Oil in Decline: The Tax That Proves a Point

Talk about tax policy follows like a swell behind the election season speedboat. And yet there is precious little discussion of the lessons learned from the one new tax that our economy has experienced in spades during the past three years. That, of course, would be the oil tax.

We are not talking trivial here. With oil around $90, this tax is running about $60 per barrel more than whatever an economist might have calculated it to be in 1993 based on $30 oil. Since America consumes about 21 million barrels per day, that $60 represents about $1.26 billion per day or about $460 billion per year in additional oil tax during 2007 alone, or about $3,500 per American family per year. In total from 2004 through 2007, the tax imposed by oil prices above $30 has probably consumed about $835 billion. Not trivial.

The oil tax is paid by Americans every day in obvious and hidden ways. The clearest part of the oil tax is its effect on the price of gasoline, but it is also acts like an invisible VAT tax paid on nearly every purchase by every consumer or business since oil is an input to virtually every product and service.

What makes the oil tax even more potent than its size alone is its quality; most of the tax immediately leaves our country. We import 2/3 of our oil, so nearly all of that part of the tax goes overseas and does not benefit our economy in any way. The other third goes to producers of domestic oil who also spend large amounts of it on activities outside the U.S.

Thus, unlike a tax that is paid to the U.S. Government and which is then spent very largely on Americans in America and for America’s benefit, the oil tax is nearly all wasted in terms of having any positive impact on the American economy. In fact, some argue convincingly that part of the oil tax actually finances America’s Muslim fundamentalist adversaries, which adds to American defense costs. So not only is the oil tax very large in comparison with most changes to the U.S. tax code, it is also arguably much more destructive to the U.S. economy – and U.S. interests - than any tax that is collected by our own government.

If one takes seriously the reasoning of those who say that any tax is destructive to the economy, you would think that the 2004 – 2007 period might have been difficult for the U.S. Au contraire. The U.S. economy grew smartly without great inflation during 2004 – 2007. It took a different exogenous event – the subprime mortgage mess and credit crunch – to slow down the growth rate of the American economy. What shape might our economy be in now if there had been only normal home lending policies in place? One cannot know for sure, but it certainly seems likely that the U.S. economy would still be merrily humming along right now - even in the face of the $835 billion of new oil taxes imposed over the past three years.

Thus the experience of the past three years’ oil tax invalidates a fundamental theory of one of the major American political parties, the idea that higher taxes are death to economic growth. That party holds so tenaciously to this incorrect idea that its “no-tax Nazi’s” try their best to virtually destroy the viability of any candidate for office whose track record includes the acceptance of higher taxes for any purpose. What a wasteful effort.

The oil tax proves beyond a doubt that taxation – even in the most venal and pernicious form that the oil tax embodies – does not necessarily lead to economic stagnation. To get a sense of how incorrect the Republican theorists are about taxation, just imagine what the American economy might have done over the past few years if this $835 billion of oil tax had been collected not by foreign and domestic oil companies but by our own government and had therefore been spent mostly in America on projects like improving our infrastructure or our educational systems. In that case, our economy might have even over-heated, so dynamic would have been its growth during this period of the enormous incremental oil tax.

Impact on the Tax Collector

The other side of the oil tax coin is that oil exporting countries have been experiencing windfall profits. Saudi Arabia and Russia, the two largest exporters, have each reaped about $130 billion per year of incremental profits on oil exports on average over the past three years. That average amount is about doubled on a going forward basis at current oil prices. This fiscal windfall has yielded these countries internal growth rates in the 5 -8% per year range.

The oil-intensiveness of developing economies is far greater than that of the American and EEC economies. Thus internal use of oil expands even more in the oil exporting economies as a percentage of their economic growth than would be the case in a developed economy. As the growth of oil exporting economies lifts their own internal use of oil, it necessarily reduces their ability to export their oil. Thus, by limiting their ability to export oil, the economic growth of oil exporting countries tends to increase the price of oil itself. This in turn feeds the oil exporters’ surplus further and further hikes their economic growth rate and their internal oil use. And so on. This phenomenon is known by economists as a virtuous cycle – a cycle that re-enforces itself - and it is a substantial driver of oil prices to higher levels. Of course, seen from the U.S. vantage point this cycle is not so virtuous.

Squaring the Circle

There seems to be a bit of a logical conundrum here. On the one hand, the U.S. has experienced an enormous tax outflow - $835 billion over three years - with minimal if any economic impact until the mortgage crisis came along. On the other hand, Russia and Saudi Arabia, with “only” about $390 billion each of tax revenue inflow over three years – have seen extremely positive economic impacts. How can the oil tax be effective in Russia and the KSA but not effective in the U.S.?

I suspect you are ahead of me here. The obvious answer is the different scale of the U.S. vs. the Russian or Saudi economies. The $13.1 trillion U.S. economy is so enormous that $835 billion over three years does not have much impact. It is about 2% of GDP. On the other hand, the Russian GDP is about $765 billion per year, so their additional oil tax collection has been more than 17% - thus having a very real economic impact. The Saudi economy is just a fraction of the size of Russia’s, of course but it is also more centrally managed and so less subject to market forces.

Economists may argue that a 2% impact on the U. S. economy is not trivial. That is true, and clearly there were other offsetting U.S. macro-economic trends during 2003 – 2007 such as cheap imports and healthy exports. But isn’t it always the case that there are many economic forces acting on our economy at the same time? And, in a sense, is that not really the point? Politicians love to draw direct lines between one tax or fiscal policy and the behavior of the U.S. economy. But in the end, isn’t that argument always such an over-simplification that it becomes a form of demagoguery?

Other Players

What about China, India, and other exporters of non-oil goods and services? If the huge U.S. oil tax had little impact on the U.S. economy, one can conclude that the much smaller one that China and India have been experiencing has not been a significant factor for them. Thus, they will probably continue to grow through a U.S. recession although at reduced rates. They will add to global oil demand growth at a slower rate than they have in the recent past. While their exports to developed countries may slow somewhat, their economies are increasingly driven by internal demands, particularly for new infrastructure. The palpable aspirations of their under classes for a share in the middle class experience have their governments’ support, so their fiscal policies will also favor a continuation of their growth trends.

Conclusions and Inferences

1. It takes a lot of force and a long time to turn the Titanic. The $835B oil tax over three years was not enough by itself to slow the U.S. economy.

2. Oil is the dividing line between those economies with a wind to their back and those with the wind in their face. Oil exporters like Russia, the Middle East, Venezuela and Mexico are getting a huge lift from oil export revenues that will continue to push their economies forward and their oil use upwards regardless of any U.S. recession. On the other hand, the same oil tax is not helpful to the U.S. and European economies.

3. Global oil demand will probably grow slowly through the U.S. recession. Oil demand in slowing developed economies may decline slightly, although in past recessions it was flat and now oil is an even smaller part of U.S. GDP than it was during past recessions. Any such oil demand decline, if it happens, will likely be more than offset by oil demand growth in developing economies, which will continue to grow and are more oil-intensive. The internal domestic use of oil by oil exporting countries will continue to grow 5% - 7% per year.

4. American politicians should level with voters and stop their implausible exaggeration of the impact of U.S. tax policies. In fact, none of the tax increases – or decreases – that either party might want to take credit or blame for will have or have had much impact on the American economy because the economy is so huge in relation to the effects of the policies. Is it likely that Hillary Clinton’s proposed $70B fiscal stimulus plan or Obama’s slightly larger one will be felt by the U.S. economy if the oil tax of $835 billion over three years – that was doubly insidious by having been spent mostly outside the U.S. – could not stop the dynamic growth of the U.S. economy from 2004 - 2007? Remember: despite all the New Deal spending programs, it took WW II to turn around the Depression.

5. The combination of the oil tax and the mortgage market debacle may have brought the U.S. to an inflection point in its place in history. This coming U.S. recession may mark the point in time when the U.S. stopped dominating the world economically. We could have a recession that may not matter that much to the rest of the world.

Investment Implications

If I’m right, the period ahead will see continued but slower growth in oil demand despite a U.S. recession and possibly an EU slowdown as well. That scenario seems supportive of the opinion on oil prices that I expressed recently. To whit: in the early part of 2008 oil is more likely to be weaker than stronger but not likely to drop under $80 because OPEC will begin to withhold supplies if that price point seems threatened.

If that scenario plays out, the first half of ’08 is not likely to be happy for the energy investor. As I pointed out a couple of weeks ago, it is probably a good time to have a great deal of cash in reserve. There will be some violent up-days in the market, but my guess is that there will be general weakness in stock prices – and particularly energy stocks – until a recession is fully discounted by the market and is well in evidence on the nightly newscasts.

Comments

[viva:]

The main complaint from the no new taxes crowd is that flooding the US Treasury (Congress implied) is that reckless spending ensues shortly thereafter. Look at what the Democratic congress did with the increaing revenues after Reagan's tax cuts and again after Bush 43 tax cuts. They wiped their asses with earmarks like toilet paper and flushed our tax dollars down the toilet. There is a 50% tax increase looming out in the never-speak land to "fix" Social Security again. Our children won't be able to leave home because their net paychecks won't allow it. You're out of touch with reality like your Socialist elite friends.

2008 Jan 17 09:45 AM

[Reagan Repu...:]

Taxbigot go and continue to keep your head up Bush's "where the son does not shine" Bush 43 and this kluz will go down as 2 of the country's worst president. You like Bush do not understand markets nor effective tax policy. You need to go revisit the "Lefler Curve" and the Kemp Roth tax policy of the mid 80's that encouraged investment in this country.
The author is right on with this article and has a complete understanding of the economy and tax policy. Us repulicians should be ashamed of what Bush and Karl Rove have done to our party. For once and for ever, through this Kluz we will be able to eridicate the Rockefeller/Bush wing from our party. Keep in mind, the worst and only mistake Ronald regan ever did we name George HW Bush as his running mate. Had Reagan named other people as his VP, we would not be were we are at today, and the Bush/Rockefeller wing of the party would have been extingushed at that time. Get ready for the Demo's to recapture the white house thanks to you and the Bushies

2008 Jan 17 11:50 AM

[David White:]

I can't believe some of the comments. Did you guys even read what he wrote? It makes a lot of sense. You obviously know very little about macroeconomics. You are probably cheering the stimulus package being proposed, which includes tax cuts. However, what Mr. Kingsdale is saying is that if we did something about our oil dependency, we would be giving ourselves a $460B stimulus package every year. Imagine how much better shape the economy would be in then. Solar is definitely one of the answers. Yet we are not the leading nation in adopting it. This borders on the moronic, since we are the largest energy consumer. I also disagree with Mr. Kingsdale slightly about one point. I think it would be much better if we were paying U.S. oil companies for the oil. A lot of that money would still recycle into (restimulate) the U.S. economy. However, such things as solar panels on hybrid gas/electric cars should already be a reality. Solar panels on homes and businesses should be also. We badly need to correct our energy dependence. We need to do it in a hurry.

2008 Jan 17 01:16 PM

[Greg Pinelli:]

Of course, the first 2 posts made my day. That I'm competing in the investment market place against those 2 makes for sunny possibilities.
As for the article....there is no end in sight for oil substitues and the political games to be played. Crop based ethanols are/will destroy our soil inheritance and solar is comfy and correct but is very far away from ever being a significant player.
A large part of the answer to our "tax" is rail (for goods and people) and barge (for goods)..and a realization that the next generation of plug in hybrids will not get us closer to what we need to face up to...the passing of the mass transit auto and the culture it saturated us with.

2008 Jan 17 02:21 PM

[speculators...:]

David, as long as the oil industry is allowed to "sit in" on major energy policy (i.e; Cheney Energy Task Force) we will NEVER see solar, wind or any other type of energy being developed in any great quantity. The day we allowed these greedy "oil" robbers into the Whitehouse was the day we gave up our right to cleaner cheaper energy.

2008 Jan 17 02:30 PM

[rocksolidtruth:]

Oil dependency is no secret.
Money pouring out of our country to other countries is no secret.
Tax cuts and rebates having no long term vector change effect on the US economy is no secret.

Hey, if the top 1% of the population sees a couple trillion of their wealth disappear, poof, gone, trillions, because they were greedy and put their bets on high return risks........it still won't have much effect long term on the US economy. Most of them already made as much as they lost. Even Steven. But the banks are now left holding the bag. And they are not waiting around for the FED or the White House to help them out.....they know that will take months if not years........they are going to their buddies overseas because they need a check tomorrow......and the checks are rolling in if you haven't noticed.

Jim, please write us an article on this: The US, and largely the world economy, is not a cash economy. It is not a physical economy based on interest and profit measured in doubled yields of crops per acre, and exponentially increased births of baby cows, pigs, chickens and salmon, and doubling of the efficiency of our fuel (oil) use, and tripling of the world’s fresh water supply with desalination. It is a credit economy.

When the world's top 1% wealthiest stop investing in US promises for incredible returns, growth stops for us. We don't have any cash to finance our own growth. The amount we send to other countries for the cost of oil is minimal compared to the interest payments on investment we send out. Take a look people.....the US government is bankrupt and helpless......why are all the investment houses and banks going to foreign counties for bailouts on these failed mortgage Ponzi schemes ?????? Because those countries have all our cash. We gave it to them. We sent them their interest payments for helping us grow......and now they are sending it back once again and reinvesting it again. Each time we fail......we sell more of the country to the world, because the government and the banks are bankrupt and can't finance the deals. When this cycle stops. We stop. This is where we are. The current crisis has nothing to do with oil at the moment, although it could start to contribute in the very way that Jim has explained, if we no longer have the cash to purchase the 2/3 imports we need. We get that cash from borrowing ( through investment instruments ) from the very countries we buy oil from. This is the real danger. The stop of credit flow, not oil. And this is the tax that is now spreading like cancer throughout the system at all levels, especially the middle class with little or no cash reserves or equity. No access to new credit......the old credit goes into default.

Without huge amounts of available credit the US economy stops.
Oil problems are just a bothersome fly that won't leave us alone.....although eventually the world will be using more oil than we are pumping....that is a given. But for now...no credit flowing....no economy going.

2008 Jan 17 02:31 PM

[Kunst:]

"Look at what the Democratic congress did with the increaing revenues after Reagan's tax cuts and again after Bush 43 tax cuts."

Excuse me, wasn't that a Republican congress from 2001-2007 that spent like drunken sailors?

2008 Jan 18 02:10 AM

[Grumpy:]

The article is twaddle. So the US economy took an oil tax hit and kept on growing. Therefore taxes don’t impede economic growth. And you smoked a pack of ciggies yesterday and you’re still alive today. So smoking isn’t bad for your health. As the author admits, $800b over 3 years isn’t really that much in the context of a $13 trillion economy. So why would you expect it to poleaxe growth? What he doesn’t consider is that without the oil tax the growth rate would have been even healthier. That and the fact that with government it is never just one little tax increase – it is another 1%, then another 1% then another 2% - it never stops. One little hit of crystal meth won’t hurt you either. But the correct amount to ingest is zero. Tax increases are exactly the same. No new taxes!

2008 Jan 18 10:54 AM

[Rayden:]

Bullshit. The oil "tax" is not a tax, it is supply and demand. "Tax" is money that the government takes away and then spends (uses) in a way different from how you choose to use it if it had not been taken away from you. People who think that taxes hurt the economy simply think that the government tends to make very poor choices in how they spend taxes, thus creating uneconomic allocation of resources - and they're right. In the case of the oil "tax", people choose to pay that, not the government, and their choice is presumably a rational choice, at least in the short term. The oil "tax" is in fact easily avoidable - just use less oil; or conversely build up domestic synfuel production capacity - and both of those will no doubt happen if oil prices stay sufficiently high.

2008 Jan 19 08:15 PM

[maximax:]

I stopped reading this article after the 'credit crisis=exogenous event' statement. Of all events affecting the US economy, the credit crisis is the least exogenous. To rebrand the oil price as a tax is just wrong - as if Americans owned Middle Eastern/Venezuelan etc oil and the costs of finding it, getting it out of the ground, shipping and refining it wouldn' exist. And only a tiny marginal fraction of oil revenues finances terrorism. And terrorism also flourished in years of low oil prices. And spending whatever that oil tax is supposed to be on infrastructure and education is not necessarily more beneficial than investing the dosh abroad, especially as US growth has lagged other regions during the recent years. But reducing US oil consumption would certainly be applauded by the rest of the world, so feel free to go ahead on that point, for whatever reason. This author clearly has an agenda which he tries to wrap in a fake analysis. What I would like to read her are genuinely analytic&unbiased articles.

2008 Jan 23 08:07 AM