Wednesday, September 03, 2008

Windfall Profits Tax on Corn, Soybeans, Wheat?

Crop price increases above (click to enlarge) are from the Chicago Fed's August 2008 Agricultural Newsletter, and crude oil is from the St. Louis Fed.

What about a windfall profits tax on corn and soybean farmers? After all, the prices for their products have increased more than oil over the last year, 69% and 88% for corn and soybeans vs. 61% for oil. And compared to two years ago, corn (162%) and soybeans (153%) have increased more than two times as much as oil (59%), even more reason to impose a windfall profits tax on Big Corn and Big Soybeans. And don't forget wheat, it's increased in price by 92% over the last two years, so let's impose windfall profits taxes on Big Wheat.

As Dean Baker explains, "Oil companies (MP: add corn and soybean farmers here) are making enormous profits at present because oil (corn and soybean) prices went up far beyond what almost anyone had anticipated. In other words, Exxon-Mobil, Shell, and the others (Big Corn and Big Bean) had not anticipated $120 a barrel oil ($5.50 and $12.50 per bu.) when they undertook their investments (bought farm equipment and farm land) 10-20 years ago. They would have made a fine profit if oil (corn and soybeans) had stayed in the range of the $30-$40 a barrel ($2 and $5 per bu.) they anticipated when they made their investments. The gap between the return they expected and the return they are getting because of unanticipated events is what economists call a "windfall."

In other words, any argument in favor of windfall profits tax on oil could also be made for any commodity, like corn and soybeans, whose prices "went up far beyond what almost anyone had anticipated." Windfall profits taxes for Big Corn, Big Bean, and Big Oil.


At 9/04/2008 6:59 AM, Anonymous Anonymous said...

Hi Mark,

Glad to see you posting on my note. While we could in principle put a windfall profits tax on any commodity, as you note, there is a big difference between oil and the other items on your list.

The short-term supply elasticity for oil is extremely low. There is very little oil that is profitable to pull out of the ground at $140 a barrel, that is not also profitable to pull out of the ground at $120 or $100 a barrel, once the holes have already been dug.

As I note, if oil companies anticipate that future windfalls might be partially taxed away, they will undertake less exploration, but given the long lead times between exploration and bringing oil to the market, it could be a decade or more before we see any noticeable effect.

On the other hand, farmers make decisions on planting crops every year. If the price of corn has tripled, then we want farmers to get the market signal to plant more corn next year. If they expect to see their profits on corn taxed away, then they will not increase their corn production and we will continue to see very high corn prices.

The key issue here is the difference in short-run supply elasticities. That is why a windfall profits tax on oil can make sense in a way that a windfall tax on corn or barley would not.

At 9/04/2008 8:16 AM, Anonymous Anonymous said...

"it could be a decade or more before we see any noticeable effect"

Isn't that the precise reason why windfall profit taxes are not a great idea? Aren't we simply driving production of oil out of the U.S. over the long term and raising dependence on foreign oil?

At 9/04/2008 9:54 AM, Anonymous Anonymous said...

Having probably evaluated more energy investments than Dean Baker, I can say that this statement is dubious and misleading:

In other words, Exxon-Mobil, Shell, and the others had not anticipated $120 a barrel oil when they undertook their investments 10-20 years ago.

When we evaluate a project we recognize prices are uncertain. We do not assume some discrete case ($30 or 40 oil) will prevail for the next 20 years. We recognize there is a chance prices will go up, and there is a chance prices will go down.

We assume the risk that prices will go down in part because we benefit from the outcome if prices go up.

If the government wants to take away the upside (more so than the 35% windfall it already receives from the additional income tax revenue, from capital risk that it did not take) then perhaps it should take away the downside as well.

In any case, if an investor can expect that government will take away the upside, it fundamentally changes the risk/reward profile of the project.

A higher price would be required to go after the same reserves.

In addition, we live in a world where capital is mobile. A government that changes the rules midgame will cast a cloud over future investment. I worked with a power plant developer that considers California a place with the equivalent of 3rd world country political risk.

At 9/04/2008 11:07 AM, Anonymous Anonymous said...


Well said, sir.

At 9/04/2008 12:46 PM, Blogger bob wright said...

"On the other hand, farmers make decisions on planting crops every year."

True, but they also buy capital equipment that can run into the millions.

It would seem that the decision to buy a $750,000 [this is a guestimate] tractor must be taken with more than one year of profits in mind.

At 9/04/2008 7:56 PM, Blogger juandos said...

Hmmm, I noticed that dean baker doesn't seem to care who's money the government steals via the taxation system...

So much for pensioners, widows, and children eh, baker?

Average Joes own Big Oil, says API-commissioned study by leading economists

Maybe John Hofmeister can explain it to you...

At 9/05/2008 2:40 PM, Blogger OBloodyHell said...

> California a place with the equivalent of 3rd world country political risk.

I'd put it at more of "another world" political risk.

I don't think there is one single shred of evidence to support the notion that their politicians have any connection to the Real World.

One might as well speculate on the effects of events changing in Melniboné for all the connection California politics has to this world

At 9/05/2008 4:29 PM, Anonymous Anonymous said...

I'd put it at more of "another world" political risk.

I may not have done a good job explaining "political risk".

There are a handful of general risk categories one would consider before embarking on a capital intensive, long lived energy project.

"Commodity price risk" is clearly one. Then there are things like "geological risk" (is the oil there, can it be produced) and "market risk" (is there enough infrastructure to connect me to illing buyers).

Oil is an international business, so there is also talk of 'Country risk". Will Hugo Chavez let me keep my asset after I have oil production. Will Valdidmir Putin kill me with some new tax. (there is a term we use called "creeping expropriation" where the host government slowly bleeds the your economic return away with new rules and taxes without an old-style outright nationalization.

Countries develop reputations for having high or low political risk based on their behavior. The more risk the country is perceived to have, the higher return on capital one would need to see to invest there. Obviously, only an idiot would invest in a big project in Venezuela right now.

Anyway, there was one company I worked with that rated California about as risky a political environment to invest in as a 3rd world country for electric power. Their interference in the market and threats of nationalization a few years back did not go unnoticed. The people of California will pay more for power because of it.

Capital is mobile.

The other big issue for the windfall profit taxers is that most of the oil in question (the oil that drives the profits of companies like ExxonMobil) is not domestic oil. If a company like ExxonMobil is subject to a massive tax on oil produced in Nigeria but a company like BP, Shell, Total or Agip is not, you can be pretty sure the US company will not own that oil for long, and will not be competitive for any new projects. At some point there is a limit to the amount US tax they are willing to pay on their foreign operations before they just up and leave.

At 9/12/2008 8:26 PM, Anonymous Anonymous said...

We are indeed in an age that most have not clue about any aspect of farming.


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