Tuesday, May 06, 2008

Call it a wash 

That's my verdict on the windfall profits tax versus gas tax holiday discussions you hear from the news today. I base this on the analysis at the Tax Foundation last week reminding us that taxes get shifted.
We distribute a $9 billion windfall profits tax (assumed to be borne by domestic owners of oil companies) and a $9 billion gas tax holiday. We show the results of the gas tax holiday under two scenarios: (1) the assumption made by Hillary Clinton and John McCain that the reduction in the tax will be fully passed forward to consumers and (2) the assumption of most economists that a temporary gas tax holiday would merely increase the profits of the oil industry due to the inability of domestic supply to respond to increased demand in the short run.
So it would just be a method of how the tax gets paid. Now at least one candidate wants to stop the shift,
It should be pointed out that Clinton attempts to reconcile these two assumptions with a provision that would force the Federal Trade Commission to mandate that the tax cut be reflected in the price at the pump. This is the worst provision of them all: essentially, she wants to control the economic incidence of a tax via legal mandate. Such a policy is economically equivalent to price controls.
And you wonder why we don't trust her with health care! But aside that, it's the legal incidence that is changing, not the economic burden, between the Obama and Clinton/McCain plans. (I know I just gave my GOP friends a heart attack joining those names. Tell me, aside the above, what are the differences between their plans?)

One curious point from the earlier link on windfall profits:

Amy Myers Jaffe, a fellow in energy studies at the James A. Baker III Institute for Public Policy just finished a two-year study looking at oil companies and how they spend their money.

The study found that for the five big international oil companies - ExxonMobil (XOM, Fortune 500), Royal Dutch Shell (RDSA), BP (BP), Chevron (CVX, Fortune 500) and ConocoPhillips (COP, Fortune 500) - spending on share buybacks went from under $10 billion a year in 2003 to nearly $60 billion a year in 2006.

Spending on developing their existing oil fields, however, went from about $35 to $50 billion, while spending on finding new oil fields went from about $6 billion to $10 billion.

"These companies are spending a very small amount of their operating cash flow on exploration," she said. "They are spending the majority of their funds buying back stock."

And that might or might not be a bad thing. If it was to indicate the stock was undervalued, buybacks are good as a signal of economic value. Or, it could be that free cash flow is high and that, in order to prevent managers from spending unwisely, the stockholders have money returned through buybacks. But it is also the case that buybacks might indicate slopping up the exercise of options by insiders (short story: CFO Mr. Big exercises 10mil in options on stock at a strike price of $10; to keep earnings from being diluted, the company buys back 10mil in stock -- perhaps but not necessarily from Mr. Big -- at the current market price of $25.) The buyback is in essence part of Mr. Big's compensation.

If you think that Mr. Big makes too much, you may prefer the windfall profits tax to discourage this practice. But the burden of the tax is borne by all shareholders, not just him.