they profit off the $50 a barrel oil when the market price is higher.

So …. oil companies can only affect price to the extent that they are able to manipulate supply?

care to explain how else they’d affect price while still trading on the commodities market?
That’s exactly what will happen. That, and the oil companies will halt any further investment in the US. People will bitch about how gas has gone from $4.29/gal to $5.49/gal and accuse the oil companies of gouging them further.

Then I should inform my utility company that electricity is important to my basic living standards and that shutting them off due to an overdue bill is unpatriotic.

Somehow, that’s not gonna wash well.

that letter is about manipulating supply

… individually and with a semblence of freedom in the markets, as you wanted to imply ? No.

This would be an alternative to your original (unsupported) assertion about the causality of prices and profits. Good attempt to deflect, though.

The oil company is expected to try to maximize profit. They generally do not want to give up market share to increase margins, unless the increase in margin more than justifies the decrease in market share (costs go down by more than revenue). A single producer reducing production could affect price based on supply but they would be hurting their profits to help the margins of other producers. Shareholders wouldn’t be happy about increasing total profit and profit margins of other companies. When supply and demand are balanced the company is operating at its highest profit efficiency. Large efficient companies in competitive markets drive market prices down, not up(as companies grow in size margins generally decrease). There are enough oil companies to make a fairly competitive market. Reduction in government barriers to entry, and increases in penalties for collusive actions, would make oil more competitive, which would bring us closer to the real market equilibrium and not the artificial equilibrium we currently have.

Its too bad that the oil lobby has no interest in reducing regulation, as the reduction in competition caused by strict regulation helps protect their market share. At the same time, the environmentalists don’t want to allow things that could bring oil costs down; new refineries, getting off of mandating ethanol as an additive, increasing drilling etc… Why would they, the increased cost of oil drives up spending on the alternatives.

Speaking of oil. It has dropped to $119 per barrel. Since we know how high it can go, it may be a good time to put all of our money in it. It may dip below $110 per barrel. When it shoots up, we make $$$$ and dont have to worry about rising gas prices.

Assuming the FEW major oil producers aren’t already colluding to maniupulate supply. Of course, we know that the OPEC cartel does this as a matter of course, so there’s no question that collusion is rampant in oil industry. Pretending that the free market solves these problems isn’t realistic.

If we want to speculate, then ….. what could also help is more regulations to break the monopolistic tendencies of the companies.

Then we need better enforcement on the laws against collusion, not add new laws that we wont enforce. Collusive actions are not accepted by most free market supporters as natural market forces, and thus are something that the government should regulate. Plus the most that could be done through regulation (without socialization) is a reducing margins, and with them sitting at 8-10% right now there is not much that can be done to make a significant impact on gas prices. Ending the use of ethanol as an additive would have a larger impact on gas prices (the last study I read showed ethanol as 50 cents per gallon). Pretending that adding more regulation will fix the problem isn’t realistic.

Can we really enfoce those laws?
my political science proff today in class talked about how the windfall tax will be pass along to the customer. just thought i would throw that out there

No shit. Anyone with a fundamental understanding of economic concepts would know that an inelastic good, when smacked with taxes, will have the consumer paying for most of those taxes.

Read my earlier post for a better understanding of why that may be a good idea in the LONG RUN.

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