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Gas prices, demagoguery, and economic illiteracy

Posted by Richard on April 27, 2006

It’s bad enough having to listen to the Democrats’ demagoguery on the issue of gasoline prices. Jeez, these are the same people who for decades have demanded higher taxes on energy in order to raise prices and punish our profligate lifestyles. Anybody remember Sen. John Effin’ Kerry’s call for a 50-cent increase in the federal gasoline tax? They should all be celebrating $3/gallon gas — they’ve demanded it for years!

But what’s even worse — in fact, just pitiful — is watching a bunch of spineless Republicans wet their fingers, hold them up to the wind, and begin spouting populist poppycock about "price gouging" and "excess profits." Even W., who’s an oil man, for cryin’ out loud, and ought to know better!

Econ 101, folks: Prices serve purposes other than giving you something to do with your wages. They convey critical information and affect behavior, and they do so in a way that’s far more effective than any news story, preacher’s sermon, or exhortation by a politician. An increase in the price of gasoline tells you that gasoline supplies are relatively tight, and that you need to adjust your behavior accordingly. It also tells refiners, producers, explorers, and assorted autocrats sitting on huge pools of petroleum that demand is relatively high, and that they might want to take advantage of that fact.

No amount of pleading with people to conserve will reduce demand as effectively as an increase in price. No amount of schmoozing with the Sa’ud family or cajoling of Chavez will ease supply shortages as effectively as an increase in price. Price, left to find its own level, will resolve short-term shortages, stimulate long-term supply increases, and provide for gradual very-long-term development of alternatives. Price must be left alone to fulfill its essential role.

This isn’t purely theoretical crap out of some econ text. All this was demonstrated in the real world within the lifetime of most people reading this. The worst president of my lifetime, Jimmy Carter, following the economically illiterate example of another sorry president, Richard Nixon, kept price controls on oil throughout most of his abysmal single term, and when finally pressured to ease them, substituted a "windfall profits" tax. The consequences were long lines at gas stations and massive shortages, distortions, and economic disruptions. Double-digit inflation. Double-digit interest rates. Double-digit unemployment. No growth.

The best president of my lifetime, Ronald Reagan, deregulated oil prices on his first day in office. The price of gasoline rose to what is still a record level (about $4/gallon in today’s dollars), but the shortages and lines disappeared overnight. And within five years, the price of oil had plummeted to less than $10/barrel, and the oil industry was awash in red ink. Funny, I don’t remember anyone fretting about their capped oil wells, laid-off workers, and lack of profits.

Speaking of oil industry profits, which many people are in outraged tones: ExxonMobile announced its Q1 results yesterday, and it underperformed analysts’ expectations (emphasis added):

Exxon Mobil Corp., the world’s biggest oil company, said first-quarter profit climbed 6.9 percent because of record prices and the first production increase in a year and a half.

Net income rose to $8.4 billion, or $1.37 a share, from $7.86 billion, or $1.22, a year earlier, Irving, Texas-based Exxon Mobil said today in a statement. Per-share profit was 10 cents lower than the average estimate from 20 analysts surveyed by Thomson Financial. Sales climbed 8.4 percent to $89 billion.

Oil and natural-gas output rose 5.1 percent as new wells began producing in Africa.

So, let’s see: Output was up 5.1%, sales were up 8.4%, but profit was up only 6.9%. The share price has dropped on the news, and I can see why. If I were a stockholder, I’d be a bit disappointed. With oil having risen so much, this is a pretty modest rise in profits. In fact, since sales were up by 8.4% and profits were up only 6.9%, their margin — the profit per dollar of sales — actually declined.

I wonder why ExxonMobile underperformed. Oh, wait — here’s one reason (emphasis added):

Profit fell short of expectations because Exxon Mobil’s effective income-tax rate jumped to 46 percent from 39 percent, shaving $1.03 billion in net income, said Kenneth Carroll, an analyst at Johnson Rice & Co. in New Orleans.

The federal excise tax on gasoline already adds twice as much two-thirds as much (18 cents) to each gallon as the average oil company’s profit (9 cents 9%, or about 27 cents per gallon), and most state excise taxes are far higher than that. Now, it turns out that almost half of ExxonMobile’s profit went to the tax man, too!

You want to offer working Americans some relief at the gas pump, Sens. Reid, Durbin, et al? Cut taxes!

UPDATE: Note the corrections above regarding the profit per gallon vs. per dollar. I guess I was living in the past, when the two were closer to being the same. :-}

In any case, my point remains valid, although the difference is smaller than I originally stated: in virtually all states (Alaska excepted), more of your gas purchase goes to taxes than to the oil company. Here’s a page showing 2002 taxes by state (I’m sure they haven’t decreased). The average combined state and federal tax per gallon is 42 cents.

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One Response to “Gas prices, demagoguery, and economic illiteracy”

  1. Anonymous said

    Great post, rg! You can bet I’ll be linking to it.

    Also, you and I agree on the cutting taxes bit, but we came to it for different reasons…

    Check out this post for why I think it’s a great idea from a strategic point of view.

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