Monday, May 15, 2006

Proposals to control gasoline prices and tax producers’ windfall profits were popular ideas that were tried — without much success — during the oil shocks of the 1970s and 1980s.

The era of price controls is most remembered for long lines at gas stations. The controls were put in place by the Nixon and Ford administrations in reaction to a jump in fuel prices caused by cuts in production by the newly formed international oil cartel, the Organization of Petroleum Exporting Countries.

Back then, “price controls turned a minor adjustment into a major shortage,” said Thomas Sowell, author of “Basic Economics: A Citizen’s Guide to the Economy.”

Mr. Sowell says that although the best response would have been to let prices rise, giving oil companies an incentive to produce more and consumers an incentive to conserve, “this basic level of economics is seldom understood by the public, which often demands ‘political’ solutions that turn out to make matters worse.”

The public — as it does today — wanted low prices. But the artificially depressed pump prices imposed during the oil crisis of 1973 — which stayed in place in various iterations through 1980 — brought about lines at gas stations and an artificial shortage of gas, he said.

The price controls resulted in a fuel-rationing system that made available about 5 percent less oil than was consumed before the controls. Consumers scrambled and sat in lines to ensure they weren’t left without. Gas stations found they only had to stay open a few hours a day to empty out their tanks. Because they could not raise prices, they closed down after selling out their gas to hold down their labor and operating costs, Mr. Sowell said.

The shutdown of stations that had been open at all hours before price controls further raised the public’s panic level and resulted in more lines, anger and frustration in what many Americans still remember as one of the nation’s worst economic nightmares.

“No doubt many or most motorists whose daily lives and work were disrupted by having to spend hours waiting in line behind other cars at filling stations would gladly have paid a few cents more per gallon to avoid such inconveniences and stress,” Mr. Sowell said.

Those who preferred not to sit in line bought gas on the black market at exorbitant prices far above what the market price would have been, he said. “Price controls almost invariably lead to black markets.”

By the Iranian oil crisis in 1979, the controls had grown unsustainable as oil prices escalated in global markets. With lines forming once again and fistfights breaking out at the pump, President Carter quickly waived most of the controls on oil and gas prices to make more fuel available.

The resulting sharp price increases ushered in a new nightmare: double-digit inflation, as businesses quickly passed on their higher fuel costs and workers’ unions demanded cost- of-living increases to keep pace with higher prices. The surge in inflation put the Federal Reserve in crisis mode. It ordered its largest-ever increase in interest rates in October 1979, plunging the economy into a deep recession.

By the 1980s, Congress and the administration had figured out that price controls were not the answer.

President Reagan, who rode to office on anger over the recurrent energy crises and inflation of the previous decade, immediately abolished what remained of oil and gas price controls upon entering office in 1981.

Harvard University economist Joseph Kalt concluded that the 1970s price controls had saved consumers between $5 billion and $12 billion a year in gas costs, but at the price of stifling domestic oil production and causing an artificial shortage of as much as 1.4 million barrels a day.

By 1986, the deregulation of the petroleum industry led to record production levels and a glut of oil that drove prices down to $10 a barrel. The trend toward low prices and plentiful oil continued through the 1990s as major non-OPEC producers such as Russia ratcheted up output to take advantage of the high oil prices engineered by the cartel.

But the eradication of price controls came with a hitch: Congress enacted a new system of “windfall profits taxes” on oil companies in 1980 in an effort to ensure they did not profit egregiously from their newfound freedom to charge market prices.

The tax on the “windfall” revenues earned by U.S. oil companies when market prices were substantially higher than their cost of extracting oil turned out to be another bomb, said Jerry Taylor, analyst with the Cato Institute.

Increased production around the world drove down the price of oil and caused the tax to generate less revenue than expected. By the time it expired in 1988, the tax had generated $40 billion in revenue instead of the $175 billion estimated by the Treasury. After oil prices collapsed in 1986, the tax produced no revenue at all.

Because the tax was applied to U.S. oil producers but not international companies, the Congressional Research Service concluded that it had cut domestic production by 3 percent to 6 percent and increased oil imports by 8 percent to 16 percent.

The tax was “counterproductive,” said Mr. Taylor. It “discouraged investment in the oil business.”

Mr. Sowell said profits are the least-understood aspect of business, and have been under attack since the days of Karl Marx and George Bernard Shaw, who called profits arbitrary “overcharges” motivated by greed.

In reality, profits provide the vital incentive businesses need to make products consumers want at low prices, he said.

Most businesses that succeed do so because they find a way to mass-produce items that the public wants at low prices, he said, noting the examples of Henry Ford’s automobile empire and Wal-Mart’s international chain of discount stores.

In the past century, Mr. Sowell noted, socialist economies were viewed as virtuous because they operated without profits, yet they were never as good as capitalism at generating goods and services people wanted because of the bureaucratic inefficiencies of state-run economies.

Pete Geddes, executive vice president of the Foundation for Research on Economics and the Environment, noted that discredited proposals such as price controls and windfall profits taxes seem to come up every time gas prices get uncomfortably high.

“What is it about rising gasoline prices that causes IQs and body temperatures to converge?” he asked, calling the windfall profits tax “a transparently absurd act of political pandering.”

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