The windfall tax on oil company profits proposed by some in Congress is a bad idea, not only for general economic reasons, but also because it will be particularly damaging to investors such as defined benefit and defined contribution plans and endowments and foundations.
One such proposal would tax oil company profits at 50% whenever crude oil prices top $40 a barrel. That would affect the future after-tax earnings of U.S. oil companies, as well as their incentive and the revenues necessary to seek more oil.
Pension funds and other institutional investors are major owners of oil company stocks. Anything that negatively affects the earnings stream of the oil companies — Hurricane Katrina, a windfall profits tax, etc. — will hurt oil company stock prices and thus the value of portfolios that hold them.
This, in turn, will reduce the overall funding of pension plans, both corporate and public. It will also hurt the retirement savings of millions of Americans who own oil company shares through their 401(k) and other defined contribution plans or individual retirement accounts.
Pension plan sponsors have been struggling in recent years to rebuild their pension plans' funding levels, following the drop in the stock market from the dot-com crash, the 9/11 terrorist attacks, the war in Iraq and the drop in long-term interest rates. A windfall tax will only slow the restoration of funding levels.
To make up for the losses from the diminished value in oil company securities, someone will have to pay more in pension contributions. For public plans, it will be taxpayers and participants (who generally contribute part of their pay to their retirement programs). For corporate plans, companies having to make more contributions will reduce capital for business operations and expansion.
Pension funds and other institutional investors own more than half of the shares of Exxon Mobil Corp. and Chevron Corp., and a significant share of BP PLC, Royal Dutch Petroleum Co. and other major oil companies.
Pension funds benefit from corporate profits when those profits cause share prices to rise. But the size of the profits — even Exxon Mobil's record $9.92 billion in the third quarter — can be deceptive in determining corporate performance. Exxon Mobil's shareholder total return, including dividends reinvested, was 28% last year and 20% in 2003, according to company data. But in 2002 it was -9%.
For the five years, ended Dec. 31, 2004, annual total return averaged about 7%. That five-year average is below the assumed actuarial assumptions of about 8% many plan sponsors use to determine how much to contribute to their pension plans. A windfall profit tax would diminish that shareholder return.
Such a tax isn't socially responsible because it puts more money into government, instead of leaving it with shareholders or with the company. The U.S. Treasury and state treasuries already benefit from increased oil profits and from rising gasoline prices through myriad taxes.
A windfall tax won't do anything to reduce the price of oil or gasoline. Politicians calling for a windfall tax on oil profits are looking for a scapegoat to mitigate public anger about high oil prices. But such proposals, such as by Sen. Richard Durbin, D-Ill., in reality will damage pension funds and economic incentives. Some of the same people advocating a windfall tax on oil profits because of high prices criticize WaI-Mart Stores Inc. for its low prices, and seek to impose regulatory or other restraints on the company to keep it from expanding its low-price strategy.
If politicians want to look into high oil profits and gasoline prices, they ought to examine regulatory, economic and corporate-erected barriers to more competition, barriers to increased domestic drilling on land and offshore, barriers to building more refining capacity, barriers to building more near-shore liquefied natural gas terminals, barriers to alternative energy sources.
But a windfall tax won't serve any purpose other than to bolster political rhetoric and hurt pension funds and other fund sponsors and the economy.
