Crude Oil Windfall Profits Taxes: Background and Policy Considerations

Crude Oil Windfall Profits Taxes: Background and Policy Considerations

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March 23, 2022
Crude Oil Windfall Profits Taxes: Background and Policy
Considerations
Recent increases in gasoline prices and reports of high
highlighted here, as high oil prices are a motivation behind
profits from large oil companies have contributed to
current windfall profit tax proposals.
congressional interest in a crude oil windfall profits tax.
Taxing Windfall Profits
What Are Windfall Profits?
Income Tax Approach
Windfall (or excess) profits taxes are, in theory, designed to
The income tax system could be used to impose a windfall
tax the portion of profits a firm derives from an external
profit tax (WPT). Under this approach, the tax base might
event. Windfall profits are generally believed to be those
be the excess of adjusted taxable income in the tax year
that represent an excessive, unearned, or unfair gain.
over taxable income in a base period. Adjustments could
Oftentimes, windfall profits taxes are discussed in the
allow taxpayers to avoid the WPT by making certain types
context of oil markets, where fluctuations in the price of oil
of investments, for example. An alternative could be to tax
are associated with volatile profits in the industry. It is
profits above a legislatively determined rate of return.
possible windfall or excess profits may be realized in other
industries. It has been suggested that some companies
Excise Tax Approach
(certain technology companies, for example) may have
From 1980 to 1988, the United States imposed a Crude Oil
realized excess or windfall profits as a result of the
Windfall Profits Tax (P.L. 96-223), which was in the form
Coronavirus Disease 2019 (COVID-19) pandemic.
of an excise tax on domestic production. The tax was a
percentage of the difference between the price of oil and a
Rising oil prices can be associated with rising industry
base price indexed for inflation (70% for integrated oil
profits, and falling oil prices may be associated with losses
companies; 50% for others). Lower rates applied to certain
in the industry. Figure 1 plots the monthly average West
types of production (including marginally productive wells,
Texas Intermediate (WTI) crude oil prices against annual
called stripper wells, and newly discovered oil) and even
profits, as reported by the Bureau of Economic Analysis
lower rates to heavy oil and oil recovered by more costly
(BEA), in the oil and gas extraction industry and petroleum
tertiary methods.
and coal product manufacturing sector.
The 1980s WPT was imposed following the elimination of
Oil industry profits have fluctuated with oil prices over
price controls on crude oil, which had been in place
time. Profits have tended to be stronger in periods when
beginning in 1971.
prices are relatively high, with losses occurring during
periods when prices are comparatively low. Numerous

economic factors affect industry profitability. Oil prices are
Figure 1. Oil Prices and Industry Profits

Source: Energy Information Administration (EIA) and Bureau of Economic Analysis (BEA) data retrieved from FRED, Federal Reserve Bank of
St. Louis, https://fred.stlouisfed.org/, March 22, 2022.

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Crude Oil Windfall Profits Taxes: Background and Policy Considerations
General price controls were imposed in 1971-1973, and the
untaxed crude oil (both domestic and imported). If prices
controls on crude oil were continued following the 1973 oil
rise in response to the tax, higher prices could increase
crisis (the Arab oil embargo). With the elimination of price
profits for the entities that are not subject to the tax (e.g.,
controls, domestic oil prices were predicted to increase
smaller producers). Effects could also differ by region, as
substantially, as they were below the world price.
some parts of the country rely more on imports of refined
products (which would not be taxed) or on oil from smaller
Over time, the tax yielded less revenue as worldwide oil
domestic producers or smaller refiners (also not taxed).
prices fell and the base was increased by inflation
adjustments. It was repealed in 1988, prior to its legislated
An income tax type of WPT may be less likely to distort
termination date of 1991.
short-run production choices. In the short run, the burden of
Policy Design Considerations
the tax would likely fall on the oil producer. Economic
theory suggests that income-based taxes that are taxes on
There are numerous potential policy design considerations,
excess profits (e.g., profits above the normal rate of return),
in addition to the initial choice of an income or excise tax.
or economic “rents,” do not distort investment and
Would the tax be imposed on imports? Would there be
production choices. If the tax falls on normal return,
exemptions for small producers or producers with revenues
however, it could reduce investment in the long term.
or profits below some threshold? Could taxpayers avoid tax
Taxpayers might also respond to a temporary income-based
liability by making certain types of investments? How
would “windfall profits” be determined—
WPT by taking measures to reduce taxable income (by
as the excess of
making additional investment, for example).
profits over a base period or via some other method? These
choices have implications for the potential economic effects
Legislation in the 117th Congress
of the tax, as discussed below.
The Big Oil Windfall Profits Tax Act (S. 3802; H.R. 7061)
would impose an excise tax form of a WPT. The proposed
Separately, if the policy objective is to raise additional
tax would be 50% of the difference between the current
federal revenues from the oil and gas sector, there are
price of Brent crude oil and the average price from 2015 to
potential options other than a WPT. For example, numerous
2019 (inflation adjusted after 2022). The tax would be
tax provisions supporting the oil and gas sector could be
imposed on both domestic production and imports and
repealed. Alternatively, the tax treatment of multinational
would be limited to firms that produced or imported an
oil and gas companies could be modified in a way that
average of at least 300,000 barrels per day. Senator
generates additional federal tax revenue (e.g., modify the
Whitehouse (sponsor of the Senate legislation) claimed in a
way foreign oil and gas extraction income is treated for the
press release that approximately 70% of domestic
purposes of global intangible low-tax income [GILTI]).
production would be exempt.
Potential Economic Effects
Other proposals would impose an add-on tax on profits
How a WPT might affect domestic oil and gas production,
(structured as an excise tax on profits). The Stop Gas Price
imports, and prices depends on how the tax is designed.
Gouging Tax and Rebate Act (H.R. 7099) would, for 2022,
An excise tax on domestic production, like the WPT of the
impose a WPT on large integrated oil companies. A 50%
1980s, would tend to reduce domestic production, although
tax would be levied on the amount by which an adjusted
effects are likely to be moderated by several factors. If the
measure of taxable income exceeds 110% of adjusted
tax were only imposed on domestic production, the decline
taxable income during the base period (2015-2019). The
in domestic production could lead to increased imports.
Stop Profiting Off Putin’s War Act (H.R. 7103) would
When oil prices are determined in global markets, an excise
impose a 50% tax on the adjusted taxable income of large
tax on domestic producers would likely reduce the price
integrated oil companies, through 2023, if gas prices during
producers receive (i.e., be borne by firms that are
the calendar quarter exceeded gas prices on February 24,
producers), and not be passed forward to refiners or
2022. The rate could be increased to 75% if taxpayers are
petroleum consumers. If, however, changes in domestic
found to have raised prices in response to the tax. Adjusted
production contribute to reduced global market supply,
taxable income would be increased by amounts paid in
there could be consumer price effects. If the tax is
bonuses and the amount of stock buybacks, and reduced by
temporary, it would be unlikely to affect longer-term
net operating loss deductions and deductions for
drilling or the number of wells in production (although it
depreciation, amortization, and depletion.
may cause producers to pause drilling activity or shift
Each of the proposals discussed above would rebate
production to a later time period).
revenues to individuals, with rebates phased out for higher-
The effects of an excise tax type of WPT that applies to
income taxpayers. Senator Whitehouse’s press release also
imports, or one that is imposed only on certain entities (e.g.,
claimed that at a price of $120 per barrel, revenues would
large producers), might result in different outcomes. If an
be $45 billion per year, allowing for rebates of $240 for
excise tax type of WPT is imposed on imports as well as
single filers and $360 for joint filers. Oil prices have
domestic producers, the tax is more likely to be passed on,
decreased since the introduction of the legislation and have
in part, to refiners and consumers, since refiners can no
been fluctuating; lower oil prices would mean less revenue.
longer substitute nontaxed imported oil for taxed domestic
oil. Limiting the tax to certain types of entities, however,
Molly F. Sherlock, Specialist in Public Finance
makes it less likely that the tax can be passed forward via
Jane G. Gravelle, Senior Specialist in Economic Policy
higher prices, since there would be competition from
IF12064

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Crude Oil Windfall Profits Taxes: Background and Policy Considerations

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