By Maggie Angst, THE SACRAMENTO BEE
October 27, 2022
Nearly a month after California Gov. Gavin Newsom proposed a new tax on "greedy" oil companies charging high gas prices while enjoying unprecedented profits, his administration has shared few details about the plan.
Newsom called for a windfall profits tax that would fund rebates for California taxpayers getting squeezed at the pump. Underscoring the urgency of the matter, the Democratic governor called on state legislators to convene in Sacramento for a special session in December to hammer out the specifics.
"They're screwing you, taking advantage of you," Newsom said about oil companies after his gubernatorial debate on Sunday. "... A price gouging penalty to put money back in the pockets of people that are being taken advantage of is not only the right thing to do, it's the moral and ethical thing to do."
But interviews with economists and oil industry observers suggest that passing and successfully implementing such a tax poses difficult political, legal and practical questions. The levy could lead to unintended consequences, some warn, including even higher gas prices.
"If the goal is to claw back some of the profits from these extreme price spikes, I think a windfall profits tax could potentially do that," said Severin Borenstein, an energy economist at UC Berkeley. "... But the bottom line is this is not an easy thing to design, it's not an easy thing to administer, and I think it will take some very careful planning."
Some of the outstanding questions:
How will this affect gas prices?How much profit constitutes a windfall and what metric will be used to calculate it?How will the rebates work and who will be eligible?Will the policy be crafted as a 'tax' or a 'cap' on profits?Will the statute be set retroactively to address the 2022 spikes in gas prices or serve solely to deter future surges?
'What it does not do is reduce gasoline prices'
A windfall tax is intended as a check on companies when industry or economic conditions result in profits above a legally-established threshold.
Many economists say such a tax could be successful in trimming unprecedented profits and providing consumers with a cut of those earnings. But the half-dozen economists who spoke to The Sacramento Bee all wagered that it would do little to bring down California gas prices.
"The only three purposes I see for a windfall profit tax is as transfer income, punishment (for oil companies) or political attention," said James Sweeney, a professor of management science and engineering at Stanford. "What it does not do is reduce gasoline prices. If you tax the producers of gasoline that does not reduce the price of gasoline."
In fact, Borenstein said, a poorly designed windfall profits tax could actually drive up the cost of gas in the Golden State.
"The concern is that you don't want to make it uneconomic to produce more product," he said. "Because if you do, that would cause the price of gasoline to go up."
The average price of gasoline in California has fallen 76 cents from its peak of $6.44 in June, according to data from AAA. Yet it remains substantially higher than in other states. It was $5.68 on Wednesday -- nearly $2 higher than the national average of $3.76.
While California gas prices are routinely higher, such a significant gap is unprecedented.
The rise and fall of gasoline prices is typically driven by global factors out of the hands of a state governor like Newsom. They fluctuate with the price of crude oil, which is determined by circumstances affecting supply and demand. Events like the Ukraine War, pipeline and refinery disruptions and policy shifts by the Organization of the Petroleum Exporting Countries or OPEC all play a role.
But Newsom argues that the situation in California cannot be attributed to international market forces. Gas prices failed to budge as the cost of crude oil recently dropped. He blames the differential on Big oil "ripping Californians off" to make record profits.
In its latest earning report released on Tuesday, Valero reported making $2.82 billion from July to September of this year, up from $463 million during the same period last year - a spike of more than 500%. Other major oil companies serving California, including Chevron and Marathon Petroleum, are expected to report their third quarter earnings soon.
And while the governor assures that consumers would not bear the burden of the tax, Alan J. Auerbach, director of the Burch Center for Tax Policy and Public Finance at UC Berkeley, said there is no guarantee that the state can prevent companies from passing the added costs on to motorists at the pump.
"You can put the tax on the companies and say you're taxing their profits, but if this leads to higher prices of gasoline then (consumers) would end up paying some of the taxes," Auerbach said.
But Jamie Court, president of the non-profit organization Consumer Watchdog, said that while the tax would not directly bring down gas prices, it would serve as a "deterrent" for extreme price spikes in the future.
"When the profits at these levels are seen, they cannot be allowed to be repeated,"said Court, a leading supporter of Newsom's proposal. "Otherwise we'll have a new threshold as to what's acceptable."
Much depends on how legislators choose to define windfall profits.
Newsom has yet to offer his definition or what measurement he would use to establish that threshold. For instance, it could be designed as a surcharge on corporate income taxes or on a refinery's baseline gross refining margin -- the difference between the value of the refined product and the cost of the crude oil and other feedstock used to make it.
Court's organization has recommended taxing oil companies when they exceed a gross refining margin of 50 cents per gallon -- a level that he says has only been reached a handful of times prior to 2022.
According to Court, this approach could help discourage companies from manipulating their books and allow the state to define the measure as a profits cap rather than tax. A cap would require a simple majority for legislative passage rather than the two-thirds needed for a tax.
"If the money doesn't go to the state and the state doesn't use it for purposes other than giving it back to consumers, then that's technically not a tax," Court said. "That's a refund."
Questions linger about Gavin Newsom's oil windfall tax
While imposing a windfall profits tax on oil companies is not a new idea, a state-level regulation targeting companies that extract, produce, and refine oil would be the first of its kind.
Spain, Greece, Italy and the U.K., have all recently implemented windfall taxes on energy providers. The last time the U.S. adopted one was at the federal level in 1980.
President Jimmy Carter introduced the levy on crude oil, imposing a 50-70% excise tax on the amount by which crude oil prices exceeded a base price indexed for inflation.
It didn't exactly live up to expectations. Oil companies figured out ways to manipulate the system and gas companies reduced domestic investments. The tax generated $80 billion, 80% less than the projected $393 billion, according to the Library of Congress. It was repealed in 1988.
In 2006 Alaska adopted a similar measure for oil produced in the state, taxing the net value of oil and natural gas -- production costs minus the market value per barrel -- and increasing that tax as the net value rose above $40 per barrel. Once again, the policy fell short of projected revenue goals and led to a decline in production.
Unlike those regulations, Newsom's proposal is intended to address price spikes at refineries rather than on crude oil. Still, Borenstein said it "demonstrates the sorts of problems you could have when you try to walk this line."
Newsom has yet to reveal details of his proposal, telling reporters on Sunday that he has set a "date with destiny -- December 5," which marks the first day of the special session.
Legislators will be tasked with hammering out the specifics, including equity questions posed by who will be eligible for rebates generated by the tax. Will it be distributed based on income level or the number of miles an individual drives annually? Will only registered California drivers be eligible for the payments?
They'll also need to decide when it will take effect. Will it be adopted retroactively to claw back historic profits already realized by oil companies since the second quarter of 2022 -- or merely put in place as a mechanism to block future price spikes?
Kirk Stark, a professor of tax law and policy at UCLA, believes that it's "administratively doable" but may not be without some "unintended consequences," depending where lawmakers come down on some of these outstanding questions.
"You can likely expect that something like this is not going to work perfectly," Stark said. "But at the same time, we're not talking about disrupting a perfectly free market. This is an industry that has benefited from some significant market-distorting tax subsidies over the years."
The mysterious surcharge hidden in California gas prices
Some of California's higher-than-average gas prices can be explained by factors such as the state's 54-cent gasoline excise tax -- the second highest in the nation -- and stringent environmental rules that mandate the production of special fuel blends. California is also considered a "fuel island," because it's largely dependent on a handful of companies that refine oil instate because there are no pipelines bringing oil from other refining regions.
But that doesn't completely explain why prices in California are so high, according to Borenstein, who has spent years studying the subject.
There's also what he calls the "mystery surcharge." It appeared in 2015 after an explosion at a Torrance oil refinery and has ratcheted up since then to about 40 extra cents per gallon. Borenstein estimates that the price premium has amounted to more than $40 billion over the past seven years.
Newsom's proposed oil windfall profits tax will not address this unexplained charge -- an issue that Borenstein and Sweeney argue should really be the focus of state regulators.
"That's what is really draining drivers pockets," Borenstein said. "It's very easy to get distracted with these price spikes but that's just not something that is costing California nearly as much."
Sweeney agrees, adding that the state should order an investigation to figure out what factors are contributing to these unexplained costs, including whether contracts between refiners and retailers may be part of the problem.
"I think that the governor is talking about creating a special session of the legislature to solve a problem that they don't really understand the genesis of," he said. "And I don't like that as a method of making policy."