Is a Windfall Tax a Populist Pander?

Barack Obama’s economic policy, says Justin Fox, is "a hard-to-summarize mix of moderate Democratic standbys, populist silliness and the occasional truly visionary proposal". His example of an Obama "populist pander"?

He favors a windfall profits tax on oil companies (which could discourage investment in new energy resources).

I think this is unfair to Obama. A populist pander is McCain’s idea to abolish gasoline tax for the summer. A windfall tax on oil companies, by contrast, actually makes a certain amount of sense.

For one thing, it raises money for the federal fisc – something important when you’re coming up with new spending plans, as Obama is. For another thing, it acts as an indirect carbon tax, which is a pretty good stopgap until you can get a proper carbon tax or cap-and-trade system up and running. And the downside to a windfall tax is actually very small.

Justin’s argument (I think) is that if oil companies rationally expect to face windfall profits taxes in the future, then they’ll be less keen to invest money in the present. I don’t buy it, for two reasons.

The first is simple: if you’ve already spent money on investment, then that money isn’t profit. Investment is a perfectly legitimate business expense, and a rational oil company, faced with a looming windfall tax, would do well to invest its profits back into its business, thereby avoiding paying a windfall tax on them.

But investments should have a positive expected return, so won’t there be even more in the way of windfall tax to pay when the investment finally pays off? No: because a windfall tax, by its very nature, is a one-off beast. It doesn’t get levied every year, it only gets levied once. So the calculation that the oil company has to make is easy: does it pay a certain windfall tax this year, or does it run the risk of paying a larger windfall tax in the future? Given that windfall taxes are very rare beasts, the latter is the obvious course of action.

What’s more, oil companies risk running into future windfall taxes whether or not there’s one in effect right now. Does the risk of a future windfall tax reduce investment today? Yes, probably. But implementing a windfall tax today doesn’t change that calculation much if at all, because it doesn’t significantly change the probability that there will be another windfall tax in the future.

All that said, I’m not a huge fan of windfall taxes, and they wouldn’t be at the top of policies I’d recommend to Obama. I just don’t think they’re stupid populist panders.

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