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The recent rise in gasoline prices has led many observers to call for government price controlsand special taxes on oil companies. Yet policiesthat restrain prices result in less supply and con-servation. Additional taxes reduce the incentiveto invest in new supply. Because price controlsand profit taxes can be levied only by the U.S.government on U.S.-based companies, such poli-cies also increase the economic attractiveness of foreign relative to domestic oil. The U.S. experi-ence with price controls from 1971 to 1980 andthe Crude Oil Windfall Profit Tax from 1980 to1988 amply demonstrates the problems.There is no evidence to suggest that recently reported oil company profits are particularly largewhen contrasted with the profit margins of all pub-lic companies. Profits in the oil sector have histori-cally been lower than profits in the rest of the U.S.economy, so profits would have to be quite large forsome time before they equaled returns in other sec-tors of the economy. Restricting profit opportuni-ties now would amount to a form of one-way capi-talism in which meager profits are allowed butmore robust profits are punished. Interventionunder those conditions would certainly reduce theincentive to invest in the oil business.
 Economic Amnesia
The Case against Oil Price Controls and Windfall Profit Taxes
by Jerry Taylor and Peter Van Doren
_____________________________________________________________________________________________________
 Jerry Taylor and Peter Van Doren are senior fellows at the Cato Institute.
Executive Summary 
 January 12, 2006No. 561
 
Introduction
From the first week in September 2004 tothe first week in September 2005, gasolineprices increased by a staggering $1.22 per gal-lon—to a national average of $3.12 per gal-lon—before dropping to $2.25 on November21, 2005.
1
 A poll released in mid-Septemberby the Pew Research Center for the Peopleand the Press found that 69 percent of  Americans now support the imposition of price controls on gasoline.
2
Even thoughgasoline prices are now at pre-Katrina levels,politicians have reacted to the recent angstover pump prices with a variety of initiativesto restrain prices and control profits.The most popular idea is a federal law against price gouging. Generally, such lawsprohibit price increases during a declared stateof emergency. In effect, they are price controlmeasures that take effect in special circum-stances. The Republican-controlled Congresspassed anti-price-gouging legislation onOctober 7, 2005, as part of HR 3893, theGasoline for America’s Security Act of 2005.The bill, which has yet to pass the Senate,would give the Federal Trade Commission thepower to define price gouging and empowerthe agency to impose fines of $11,000 a day oncompanies found to be gouging the public.
3
Most Democrats and even some Republicans—including, most notably, conservative Rep. BobNey (R-OH)—wanted tougher anti-gougingstandards than those adopted in the bill.
4
 Anti-gouging sentiment is equally popularin the Senate. An amendment sponsored by Sen. Maria Cantwell (D-WA) to incorporateanti-gouging legislation in the Senate budgetreconciliation package attracted 57 votes onNovember 17, 2005, but the proposal failed onprocedural grounds because 60 votes wererequired to gain a straight-up vote on thefloor.
5
Sens. Pete Domenici (R-NM), chairmanof the Energy and Natural ResourcesCommittee, and Ted Stevens (R-AK), chair-man of the Commerce Committee, havepledged to support and advance an anti-goug-ing bill in 2006 despite their respective votesagainst the Cantwell amendment.
6
 Another popular idea in Congress is theadoption of a windfall profit tax. Democraticmembers of the House Budget Committeeattempted to attach such a tax in the budget rec-onciliation package but were defeated on a party-line vote on November 3, 2005.
7
In theSenate Byron Dorgan (D-ND) and ChristopherDodd (D-CT) have cosponsored the WindfallProfits Rebate Act (S. 1631), which wouldimpose a 50 percent excise tax on the sale of oilwhen prices rise above $40 a barrel. The taxwould apply only to major integrated oil com-panies if their profits were not invested in new refinery capacity, renewable energy projects, ordomestic oil and gas production.
8
The proposalreceived 35 votes on November 17, 2005 (nonefrom Republicans, however), when the sponsorsattempted to attach it to the budget reconcilia-tion package then on the Senate floor.
9
Other variations of the windfall profit taxhave also gained support. During the sameNovember 17 debate on the budget reconcili-ation package, 50 senators voted on proce-dural grounds to consider an amendmentsponsored by Jack Reed (D-RI) to impose a windfall profit tax in order to increase federalspending on low-income energy assistanceprograms.
10
 Another 33 senators (none of whom were Republicans) voted to consider anamendment sponsored by Charles Schumer(D-NY) to impose a windfall profit tax to pro- vide a $100 income tax credit.
11
Rather than tax “windfall profits” per se,some politicians support changes to the exist-ing tax code to extract more revenue from theoil industry. One such idea is to change themanner in which oil inventories are treated fortax purposes. At present, companies are allowedto deduct the costs of inventory from revenuesin the calculation of profits to reflect the oppor-tunity costs incurred when oil is kept out of themarket. On November 15, the Senate FinanceCommittee voted to restrict the ability of verti-cally integrated oil companies to price theirinventories at market value. The change wouldbe for one year and extract approximately $5billion from vertically integrated oil compa-nies.
12
The provision, sponsored by SenateFinance Committee chairman Charles Grassley 
2
Sixty-nine percentof Americansnow support theimposition of price controls ongasoline.
 
(R-IA), received unanimous support from theRepublicans on that committee
13
and thengained 64 votes on the Senate floor when it waspassed as part of the budget reconciliation billon November 17, 2005.
14
Many Democrats inthe Senate wish to go further and deny tax cred-its for federal oil royalty payments, explorationand development costs, and depreciation asso-ciated with the geophysical deterioration of existing fields.
15
The problem with such sector-specificpolicies is their unintended consequences.For example, increased taxes on oil inventory holdings will discourage inventory buildup,which would leave oil markets more vulnera-ble to supply shocks. Many energy econo-mists contend that market actors already have insufficient incentives to maintain opti-mal inventory levels. If so, this proposedchange would only make matters worse.
16
Similarly, disallowing the deduction of explo-ration and production costs will make thoseactivities less attractive for investors.Nevertheless, proponents of constraining oilindustry profits and prices contend that gaso-line markets are not competitive (some criticsaccuse producers of price collusion), that fatprofit margins induce little more supply thanmight otherwise be induced by healthy but“reasonable” profit margins, and that gasolineprofits are largely unanticipated and unearned.Price controls or windfall profit taxes, or both,they maintain, would simply redistributewealth from producers to consumers withoutany significant effect on supply.We examine those arguments with partic-ular attention to retail gasoline markets andfind them unpersuasive. Both economic the-ory and past experience suggest that aggres-sive price controls and windfall profits taxeswill harm consumers by creating fuel short-ages and reducing investment in new supply.
The Economic Anatomy of Gasoline Prices
Economists believe that market pricesshould, as a general rule, be left alone by gov-ernment. Prices in market economies areestablished by the interplay of supply anddemand.
17
Goods and services are allocated tothose who value them most, but competitionensures that consumers face the lowest possi-ble prices. Information regarding relativescarcity or plenty is communicated quickly and unambiguously to both buyers and sell-ers. High prices encourage conservation andnew supply.
18
Government intervention, however, mightimprove overall economic efficiency if pricesdo not reflect total costs or if the market inquestion is not competitive. “Might” is the key word because no matter how imperfect mar-kets may be, government intervention posesits own set of problems. Frequently, interven-tions to correct “imperfect” markets (howeverrightly or wrongly defined) do more econom-ic harm than good.
19
 Accordingly, evidencethat market imperfections exist is a necessary but not sufficient condition for governmentintervention. Evidence must still be presentedthat the proposed intervention will on balanceimprove economic efficiency.In gasoline markets no evidence supportsany market failure claims in a manner thatwould support reduction of gasoline prices.For example, there is an extensive economicsliterature on the social costs associated withgasoline consumption that are not fully reflected in the price of gasoline at the pump,but the implication is that market prices forgasoline are too low, not too high.
20
Theremainder of this section analyses the com-petitiveness and profitability of petroleumand gasoline markets.
How Competitive Are Gasoline Markets?
 Although the oil industry has consolidat-ed over the past two decades,
21
no evidenceexists of collusion or price fixing amonginvestor-owned oil companies or gasolineretailers in domestic markets.
22
 A thoroughexamination of the literature through July 2003 finds little evidence that increases inhorizontal or vertical market concentrationin the oil sector since 1990 have increasedretail gasoline prices.
23
3
No evidenceexists of collusion or pricefixing amonginvestor-ownedoil companies orgasoline retailersin domesticmarkets.
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