Congress should enact a temporary tax on windfall profits from the oil and gas companies that are raking in record profits at a time of crisis-level energy prices. The industry should feel America’s pain at the pump as a motivation to lower costs—not an invitation to increase profits.



Although U.S. domestic oil production more than doubled since 2008, the price of oil continues to be set on a global market, which is vulnerable to the disruption of foreign petrostate dictators. As Russia invaded Ukraine last month, the average price of a gallon of gasoline jumped 50 cents in just two weeks. President Joe Biden has helped rally allies to isolate the Putin regime, including by suspending the import of Russian crude oil into the United States. This amounts to less than 4 percent of U.S. oil supplies but this suspension undermines a core pillar of the Russian economy—its fossil fuel exports.



Although the crisis in Europe does not raise domestic oil production costs, it has raised crude oil prices, and oil companies stand to profit on the difference. This comes at a time when oil companies were already reporting record-high profit levels. Last year, four fossil fuel multinational giants—ExxonMobil, Shell, Chevron, and BP—earned more than $75 billion in a single year in profits. Crude oil prices are now up 50 percent higher than their average daily price last year.



It’s no surprise that, in recent polling, more than 80 percent of voters favor “placing a windfall profits tax on the extra profits oil companies are making from the higher gasoline prices they are charging because of the Russia-Ukraine situation.”



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Recent proposals to tax windfall profits Several similar approaches to establishing a windfall profits tax have been proposed recently in response to the run-up in fuel prices. In the United States, Sen. Sheldon Whitehouse (D-RI) and Rep. Ro Khanna (D-CA) led a group of members of congress in introducing the Big Oil Windfall Profits Tax Act. The bill would accomplish similar aims by taxing the per-barrel increase in price of crude oil produced or imported by the largest companies.



Specifically, the tax would focus on the excess corporate revenue from barrels sold over the average Brent crude price between 2015 to 2019, roughly $66 a barrel. The sponsors estimate that this could raise around $35 billion to $40 billion a year that would be directly sent to consumers in the form of relief checks to help ease the burden of high fossil fuel prices.



Rep. Peter DeFazio (D-OR) and other House members have introduced legislation to tax any profits earned by oil and gas companies in excess of the level of profits in a baseline period, with revenues rebated to consumers. Italy has recently enacted a similar plan, and the European Commission proposed a similar tax on the profits energy companies made from recent gas price spikes but plan to invest the revenue in renewable energy and energy-saving renovations.



Sen. Bernie Sanders (I-VT) has also introduced legislation to tax excess profits earned by the largest companies economywide—not just the oil industry.

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Ultimately, the solution for real energy independence and climate security is to build a clean energy economy, which will cut U.S. spending on oil by up to one-quarter this decade. In the interim, Congress should not allow oil companies to reap windfall profits during a crisis at the expense of the American people.



How this policy would work



Congress should impose a windfall tax on oil company profits. There are many effective approaches that would ensure such a tax is borne by shareholders—the lion’s share of whom are wealthy individuals and foreign investors—rather than consumers. Taxing windfall profits would align the oil companies’ interests with the public’s need for lower prices.



This piece recommends an approach for setting a windfall profits tax that will rise and fall with the fluctuation of crude oil prices until they return to pre-crisis levels. This approach temporarily raises the tax rates paid by oil companies on their profits during the period that oil prices are at elevated levels.



By taxing only profits and not operating costs or investment expenditures, this approach does not increase the marginal costs of producing fuel, which might then be passed on to consumers under some circumstances. Instead, firms will continue to maximize the (now smaller) share of profits they may still retain, without any new production costs to pass along to consumers. To the degree that there is price fixing in the fuels market—an issue that deserves investigation—this measure will push any market manipulators to favor lower prices in order to terminate the new tax.



Since this is a temporary tax, it would have limited influence on the long-term expectations of return on profit for investors, meaning that it would not be expected to alter long-term investment decisions. In the short-term, it may even increase investment incentives by allowing oil companies to deduct all exploration and production expenses that lead to oil production this year.



The proposed design



In designing a windfall profits tax, Congress needs to determine what measure of income or revenues should be taxed, at what rate, and for how long, as well as which companies should be subject to the tax. As described below, this paper proposes to tax all large oil companies on a measure of profits that is more comprehensive than the current loophole-ridden definition of taxable income, at a rate that depends on the average price of oil over the course of the year, until the year in which prices return to pre-crisis levels.



First, because oil companies benefit from several implicit and explicit tax preferences, their taxable income is typically much less than their actual profits. Congress should consider basing the windfall profits tax on the broader measure of profits—or net income—that companies report to shareholders. This measure of profits already subtracts operating costs, but to further incentivize immediate investments, Congress should consider allowing companies to deduct any current year expenditures on new production that lead to oil production this year, without having to capitalize such expenses over the useful life of the investment.



Second, this piece proposes to set the rate of the windfall profits tax by a formula that rises or falls in proportion to the change in fuel prices. As prices increase, the tax rate should increase, approaching but never reaching the limit of taxing all profits. In the other direction, the tax rate should fall as prices fall, phasing out entirely once prices return to a pre-crisis benchmark.



Crude oil prices have jumped dramatically since the last full week of February 2022, when Putin invaded Ukraine. This was a massive disruption of international oil markets, which has not raised domestic oil production costs but has raised domestic oil prices. The authors propose a benchmark price of $75 per barrel of oil—West Texas Intermediate—which is the average daily price in calendar year 2021, preceding the run-up to the invasion. Notably, this benchmark already represents some of the highest prices in more than eight years. Congress could reasonably consider setting a lower benchmark at the pre-COVID-19 five-year average of $58 per barrel from 2017 to 2021.



Table 1 presents one set of proposed tax rates, which vary depending on average daily price in crude oil over the course of the full calendar year. At current crude oil prices of approximately $100 per barrel—if they persist for the remainder of the year—this equates to a tax rate of 50 percent. This would rise to just above 75 percent if the average price of oil were to reach $175 per barrel. The rate would return to zero once the price of oil returns to normal levels.




Table 1