California Focus: Prop. 87 Equals Higher Gas Prices

Next month, California voters will face an economic IQ test in the form of the Clean Alternative Energy Act. The ballot initiative, known as Proposition 87, would impose a $4 billion annual tax on intrastate oil production. Voters are confronted with two questions: What will the tax do to gasoline prices, and will it advance or set back the cause of “economic justice?”

Consider the likely impact at the gas pump. Imposing a tax on oil produced in California — which currently supplies 37 percent of the state’s market — will increase the marginal cost associated with bringing petroleum to California refineries. Unless substitutes for the California oil are available at current prices, without the tax, the production costs for California refineries — the main suppliers of California’s fuel market — will go up. And because gasoline demand is not particularly responsive to price increases in the short run, refineries will pass on those increased production costs to consumers.

The authors of Prop. 87 anticipated this problem by prohibiting companies from passing the tax on to motorists. But this is akin to prohibiting people with colds from passing their germs on to others. Absent some pretty severe public regulation, it’s simply not enforceable.

Even if California regulators figured out a way to make producers eat the tax, pump prices would still go up because forcing oil companies to pay higher costs will reduce profit opportunities — and consequently, investment — in California oil extraction and refining. In the long run, less investment equals less supply, and less supply equals higher prices. That’s a law that Prop. 87 cannot repeal.

Are somewhat higher pump prices worth paying if it allows us to “stick it to the [oil]man?” Well, there isn’t really anybody named “Big Oil.” The CEOs and others we associate with the oil companies are simply employees of the stockholders. The latter, not the former, are the owners of the companies and the ultimate recipients of oil profits.

So, are oil company stockholders getting filthy rich at our expense? Hardly. If we look at returns on investment capital in the oil sector from 1973 through the end of 2004 (the last year in which data is publicly available from the federal government), we find that investments in oil companies produced less than the average returns available on the S&P 500. Moreover, oil returns were on average more volatile — that is, more risky — than the returns of other large corporations.

It’s not as if oil companies aren’t paying steep taxes already. Last year, for instance, ExxonMobil — the most profitable of the privately held oil companies — earned $36 billion in profit but shelled out $99 billion in taxes worldwide. Over the past five years, Exxon’s U.S. earnings totaled $22 billion, but the government’s earnings from its operations in the United States totaled $57 billion. Even these figures understate the reality, because oil profits are taxed a second time when they are passed on to stockholders. In short, if anyone’s getting rich off the oil business, it’s “Big Government,” not “Big Oil.”

Some proponents of Prop. 87, of course, argue that this isn’t really about sticking it to the oil companies or cutting pump prices. It’s about kicking our much-ballyhooed “addiction to oil” — which is true insofar as the proceeds from this tax are directed toward renewable energy and energy conservation subsidies. But if doubling gasoline prices over the past couple of years can’t jump-start alternative energy industries or get people to consider energy efficiency investments, then what can?

Compared with the impact that recent $70-plus oil has had on the energy market, a $4 billion a year state-managed slush fund for soft energy subsidies is a drop in the bucket. If investment in renewable energy and/or energy conservation makes sense, it will occur whether government subsidizes it or not.

We like “clean alternative energy” as much as the next guy. We don’t, however, like expensive energy, gratuitous taxes or corporate welfare. And that’s all that the Clean Alternative Energy Act will likely deliver.

Jerry Taylor and Peter Van Doren are senior fellows. Peter Van Doren is also editor of Regulation magazine.