Thursday, August 07, 2008

Is a windfall profits tax Pigovian?

Several people have asked me whether Obama's proposed windfall profits tax on oil companies is like the Pigovian tax on gasoline I have often advocated in the past. The answer is no.

Here is one reason, as explained by Josh Barro (son of Harvard economist Robert Barro):

Windfall profits taxes also drive up oil imports because they discriminate against domestic oil producers to the benefit of the Saudis and the Venezuelans—even Barack Obama lacks the power to impose production taxes on foreign oil producers.
To keep things simple, imagine we were considering a small country that takes the world price of oil as given. Then a windfall profits tax on domestic companies discourages domestic production, but has it has no effect on domestic consumption. By contrast, a Pigovian tax at the gas pump reduces domestic consumption but has no effect on domestic production.

In a hypothetical closed economy, production and consumption are the same, so the two plans become closer. But even then they are not exactly the same. A tax on (accounting) profits is not the same as a tax on production. The former may distort the the choice of factor inputs (that is, capital vs labor), while the latter will not.

The Obama windfall profits tax proposal, like the McCain gas tax holiday, shows one thing: Energy is too important an issue in this campaign to let the policy wonks get their way. Both candidates' energy proposals seem to have been written by their political consultants rather than their economists.

Addendum: Obama adviser Austan Goolsbee defends his candidate's plan. Austan's argument is that the windfall profits tax is justified because the oil companies have gotten subsidies in the past. I suppose a similar logic would suggest a new tax on economists who in the past have received government scholarships and research grants and are now enjoying substantial commercial success. Steve Levitt, watch out!