- The Washington Times - Wednesday, November 9, 2005

In the wake of high gasoline prices and high oil company profits, House Speaker Dennis Hastert demands oil companies explain why they are making so much money and what they plan to do to bring down the cost of gasoline.

Sen. Byron Dorgan, North Dakota Democrat, has introduced a 50 percent windfall profit tax on every barrel of oil selling for more than $40. Let’s talk about profits.

First, there’s normal profit, defined as the minimum necessary to keep entrepreneurial resources in their current use in the long run. Normal profits reflect the opportunity cost of using funds to finance an operation, and they must be equal to, or greater than, the returns available elsewhere. Normal profits are indeed a cost of business — the payment to equity owners.

Windfall or supernormal profits are in excess of normal profit and above and beyond what is needed to keep entrepreneurial resources in their current usage. However, windfall profits are a vital component to a smoothly operating economy. Windfall profits indicate unmet human wants.

Take a simple example. Suppose a disaster wipes out food resources in Harrisburg, Pa., and I live in Philadelphia. Before the disaster, bread prices in both cities were $2 a loaf. I buy a truckload of bread, cart it to Harrisburg and sell it for $20 a loaf, earning huge windfall profits. When word gets out there are profits to be made, what do you think happens?

Go to the head of the class if you said other people start carting bread to Harrisburg, bakers work overtime to produce more bread, ovens formerly used to bake cakes and pies are switched to bread baking, bread is conserved in Philadelphia and elsewhere and eventually bread prices fall in Harrisburg and windfall profits vanish. While some might find windfall profits objectionable, the result, getting more bread to Harrisburg, is precisely what’s desired.

What if politicians said, “People are profiting from the misery of others, and we’re going to impose a bread windfall profits tax”? Say they legislated a 100 percent tax, taking all of the $18 of windfall profits. Would you expect people to make all that efforts to get bread to Harrisburg? Suppose there were huge startup costs for companies to expand their operation or onerous regulations to enter the bread business, would that be good or bad news for Harrisburg?

What prevents a robust supply response to availability changes in gasoline? U.S. oil refining capacity is now less than it was in 1980, and since then there has been a 25 percent increase in demand. Because of costly environmental regulations, 30 years have passed since a new refinery was built. The American Petroleum Institute says it cost the oil industry $47 billion to comply with costly and sometimes useless environmental controls in the last 10 years. Exploiting huge reserves in Alaska, the Gulf and the Atlantic and Pacific coasts is restricted.

Mr. Hastert said: “These are extraordinary times that call for extraordinary measures. We expect oil companies to do their part to help ease the pain American families are feeling from high energy prices.” Instead of mouthing platitudes and beating up on oil executives, Mr. Hastert should lead the effort to reduce restrictions on drilling and refinery construction. Mr. Dorgan should review our 1970s experience with an oil windfall profits tax that reduced American production and increased our dependence on foreign sources.

Walter E. Williams is a professor of economics at George Mason University and is a nationally syndicated columnist.

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