The Crude Oil Windfall Profit Tax of the 1980s: Implications for Current Energy Policy

CRS Report for Congress
The Crude Oil Windfall Profit Tax of the 1980s:
Implications for Current Energy Policy
March 9, 2006
Salvatore Lazzari
Specialist in Public Finance
Resources, Science, and Industry Division

Congressional Research Service ˜ The Library of Congress

The Crude Oil Windfall Profit Tax of the 1980s:
Implications for Current Energy Policy
In April 1980, the federal government enacted the crude oil windfall profit tax
on the U.S. oil industry. The main purpose of the tax was to recoup for the federal
government much of the revenue that would have otherwise gone to the oil industry
as a result of the decontrol of oil prices. Supporters of the tax viewed this revenue
as an unearned and unanticipated windfall caused by high oil prices, which were
determined by the OPEC (Organization of Petroleum Exporting Countries) cartel.
Despite its name, the windfall profit tax (WPT) was actually an excise tax, not
a profits tax, imposed on the difference between the market price of oil and an
adjusted base price. While most domestically produced oil was subject to the tax
(about 2/3 in 1985), the remaining 1/3 that was tax-exempt was significant (1.3
billion barrels in 1985, or 360,000 barrels per day). The $80 billion in gross revenues
generated by the WPT between 1980 and 1988 was significantly less than the $393
billion projected. Due to the deductibility of the WPT against the income tax,
cumulative net WPT revenues were about $38 billion, significantly less than the $175
billion projected. This report presents estimates of the amount of foregone oil
production from 1980-1986 due to the WPT under three alternative supply price
responses, reflecting three different assumptions about the price elasticity of the
domestic oil supply function, a critical factor (statistic) in estimating lost oil output
and increased import dependence. From 1980 to 1988, the WPT may have reduced
domestic oil production anywhere from 1.2% to 8.0% (320 to 1,269 million barrels).
Dependence on imported oil grew from between 3% and 13%. The tax was repealed
in 1988 because (1) it was an administrative burden to the Internal Revenue Service
(IRS), (2) it was a compliance burden to the oil industry, (3) due to low oil prices, the
tax was generating little or no revenues in 1987 and 1988, and (4) it made the United
States more dependent on foreign oil. The depressed state of the U.S. oil industry
after 1986 also contributed to the repeal decision.
Reinstating the windfall profit tax would reduce recent oil industry windfalls
due to high crude and petroleum prices but could have several adverse economic
effects. If imposed as an excise tax, the WPT would increase marginal production
costs and be expected to reduce domestic oil production and increase the level of oil
imports, which today is at nearly 60% of demand. Crude prices would not tend to
increase. Some have proposed an excise tax on both domestically produced and
imported oil as a way of mitigating the negative effects on petroleum import
dependence. Such a broad-based WPT would tend to reduce import dependence, but
it would lead to higher crude oil prices and likely to oil industry profits, potentially
undermining its original goals. Because the pure corporate profits tax is relatively
neutral in the short run — few, if any, price and output effects occur because
marginal production costs are unchanged in the short run — a possible option would
be a corporate income surtax on the upstream operations of crude oil producers.
Such a tax that would recoup any recent windfalls with less adverse economic
effects; imports would not increase because domestic production would remain
unchanged. In the long run, such a tax is a tax on capital; it reduces the rate of return,
thus reducing the supply of capital to the oil industry.

Background ......................................................1
The Oil Price Control Program...................................1
Origins of the Crude Oil Windfall Profit Tax of 1980..................3
Amendments to the Windfall Profit Tax............................4
Repeal of the Windfall Profit Tax.................................5
Structure of the Tax................................................5
Rationale for the Windfall Profit Tax..................................8
Oil Price Decontrol and Windfall Profits............................8
Distributional Equity (“Fairness”)................................10
The Industry’s Historically Low Effective Tax Rates.................11
Budget Deficits and the Need for Additional Revenue................13
Economic Effects.................................................14
Revenue Effects: Projections vs. Realizations......................14
Revenue Effects: Gross vs. Net Actual Revenue....................16
Effects on Domestic Oil Production and Oil Imports.................18
Estimates ...............................................19
Economic Efficiency and Resource Allocation......................22
The Burden of Tax Compliance and Administration..................23
Reasons for Repeal of the Windfall Profit Tax......................25
Windfall Profit Tax Legislation in the 109th Congress....................28
Excise Tax Type of WPT.......................................28
Income Tax Type of WPT......................................28
Economic and Policy Issues.....................................29
Current Market Conditions.................................29
The Question of Windfall Profits.............................29
Economic Implications....................................31
Alternative Policy Options......................................32
Technical Appendix...............................................34
List of Tables
Table 1. Summary of the Oil Price Control Program in 1979...............4
Table 2. Structure of the Crude Oil Windfall Profit Tax...................7
Table 3. Gross Windfall Profits Tax Revenues: Projected vs. Actual,
Fiscal Years 1980-1990........................................15
Table 4. Estimated Revenue Effects of the WPT, Fiscal Years 1980-1990....17
Table 5. Estimated Reduction in Domestic Oil Production in Response
to the Windfall Profit Tax......................................21

The Crude Oil Windfall Profit Tax of the
1980s: Implications for Current
Energy Policy
Recent high crude oil and petroleum product prices, have sharply increased oil
industry profits, which have prompted some policymakers to propose that either the
windfall profit tax of the 1980s (WPT) be reinstated or that some new version of that
tax be enacted. Currently, fourteen congressional bills propose some type of windfall
tax on domestic oil companies. Three of these bills have been offered as amendments
to S. 2020, the Senate’s tax reconciliation bill. Such proposals are not uncommon
when oil prices rise sharply to high levels. The doubling in oil prices from June to
August of 1990, due to the crisis in the Middle East (Iraq invaded Kuwait on August
2, 1990), prompted similar proposals to reduce what many policymakers viewed as
an unduly large increase in oil industry profits.
This report provides an overview and analysis of the crude oil windfall profit
tax that was in existence from 1980 to 1988. The first section provides a brief history
of events surrounding enactment of the tax. The second section describes the
structure of the tax. The third section discusses the rationale for the tax. The fourth
section examines the revenue effects and other economic effects, and shows how the
windfall profit tax increased dependence on imported oil. The lessons that can be
learned from the eight-year experience with the tax and the implications of
reinstating the tax are discussed in the final section.
The Crude Oil Windfall Profit Tax Act (P.L. 96-223) was enacted in 1980 as
part of a compromise between the Carter Administration and the Congress over the
decontrol of crude oil prices. The structure of the WPT was based on the structure
of the oil price control program.
The Oil Price Control Program
From August 1971 to January 1981 the price of domestic oil was controlled by
the federal government — it was constrained from rising to market levels. Oil price
controls were initiated under President Nixon’s general wage-price freeze of August

15, 1971, which consisted of four stages or time periods called phases, each with

various degrees of controls.1 These controls were not focused on oil alone — they
applied generally to most goods and services. The general wage-price freeze
terminated in 1973, but under phase IV of the program — effective from August 12,

1973 to April 30, 1974 — price controls on petroleum were retained.

Oil price controls were extended through 1975 under the Emergency Petroleum
Allocation Act of 1973 (P.L. 93-159) — enacted in November 1973, at the onset of
the Arab oil embargo.2 This law created the two-tiered price control program, making
the structure more complex. Most domestically produced oil was categorized as
either “lower tier (old) oil” or “upper tier (new) oil,” each with its corresponding
controlled base price. Lower tier oil was generally oil from properties that began
production before 1973. Under regulations, the price ceiling on this oil was the
highest posted price in effect on May 15, 1973 plus $0.35/barrel on all oil produced
from wells that produced at less than their 1972 levels, which resulted in a posted
price for old oil of about $4.25/barrel. Subsequent regulations increased the ceiling
price in 1973 to $5.25/barrel. New oil (oil produced from wells that began production
in1973), stripper oil (oil produced from wells that produce 10 bpd or less), and
imported oil were not price controlled — it could be sold at the market clearing price,
which was determined by the delivered prices of imported crude inclusive of the
customs duties. Note that these tiers were artificial designations for the purposes of
controlled pricing; the distinctions were made only for purposes of establishing
different base prices; they had no other meaning.
Oil price controls were amended under the Energy Policy and Conservation Act
of 1975 (EPCA75), and the Energy Conservation Act of 1976 (ECA). EPCA75 (P.L.
94-163 ) replaced the two-tiered price control system with a three-tier system. Lower
tier oil was oil produced below the “base production control level,” — the level
below the 1975 average monthly production; upper tier oil was output in excess of
this base level or output from new wells — those brought into production after 1975.
Stripper oil was initially classified as (controlled) upper tier oil, but subsequent
changes (see below) decontrolled it altogether. EPCA75 also established a national
average price for all oil of $7.66/barrel, the weighted average price of lower tier oil
(old oil), which had a ceiling of $5.25/barrel and upper tier oil (new oil and stripper
oil), which, by this time also became controlled at $11.28/barrel. The average
domestic oil price was permitted to increase at the rate of 10% annually. (In 1975,
uncontrolled imported oil sold for about $13.25/barrel. At the onset of the oil price
control program, domestic oil prices were just above $3 per barrel.) EPCA75 also
gave the President the discretionary authority to end oil price controls anytime
between May 31, 1979 and September 30, 1981 — on October 1,1981 all controls
would expire. The ECA of 1976 made further (mostly technical) amendments to the
price control system — e.g., exempting stripper oil from the price controls — but
otherwise it left the basic structure of the oil price control program intact. Thus, in

1 Wage and price controls were authorized under the Economic Stabilization Act of 1970.
2 The Yom Kippur was occurred in October 1973, and the Arab oil embargo lasted from
October 1973 to April 1974. The Emergency Petroleum Allocation Act also created the
Crude Oil Entitlement Program and other programs intended to subsidize and protect small
refiners. For a discussion of that program see CRS Report RL32248, Petroleum Refining:
Economic Performance and Challenges for the Future, by Robert Pirog.

1979, on the eve of the WPT, the oil price control program categorized all domestic
oil production into these tiers, each with its own corresponding controlled or market
price. Table 1 summarizes this structure, which was the foundation for the 1980
EPCA75 also gave the President discretionary authority to gradually phase out
oil price controls over the 28 month period between June 1, 1979, and September 30,
1981, after which prices would rise to world market levels. On April 5, 1979, the
Carter Administration announced its intention to use that authority, and throughout
its remaining term in office price controls on petroleum products and various types
of crude were selectively decontrolled. The intent of the gradual decontrol was to
promote energy conservation and to stimulate energy exploration and production
without the dislocations that might result with sudden decontrol. Between April
1979 and January 1981, oil prices were partially and gradually decontrolled — newly
discovered oil was completely decontrolled, but price controls on other types of oil
continued. President Reagan repealed price controls on January 28, 1981, which was3
one of his first official decisions as President.
Origins of the Crude Oil Windfall Profit Tax of 1980
Excess profits taxes are extraordinary measures as tax policy instruments, their
use limited to wartime or other periods characterized by economic emergencies and
instabilities such as inflations and hyper-inflations. Such was the case with the surtax
on business profits imposed as a temporary measure to control large profits earned
during World Wars I and II, and the Korean War.4
The origin of the 1980 WPT was, as with many other energy taxes and energy
tax subsidies, the first oil crisis of the 1970s — the Arab Oil Embargo of 1973-74.
Between 1973 and 1980, attempts to decontrol oil prices were accompanied by
proposals to impose an excess profits tax. In 1974, the Ford Administration proposed
an “emergency windfall profit tax” to recapture oil industry windfalls resulting from
price decontrol. In August of 1975, the Senate Finance Committee approved a
windfall profit tax conditioned on price decontrol. Congress, however, did not
decontrol oil prices. In 1977, the Carter Administration proposed an oil tax similar
to the 1980 windfall profit tax — the crude oil equalization tax — as part of a5
program to restructure the existing price controls. These proposals were the
precursors of the 1980 windfall profit tax.

3 For more detail on the oil price control program see Kraft, John and Mark Rodekohr.
Crude Oil Price Controls: Their Purpose and Impact. The Denver Journal of International
Law and Policy, winter 1979. pp. 315-333.
4 Hakken, John. Excess Profits Tax. The Encyclopedia of Tax Policy. Joseph J. Cordes,
and Jane Gravelle, eds. The Urban Institute Press, 1999. pp. 108-111.
5 U.S. Congress. Senate. Energy Tax Provisions, 4: Crude Oil Equalization Tax and
Rebate. Committee Print. Senate Finance Committee. September 19, 1977. U.S. Govt.
Print. Off. Washington, 1977.

Table 1. Summary of the Oil Price Control Program in 1979
Quantity of
productionPrice at the
(million w ellhead
Type of oilDefinitionbarrels/day)($/barrel)
Lower Tier OilOil from properties that
(Old Oil)began producing before3.0$5.86
Upper Tier (NewOil from properties that
Oil)began producing after3.0$13.06
Uncontrolled OilStripper oil, Alaskan
North Slope oil, and oil2.6$18.50a
from the Naval Petroleum
Source: U.S. Congressional Budget Office, The Decontrol of Oil Prices: An Overview, Background
Paper, May 1979, pp. 5-7.

a. Price for uncontrolled oil is at the refinery gate, which is basically the import price plus
transportation costs.
The windfall profit tax that was ultimately enacted in 1980 originated with
President Carter’s April 5, 1979 decision to gradually phase out price controls
between June 1, 1979, and September 30, 1981, as discussed above. At the same
time, the Carter Administration announced its proposal to impose a WPT “to prevent
unearned excessive profits” by the oil industry. In Congress, the Carter
Administration’s original windfall profit tax bill, H.R. 3919, was proposed by
Representative Al Ullman, Chairman of the Ways and Means Committee. The
House approved an amended version on June 28, 1979. The Senate approved its
version at the end on 1979, and the House-Senate Conference deliberated for about
three months. President Carter signed the bill into law on April 2, 1980.
Amendments to the Windfall Profit Tax
The WPT was amended many times after it was enacted in 1980. Virtually
every tax law that was enacted between 1980 and 1988 made some type of
amendment to it, usually minor and technical, but sometimes, significant. For
example, the Technical Corrections Act of 1982 (P.L. 97-448) made several minor
and technical amendments. Major changes were made, however, under the
Economic Recovery Act of 1981 (P.L. 97-34), which reduced tax rates on newly
discovered oil, made stripper oil (from small wells) tax exempt, and introduced a tax
credit for royalty owners.
Soon after enactment of the WPT there were proposals to reduce tax rates,
liberalize some of the provisions. Proposals to repeal the WPT altogether were also
common throughout the eight-year life of the tax. Repeal was part of President
Reagan’s platform in the 1980 presidential campaign and repeal proposals were

embodied in the Administration’s FY1988 and FY1989 budgets.6 WPT repeal was
part of the Treasury Department’s tax reform proposal of 1984 as part of a
compromise that would have repealed the oil industry’s two major tax incentives
(subsidies): the percentage depletion allowance and expensing of intangible drilling
costs. In the spring of 1986, there was speculation that a WPT repeal proposal would
be part of the tax reform bills of 1986. The eventual law — the Tax Reform Act of

1986 (P.L. 99-514) — did not, however, repeal the WPT.

Another major repeal attempt was made through an amendment to the 1986 debt
limit bill (H.J.Res. 668) which would have increased the debt ceiling to over $2.3
trillion through FY1987. This amendment was approved by the House and Senate,
but it was deleted in conference. Some Members of Congress also favored repeal;
congressional support for repeal probably reached a peak in 1987 and 1988. In May
1987, for example, ten bills were pending in the Congress proposing to repeal the
Repeal of the Windfall Profit Tax
The actual repeal of the WPT in 1988 was made through an amendment to
omnibus trade legislation (H.R. 3). After hearings in the summer of 1987, the Senate
voted 58-40 in favor of a repeal amendment to the trade bill. The original House
trade bill, however, did not contain the amendment. While House conferees were
generally opposed to WPT repeal, conferees from the Senate Finance and House
Ways and Means Committees did agree on a repeal amendment on March 31, 1988.
The House approved H.R. 3 with the repeal amendment on April 21, by a vote of

312-107. The Senate approved the conference report on H.R. 3 on April 27.

Enactment of H.R. 3 including the WPT repeal amendment was precarious because
President Reagan — objecting to several of the provisions in the trade bill — had
threatened to veto it. Eventually, however, these problems were resolved and the
trade bill with the repeal of the WPT was signed in August of 1988.7
Structure of the Tax
Despite its name, the crude oil windfall profit tax was not a tax on profits. It was
an excise tax — or more accurately, a system of excise taxes — on domestically
produced oil effective March 1, 1980. The tax was imposed on the difference
between the market price of oil, which was technically referred to as the removal

6 Executive Office of the President. Office of Management and Budget. Budget of the United
States Government: Fiscal Year 1988. January 1987. U.S. Govt. Print. Off. Washington.
p. 2-42; and Executive Office of the President. Office of Management and Budget. Budget
Document of the United States Government: Fiscal Year 1989. February 1988. U.S. Govt.
Print. Off. Washington. p. 4-16.
7 The tax was repealed by §1941(a) of P.L. 100-418, The Omnibus Trade and
Competitiveness Act of 1988.

price, and a statutory 1979 base price that was adjusted quarterly for inflation and
state severance taxes.8
All domestically produced oil that was not specifically tax-exempt was
classified into one of three categories or “tiers” based upon the age of the well, the
type of oil, and the amount of daily production. These categories were a carryover
from the oil price regulations which also categorized oil into various tiers. For
example, tier I oil was oil classified as lower and upper tier oil under price controls;
tier II and tier III oil was oil exempt from price controls. Domestic crude oil is oil
produced from an oil well located in the United States, or in any of its possessions,
and it includes the Continental shelf area of the United States.
For each oil category there was a corresponding tax rate (or rates, as explained
below) and a corresponding adjusted base price. The tax rates and adjusted base
prices differed not only according to the type of oil but also according to whether an
oil producer was an integrated producer (called a major) or an independent oil
producer. The tax rates applicable to oil sold by an independent oil producer were
lower than the tax rates applicable to oil sold by a major integrated producer.9 The
windfall profit tax liability on any barrel of oil was limited to 90% of the net income
(profit) from the sale of that oil, which was basically the taxable income (gross
income less costs) corresponding to that same oil.
Five categories of oil were originally exempt from the windfall profit tax: (1)
oil owned by a state or local government or any political subdivision thereof; (2) oil
owned by a qualified educational institution or a charitable medical institution; (3)
oil owned by Indian tribes or individual Indians on January 21, 1980, over which the
U.S. exercises trust responsibilities; (4) new oil produced from much of Alaska; and
(5) “front-end tertiary oil.”10 Stripper oil, and a limited amount of oil produced by
royalty owners, became tax exempt under an amendment in the Economic Recovery
Tax Act of 1981. Table 2 shows the structure of the tax just prior to its repeal. Note
that newly discovered oil is oil produced from a well which was not producing in
1978. For perspective, the average world market price was $32.37 in 1980, and
$13.25 in 1988.

8 P.L. 96-223 also contained amendments to the energy tax credits, as well as to several
non-energy tax provisions. See Joint Committee on Taxation. General Explanation of theth
Crude Oil Windfall Profit Tax Act of 1980 (H.R. 3919, 96 Congress; Public Law 96-223).
Joint Committee Print. U.S. Govt. Print. Off. Washington, 1981.
9 An independent producer was one that was not a integrated producer, i.e., one with no
more than 50,000 barrels per day in refinery capacity and $5 million or less in revenue from
any gasoline retailing operations.
10 This was oil from any well subject to price controls the revenues of which were used to
finance enhanced oil recovery projects up to $15 million. That is, only oil that generated $15
million in revenues or less for such projects was exempt from the WPT, and only through
September 31, 1981. Tertiary oil is oil that is recovered through certain enhanced oil
recovery techniques such as flooding the reservoir with hot water or steam, or gases such
as carbon dioxide. This is oil that is usually not recoverable through secondary recovery

Table 2. Structure of the Crude Oil Windfall Profit Tax
Average Basend
Average BasePrice in 2
Price in 1980Quarter of 1988
Oil TypeTax Rate($/barrel)($/barrel)
Tier I (most70% for Majors$12.81$19.54
domestic oil in
reservoirs50% for Independents$12.81$19.54
productive before


Tier II (oil from60% for Majors$15.20$23.19
stripper wells and
the Naval30% for Independents$15.20$23.19
Tier III (heavy oil,30% for heavy oil and$16.55$22.92
incremental tertiaryincremental tertiary oil
oil, and newly
discovered oil)22.5% for newly$16.55$22.92
discovered oil
Source: Sections 4986-4998 of 1986 Internal Revenue Code; Commerce Clearinghouse, 1987; and
Research Division of the Internal Revenue Service.
Notes: Tier I oil is oil that was lower and upper tier oil under EPCA75, and Sadlerochit oil from
Alaskas North Slope; Tier II and Tier III oil was uncontrolled oil under EPCA75; The 1981 ERTA
legislation changed the rate structure as follows: (1) The tax rate on new oil was reduced gradually,
but further reductions were frozen in 1984 so that the rate remained fixed at 22.5% until 1988; (2)
Stripper oil produced by independents was made tax-exempt; (2) Royalty owners received a tax credit
followed by an exemption for limited amounts of oil production.
The WPT was imposed on domestic oil producers at the point of the first sale
of taxable oil, which was generally to a refiner. The refiner — known also as the first
purchaser — withheld the tax from the amounts otherwise payable to a producer and
deposited the funds semi-monthly into an account. In other words, the tax amount
per barrel was subtracted from the oil’s purchase price. The first purchaser was
required to file tax returns on a quarterly basis. In cases where withholding was not
required, such as when the producer and first purchaser were one and the same, the
tax was paid directly to the Treasury.
The WPT was a deductible expense in determining an oil producer’s income tax
liability because, as with all other excise taxes, it was considered a cost of doing
business. As explained in a later section, this meant that, as a result of paying the
WPT, a producer’s income tax liability was lower than it would have been without
the tax.
The WPT was a temporary tax. The statute provided that the tax would begin
to phase out sometime during the three-year period between January 1988 and

January 1991. The precise starting point for the phase out depended on cumulative
net revenues. If the Secretary of the Treasury reported that, on a given month
beginning January 1988, cumulative net revenues would exceed the pre-established
target of $227.3 billion, then the phaseout of the tax would begin on the month
following the attainment of the target. If estimated cumulative net revenues would
not exceed $227.3 billion between January 1988 and January 1991, then the phase
out of the tax would begin January 1991. Irrespective of the onset of the phaseout,
once the phaseout began, the tax was to have been phased out over a 33-month period
by reducing each producer’s tax by 3% each month (with 4% on the last month).
Cumulative net revenues, which totaled about $43 billion between 1980 and
1987, fell far short of the $227.3 billion target. Hence, had it not been repealed, the
WPT phase out would have begun January 1991 and the tax would have terminated
on October 1, 1993. As already discussed, the WPT was repealed in August 1988,
before the onset of the phase-out rules.
Finally, while the tax was called a “profit” tax, it was not really a profit tax but
rather a special type of excise tax — a selective excise tax on oil producers. The tax
was paid first, before profits from the sale of the oil were determined. And except
for the net income limitation, profits had no bearing on how much WPT was paid.
The base prices had no precise or even approximate relationship to the costs of oil
production. This difference between an excise tax and a true excess profit tax is
crucial because, as will be demonstrated, the two taxes have very different economic
effects, particularly on energy prices and oil imports.
Rationale for the Windfall Profit Tax
The WPT resulted from a compromise between the Carter Administration,
which wanted to decontrol oil prices, and the Congress, which generally did not;
without the tax, many doubted that the Congress would have supported oil price
The reasons for the tax are manifold and complex; they transcend economics
and they concern the image and perception of the oil industry. The record does show,
however, that the Congress was concerned that the industry would reap enormous
revenues and profits as a result of decontrol to world oil price levels. The Congress
believed that the projected huge redistribution of income from energy consumers to
energy producers would not be fair. The Congress was concerned that the oil
industry was not paying its fair share of federal taxes. And finally, the Congress was
looking for additional sources of revenue.
Oil Price Decontrol and Windfall Profits
Price decontrol implied that domestic crude oil prices would rise from an
average of about $14 per barrel (1979) to world market levels, which at that time

were averaging about $24 per barrel and projected by some to rise to $50-$60 per
barrel or more by 1985.11
In 1979, many analysts were predicting sharp increases in domestic oil prices
and, with them, significant increases in oil industry revenues and profits. The Joint
Committee on Taxation had estimated that decontrol would increase oil industry
revenues by about $1 trillion from 1980-1990 and profits by over $400 billion.
Federal policymakers believed that these added profits were in the nature of a
“windfall” — an unearned, unanticipated gain in income through no additional effort
or expense. This windfall was thought to provide no additional incentive to produce
more oil, especially “old oil,” which was already being produced under the
preexisting controlled price regime. Rather, existing oil reserves would simply be
worth more — command a higher price by virtue of price decontrol. Moreover, all
oil would command a higher price, including oil that was discovered at historically
low costs, and produced at the controlled price. Old oil, which was primarily owned
and produced by the major oil companies, was selling for about $6 per barrel prior
to decontrol; after decontrol it would have increased to a market price of about $24
per barrel. The Congress was concerned that no additional effort, investment, or cost
would be incurred by oil producers in generating the added profits. The Congress
also believed that a higher price was not needed for all oil in order to stimulate its
production — but that a higher price might be needed for new oil. The decision to
produce much of the oil had been made with the expectation of a return based on the
controlled price.
The following quote illustrates the concerns of the Congress:
For most types of oil, after a certain point, these higher prices will only lead to
very limited increases in production. The revenues resulting from these higher
prices, however, would provide income to oil producers far in excess of what
most of them originally anticipated when they drilled their wells and in excess
of what they might now be expected to invest in energy production. Indeed, some
producers are now using their excess revenues to acquire unrelated businesses.
Thus, the committee believes that the additional revenues received by oil
producers and royalty owners, both as a result of decontrol of oil prices and as
a result of increases in world oil prices substantially above those prevailing in
1978, are an appropriate object of taxation. The windfall profit tax in this bill
will tax away a fair portion of these additional revenues while allowing
producers to receive very high prices for those types of oil whose production can12
be expected to increase in response to that incentive.
Other motivations and factors underlying imposition of the windfall profits tax
were that

11 CRS Report 88-147, Oil Price Projections and the Windfall Profit Tax on Crude Oil, by
Salvatore Lazzari.
12 U.S. Congress. House. Crude Oil Windfall Profit Tax Act of 1979. Report of the
Committee on Ways and Means. Report No. 96-304, June 22, 1979. U.S. Govt. Print. Off.
Washington, 1979.

!Domestic crude prices would rise to market levels that did not reflect
competitive market forces but the market power of OPEC; and,
further, OPEC’s prices were projected to increase in real terms at
very high rates, usually assumed to be 3% per year.
!The market price of oil was believed to be in a sense
“unanticipated,” unearned, and unneeded for the profitability of the
oil industry.
!Society should share in the economic return to natural resource
!Oil is a natural resource whose long-run supply is fixed; it is not like
other factors of production such as labor and capital. The stock of
natural resources is fixed in the long run whereas the stock (or
supply) of the other factors is variable. Since the stock of oil is fixed,
some argued that high levels of industry income were not necessary
to ensure adequate supplies. If low levels of income would ensure
adequate oil supplies, then any industry income above that income
earned from alternative use of industry resources could be deemed
excessive (economic rents) and should be taxed away.
!Some believed oil industry income was excessive to start with due
to the concentrated structure of the domestic oil industry and due to
the fact that domestic price of oil was not a competitively
determined price.
Additionally, it should be remembered that the WPT was enacted in the wake
of two oil shocks in the 1970s: (1) the 1973-1974 oil embargo, which raised oil
prices fourfold and (2) the 1978-1979 Iranian revolution, which doubled oil prices,
and created gasoline shortages (and long lines of motorists at the gasoline pumps).
Also there was a certain amount of public suspicion of the oil industry; suspicion that
the energy crisis was not real but a contrivance of the industry in concert with OPEC
for the purpose of profiteering.
Distributional Equity (“Fairness”)
Another rationale for the windfall profit tax was equity or “fairness.” It was
estimated that oil price decontrol would cause a large redistribution of income from
energy consumers to energy producers. Policymakers concluded that it was unfair
for the oil industry and landowners to experience such sharp increases in income
when so many consumers — particularly low-income consumers — would see a
sharp increase in their energy bills. They believed that society at large, through the
federal government’s policies, should also share in some of the income gains.
The fairness rationale was strongly influenced by the impact of higher energy
prices on poorer consumers. Although all energy consumers would experience a
higher absolute burden due to higher oil prices, including higher electricity prices,
natural gas prices, and coal prices, poorer people would experience a higher relative
burden. That is, in relation to their income, poorer persons spend more money on

energy and other necessities than higher income persons. Therefore, energy costs
represented a higher proportion of low income persons’ budgets than high-income
persons’ budgets — the burden from decontrol would be greater for low-income
persons than from high-income persons.
The windfall profit tax was intended to be the instrument for achieving a more
equitable redistribution of the income which would result from oil price decontrol.
Underlying this instrument was the belief that the oil companies were entitled to a
fair and reasonable return but not an “excessive” return, which was in any event
determined by OPEC-set prices rather than competitive prices.
The Industry’s Historically Low Effective Tax Rates
Another powerful argument for enacting the WPT was that the tax helped to
offset the oil industry’s low effective income tax rates due to the availability of two
oil industry tax subsidies (incentives): the percentage depletion allowance and the
provision which permits companies to expense (deduct fully in the initial year) the
intangible costs of drilling.
The percentage depletion allowance permits oil producers to deduct an amount
for the exhaustion of an oil reserve equal to a percentage of revenues. In theory, the
deduction should be based on the actual oil output and the actual investment costs of
the deposit — it should be cost depletion. The percentage depletion allowance was
introduced in 1926. In 1975 the allowance was eliminated except for a limited
amount of oil produced by independents. The deduction for intangible drilling costs
permits oil producers to expense — deduct contemporaneously — costs that,
according to economic theory and standard financial accounting practices, should be
capitalized over the income-producing life of the deposit. This subsidy or incentive
was introduced in a 1918 administrative ruling by the Treasury Department. The
cumulative value of these tax and other nontax subsidies from 1964-1977 has been
estimated at over $100 billion.13
In recent years, the value of these oil and gas subsidies has declined,14 but the
addition of other tax subsidies, such as the enhanced oil recovery tax credit, and,
more recently, the oil and gas tax breaks in H.R. 6 (P.L. 109-58) have, at a time of
very high oil prices, created more support for a windfall profit tax.15
The combined effect of the two major oil tax provisions was to lower effective
income tax rates for oil extraction below the comparable effective tax rates in other
industries and below the top marginal statutory income tax rate of 34% for

13 Pacific Northwest Laboratories. An Analysis of Federal Incentives Used to Stimulate
Energy Production. Prepared for the U.S. Department of Energy. December 1978. P.226.
14 According to the Joint Committee on Taxation, repealing the two oil and gas tax subsidies
would increase tax revenues by about $1 billion per year. See CRS Issue Brief IB10054,
Energy Tax Policy, by Salvatore Lazzari.
15 For a brief discussion of the energy tax provisions in H.R. 6, see CRS Issue Brief
IB10054, Energy Tax Policy, by Salvatore Lazzari.

corporations in 1980. This is supported by early as well as more recent empirical
research studies on effective tax rates.16
In the early studies, Harberger (1955) and Steiner (1959) demonstrated that oil
and gas, as well as other minerals, received approximately twice the amount of tax
incentives as other industries. In the category of effective tax rate studies, a 1971
report by U.S. Oil Week showed that major oil companies had an effective tax rate
of 8.7% in 1970. Cox and Wright (1973) calculated rates ranging from 8.3% to

14.7%, depending upon accounting methods and income measures used.17

Studies on effective tax rates published between 1973 and 1980 attempted to
include the cutback in subsidies and the windfall profits tax and gave mixed results.
Some studies, for example, showed that oil and gas extraction was subject to very
low effective tax rates. Several studies by the Congressional Research Service
published between 1977 and 1983 (when the corporate tax rate was 46%) show very
low and, under certain circumstances, even negative marginal effective tax rates. For
example, expensing of intangible drilling costs and dry hole costs and a 22%
depletion rate resulted in an effective tax rate of -3.0% without the minimum tax and
12.0% with the minimum tax.18 One CRS report, which included the effects of the
crude oil windfall profits tax, again showed generally low effective tax rates for oil
and gas extraction. In cases where the effective tax rates were low, however, the
crude oil windfall profits tax constituted a significant part of the total effective tax
burden.19 In an inter-industry comparison, oil extraction and production had the
lowest effective tax rates of eleven major industries — 14% compared to 17% for
construction (the next lowest) and 30% for the trade industry (the highest).20
Marginal effective tax rates in the oil and gas industry after 1986 increased due
to the repeal of the 10% investment tax credit, the lengthening of the recovery period
for depreciation, and the change in the depreciation methods. Studies continue to

16 A few representative studies include Harberger, Arnold C. The Taxation of Mineral
Industries. In U.S. Congress. Joint Committee on the Economic Report. Federal Tax
Policy for Economic Growth and Stability. Joint Committee Print, 84th Congress, 1st
session. November 9, 1955. Washington, U.S. Govt. Print. Off., pp. 439-449. Steiner,
Peter O. Percentage Depletion and Resource Allocation. In U.S. Congress.
Committee on Ways and Means. Tax Revision Compendium. Committee Print, 86st
Congress, 1 session, vol. 2, November 16, 1959. Washington, U.S. Govt Print. Off., p. 949.
17 Much of this early empirical evidence is cited in U.S. Congress. Senate. Committee on
Interior and Insular Affairs. An Analysis of the Federal Tax Treatment of Oil and Gas andrdnd
Some Policy Alternatives. Committee Print, 93 Congress, 2 session. Washington, U.S.
Govt. Print. Off., 1974. p. 18.
18 CRS Report 77-238, Tax Provisions and Effective Tax Rates in the Oil and Gas Industry,
by Jane Gravelle.
19 Effective Federal Tax Rates on Income from Oil and Gas Extraction. Typed Report by
Jane Gravelle, April 13, 1983.
20 Gravelle, Jane G. Effective Federal Tax Rates on Income from Oil and Gas Extraction.
Paper presented at the annual meeting of the Conference for Taxation, Resources and
Economic Development. October 1983. Cambridge, Mass. p. 6.

show, however, marginal effective tax rates below the statutory top marginal tax
rate, and below the comparable rate for most other industries.21
A 2000 Institute on Taxation and Economic Policy (ITEP) study found that, for
the three-year period 1996-98, petroleum and pipeline companies had the lowest
effective tax rate (12.3%) of 20 industries (the average effective tax rate for all the
industries was 21.7%).22 The study sampled 250 of the nation’s largest corporations.
In a 2004 update of the 2000 study, ITEP found petroleum and pipeline companies
had effective federal tax rates of 13.3% for the three-year period 2001-2003, but were
no longer ranked number one of the 20 industry classifications — they were ranked
6th.23 Gruber (2005) found that the mining and extraction industries combined had
an average marginal effective tax rate of 16.8%. While this was significantly below
the 35% marginal statutory tax rate for the period, it was only slightly below the
industry average of 17.4%.24
Budget Deficits and the Need for Additional Revenue
There were also important fiscal reasons for enacting the WPT — the federal
government needed money. Between 1961 and 1979 the federal budget was in deficit
in every year but one (there was a small surplus in FY1969). In FY1976 the deficit
reached $71 billion, which at that time was the highest level in U.S. history. This
deficit was 4.2% of Gross Domestic Product (GDP) the highest since 1946. In fiscal
years 1977, 1978, and 1979, the deficits were lower but still sizeable — $50 billion,
$55 billion, and $38 billion, respectively. Certainly they pale in comparison to the
deficits of the eighties and early 1990s but according to the standards of that time
they were still large. Recent deficits have been larger in absolute terms but
somewhat smaller relative to GDP. For example, in FY2004, total federal budget
deficits was $413 billion, which was 3.6% of GDP.25 In any event, revenues and

21 Rates for integrated oil companies ranged from 6% to 15%; rates for independent
producers ranged from 5% to 14%. This includes the effect of the minimum tax, which
basically raises the rate, and repeal of the windfall profit tax, which basically lowers the
rate. See Lucke, Robert and Eric Toder. Assessing the U.S. Federal Tax Burden on Oil and
Gas Extraction. Energy Journal, vol. 8, no. 4, 1987. CRS calculations showed an effective
marginal tax rate of 17% for integrated oil and gas producers. The rate for independents
was not reported. See also U.S. General Accounting Office. Tax Policy: Additional
Petroleum Production Tax Incentives Are of Questionable Merit. GAO/GGD-90-75, July

1990. Washington, 1990. p. 58.

Statutory marginal tax rates varied, and generally declined, during the life of the
windfall profit tax from 46% in 1980 to 34% in 1988, when the WPT expired.
22 Corporate Income Taxes in the 1990s. Institute on Taxation and Economic Policy,
October 2000.
23 Corporate Income Taxes in the Bush Years. Institute on Taxation and Economic Policy,
September 2004.
24 Gruber, Jonathan and Joshua Rauh. How Elastic is the Corporate Income Tax Base?
National Bureau of Economic Research. June 2005, Table 1.
25 Executive Office of the President. Office of Management and Budget. Budget of the U.S.

deficit reduction have not been the driving force behind the recent WPT proposals
in the Congress, although with large federal spending on the Iraq war, and hurricane
relief, any additional revenues would, if not spent, reduce the deficit.
Economic Effects
The major economic issues concerning the WPT and its effects were: revenues,
increased dependence upon foreign oil, economic efficiency, and the tax’s
administrative and compliance burden. As discussed above, the need for revenue
was one of the reasons for enacting the windfall profit tax and was a principal issue
in the debate over its repeal. However, the tax’s role in increasing dependence on
imported oil, distorting resource use in the energy markets and the economy, as well
as the administrative and compliance burden of the tax, all played a role in its repeal.
Revenue Effects: Projections vs. Realizations
Table 3 compares the original projections of gross windfall profit tax revenues
with actual revenues for fiscal years 1980-1990. Gross revenues are the actual tax
monies collected by the Internal Revenue Service (IRS) as a result of applying the
WPT rates to taxable crude oil production — they are revenues before any deductions
or allowances, and offsets. Note that these original 1980 projections are not adjusted
downward for changes in the tax laws enacted in 1981, 1982, and 1984, which tended
to reduce windfall profit tax revenues.26
As these data show, estimates or projections of the additional tax revenues from
decontrol with the WPT indicated that the federal government would generate, over
the 11-year period between fiscal years 1980-1990, an additional $393 billion in
gross revenues. Net revenues for this period were projected at $223 billion, reduced
by the loss of $170 billion in business income tax revenues due to the deductibility
of excise taxes as a cost of doing business. Including state and local severance taxes
and income taxes, and taxes on royalty income, all levels of government were
projected to receive about 50% of the additional revenue from oil price decontrol.
The oil industry was projected to receive the remaining 50%.27

25 (...continued)
Government, FY2006: Historical Tables. Table 1.2, p. 24.
26 The Economic Recovery Tax Act of 1981 (P.L. 97-34) made several changes to the
windfall profit tax which reduced revenues. The Tax Equity and Fiscal Responsibility Act
of 1982 (P.L. 97-248) increased the tax on Alaskan oil which increased revenues by about
$150 million per year. The Technical Corrections Act of 1982 (P.L. 97-448) made very
minor changes in the windfall profit tax which reduced revenues negligibly.
27 Berry, John M. And Art Pine. Conferees Approve $227.7 Billion Oil Tax. Washington
Post, February 2, 1980. p. A1. Under the original House and Senate Finance Committee
bills government would have received 75% and 54% of revenues from decontrol and a WPT,
respectively (25% and 46% for industry, respectively). See U.S. Congressional Budget
Office. The Windfall Profits Tax: A Comparative Analysis of Two Bill. Staff Working
Paper. November 1979. p. xviii.

Table 3. Gross Windfall Profits Tax Revenues: Projected vs.
Actual, Fiscal Years 1980-1990
($ millions)
Projected taxActual taxProjectedActual as % of
revenuesrevenuesless actualprojected
Year(1)(2)(1) - (2) = (3)(4) = (2)/(1)

1980 5,159 3,052 2,107 59%

1981 20,955 16,931 4,024 81%

1982 32,293 22,036 10,257 68%

1983 35,124 15,660 19,464 45%

1984 37,129 8,120 29,009 22%

1985 39,535 5,073 34,462 13%

1986 40,923 8,866 32,057 22%

1987 52,524 15 52,509 0%

1988 44,181 373 43,808 1%

1989 46,270 30 46,240 0%

1990 48,538 (86) 48,624 N.M.

Tot a l : 392,931 80,070 312,861 20%
Sources: (1) Projected figures are from U.S. Congress. Joint Committee on Taxation. Generalth
Explanation of the Crude Oil Windfall Profits Tax Act of 1980 (H.R. 3919, 96 Congress; P.L. 96-
223). Joint Committee Print. Washington, 1981. p. 15; (2) Actual tax revenues for FY1980-FY1986
are from quarterly excise tax reports published by the Internal Revenue Service. Data for 1986-1991
were obtained from the Congressional Budget Office.
N.M. = not meaningful.
Large overestimates of projected revenues occurred in the original forecast of
revenues made in 1979 and 1980, reflecting overestimates of crude oil prices.28 The
decline in oil prices in the mid-1980s was not anticipated even in 1981. In fact, it
was after 1983 that analysts began to adjust their oil price forecasts downward in
consideration of new sources of oil supply, increased conservation of oil, and the
development of alternative energy resources.
Table 3 also shows that, for the same period, actual gross revenues were about
$80 billion, significantly short of projections — 80% less than the projected amount

28 Bureau of National Affairs. Daily Tax Report. JCT Staff Memorandum to Members of
Senate Finance and House Ways and Means Committees on Windfall Profits Tax Revenue
Estimates. March 23, 1981. Washington. p. J-1.

of $393 billion — but still a sizeable sum.29 Most of this gain was accumulated over
the years 1981-1983, when gross revenues totaled nearly $55 billion. These large
initial revenues from the windfall profit tax were also an important reason in the early
part of the 1980s for not repealing the tax, despite President Reagan’s campaign
promise and numerous congressional attempts to repeal it.30
Finally, note also that after FY1982, gross revenues (column [2]) began to
decline, sharply beginning in 1984, and down to nearly zero in 1987. There are three
reasons for this. First, market crude oil prices declined markedly from 1982 to 1986.
Second, since 1980 base prices had been gradually adjusted upward due primarily to
inflation, as specified by law. The result was two forces acting to reduce the tax base
— the so-called “windfall profit.” The third reason was the decline in domestic oil
production. As will be discussed in a forthcoming section, the small amount of
revenue collected from the WPT in 1987 and 1988 was a principal reason for the
repeal of the tax.
Revenue Effects: Gross vs. Net Actual Revenue
Table 4 shows the estimated net WPT revenues, after adjusting for income tax
offsets, and receipts from federal oil interests. Column (1) is the same as column (2)
in Table 3. Column (2) shows WPT payments on federally owned oil attributable to
the economic interests of the U.S. Government — WPT assessed on oil produced
from federal lands. These figures are included in the gross WPT liabilities reported
in column (1) because, under the law, oil produced from federal properties was not
tax-exempt. In effect, then while the federal government was collecting WPT
revenues on its properties, it was also receiving equally less in price because first
purchasers subtracted the tax from the purchase oil price. Column (3) shows
estimated foregone payments of income taxes — reduced income tax collections —
due to the deductibility of the WPT against the income tax liability as a cost of
production. Net revenues are shown in column (4).

29 From 1991-1998, the WPT revenues were a negative $1.146 billion, representing IRS
refunds and adjustments due to overpayment and over-withholding on prior returns, i.e.,
prior production. WPT revenues during this period were also affected by IRS efforts and
legal cases to claim back taxes from companies that allegedly underestimated the market
oil prices and consequently underpaid the Treasury. See Rose, Frederick. “ARCO Says IRS
Asks $1 Billion for Back Taxes.” The Wall Street Journal. July 19, 1988. p. 6. Thus, the
actual gross revenues from 1990-98 were $78.923 million ($80.07 billion - $1.146).
30 The need for revenue became even greater in the early 1980s than in the middle 1970s as
budget deficits began to mushroom. As a result of the 1981-82 recession, tight monetary policy,
the large tax cuts in 1981, and continued spending increases, the federal budget deficits were
extremely large — over $1 trillion cumulatively for the period FY1981-FY1986. Between
FY1986 and FY1987, the annual budget deficit dropped from $221.2 billion to $150.4 billion,
but later it was projected to increase again. Deficits were large relative to our overall economy
— in FY1985 the deficit as a share of GNP was about 5%, higher than any time in the 1970s.

Table 4. Estimated Revenue Effects of the WPT, Fiscal Years
($ millions)
Less ReceiptsForegoneEstimated
Grossfrom FederalIncome TaxNet Revenue
Revenues Interests P ayments Effect
Year (1) (2) (3) (4)
1980 3,052 492 1,404 1,156
1981 16,931 1,105 7,788 8,038
1982 22,036 1,092 10,137 10,807
1983 15,660 902 7,203 7,555
1984 8,120 757 3,735 3,628
1985 5,073 601 2,334 2,138
1986 8,866 567 4,078 4,221
1988 373 N.A. 127 246

1990 (86) N.A. N.A. N.A.

Total: 1980-199080,0695,51736,68537,817
Sources: Column (1)data are from Francis, Brian. Federal Excise Taxes, Including the Slow Death
of Expired Taxes. Internal Revenue Service. Statistics of Income Bulletin, summer 1999. pp. 185-
189. Note that ‘Gross Revenues includes adjustments made as a result of errors, IRS and court
challenges, and other factors; column (2) data are from Hakken, John. Windfall Profit Tax Liability
and Receipt Estimate. U.S. Treasury. Office of Tax Analysis; column (3) is calculated by the author
based on the marginal statutory corporate tax rate at the time (46% except for 40% in 1987 and 34%
in 1988.
N.A. = not available.
The estimated net revenue gains from the WPT — the amount which actually
went into the Treasury’s general fund — were nearly over $38 billion, less than of
gross revenues, and 17% of the net revenues predicted in 1980 over the 1979-199031
period. Most of the difference between gross and net revenues was attributable to
losses in business income taxes (both individual and corporate) due to the

31 It is important to underscore the point that net revenues are not reported on any tax return
— they must be estimated from tax return data on gross revenues and marginal personal and
corporate tax rates. The WPT statute required the Treasury Department to estimate net
revenues. These are the figures shown in column (4) of Table 4.

deductibility of the gross WPT payments. Between 1980 and 1989, as shown in
column (4), income tax revenues were estimated to be about $37 billion lower as a
result of the deductibility of the WPT. The remaining revenue losses were due to
receipts from federal interests (column [2]).
Effects on Domestic Oil Production and Oil Imports
The WPT had the effect of reducing the domestic supply of crude oil below
what the supply would have been without the tax. This increased the demand for
imported oil and made the United States more dependent upon foreign oil as
compared with dependence without a WPT. Nevertheless, oil price decontrol, by
increasing prices should have increased domestic production and made the U.S. less
import dependent. And further, while a WPT made the U.S. more dependent on
imported oil, decontrol and a WPT made the U.S. less dependent than controls
without WPT.
The WPT was a excise tax on oil produced domestically in the United States;
it was not imposed on imported oil. In economic terms, such taxes increase marginal
production costs, and profit maximizing firms respond to the tax by reducing output
and raising prices. The WPT increased the marginal or incremental cost of domestic
oil production subject to the tax — every barrel of oil produced cost more to produce
by the amount of the tax. However, in the case of domestic crude oil, the higher
marginal costs are not to be shifted as higher oil prices, because, oil being priced in
the international (world) oil market — oil prices are exogenous to the U.S. (the U.S.
is a price taker, rather than a price setter).32 Oil producers could not shift the tax
forward as a higher oil selling price because the purchaser would merely substitute
imported or tax-exempt crude. Instead, the WPT reduces the net selling price paid to
producers. As noted earlier, the first purchaser (generally the refiner) subtracted the
tax from the price paid to the producer (supplier) — the producer’s net selling price
of each barrel of oil was less by the amount of the WPT.
This inability to shift the tax forward implies that the entire effect of the tax is
to reduce domestic production and supply. In other words, U.S. domestic oil
production was, to some degree, lower as a direct result of the WPT. But, as oil
imports to the United States are a residual, the difference between aggregate demand
for oil and aggregate domestic oil supply, the effect of this is an increase in the
demand for oil imports.33 Another way of stating this point is that imported oil is the
marginal source of oil — whenever an extra barrel of oil is needed to meet an
increase in demand, it is imported. Any condition or factor which either reduces
domestic supply (such as higher industry taxes) or which increases the aggregate
demand for oil (such as higher national income) will increase oil imports. and
therefore also reduced the supply of the taxed product.

32 There may be some small price effects if the export supply curve is not perfectly elastic.
33 This is discussed in detail in two other CRS reports: CRS Report 86-637, Energy Taxes:
A Comparative Analysis of the Gasoline Excise Tax and an Oil Import Tax and Their Effect
on the States, by Salvatore Lazzari; and CRS Report 86-572, Oil Import Taxes: Revenue and
Economic Effects, by Bernard A. Gelb and Salvatore Lazzari.

Estimates. The magnitude by which the WPT reduced domestic oil supplies
and increased imports depends on two variables: (1) the magnitude of the decline in
the supply price of domestic crude oil (the amount of the WPT), which determines
the after-tax price received by oil producers; and (2) the price elasticity of the supply
curve, which determines the reduction in oil production in response to the lower price
(net of the WPT) received by oil producers. Since oil prices are determined in a
world market, it is assumed that the WPT had no effect on pre-tax oil prices in the
United States. This means that the after-tax price received by domestic oil producers
is lower by the full amount of the WPT per barrel. (That is, as noted above, the WPT
cannot be shifted forward in higher prices; producers absorb the entire tax in terms
of lower profits.)
The second variable that determines the output effects is the price elasticity of
the oil supply curve, which measures the responsiveness of oil production to changes34
in oil price. An elasticity of +1.0 means that a 10% reduction in the net price of oil
to the producer translates into a 10% reduction in the quantity of oil supplied; an
elasticity of +0.5 means that a 10% reduction in price would reduce output by half
that or 5%. The price elasticity of oil supplies is determined by the technology
underlying domestic oil production.
There is little doubt that crude oil production is relatively inelastic in the short
run — even large price increases are unlikely to elicit substantial increases in
production. Over the long-run however, producers can increase their investment and
capital to increase production (development wells) from existing fields and increase
exploration of new fields. The percentage reduction in oil production in response to
the WPT would be the product of the percentage reduction in the after-tax price of
oil times the price elasticity of supply. Oil supply price elasticities are difficult to
estimate; few studies generate reliable estimates and in fact some studies estimate
negative supply elasticities, which are not plausible. In developing our assumptions
about the price elasticity of the crude oil supply curve we surveyed 20 studies.35 In
general, studies from the 1970s and early 1980s report larger supply price elasticities
ranging from .1 to .8, with a mean of about .5.36 Studies from the mid-1980s and
more recent studies tend to show smaller supply elasticities. For example, a 1985
study for the Department of Energy found a convergence around a number ranging

34 This estimate is quite sensitive to the assumed supply price elasticity, which is also
unknown and has been derived from other studies. Generally, the more price elastic is the
supply of oil, the larger would be the additional oil imports induced by the WPT.
35 Dahl and Duggan (1996) survey many, but not all elasticity studies. See Dahl, Carol and
Thomas Duggan. U.S. Energy Product Supply Elasticities: A Survey and Application to the
U.S. Oil Market. Resource and Energy Economics, vol. 18, October 1996. pp. 243-254.
36 For example, Mancke (1970) estimates a supply price elasticity ranging between 1 and 2.
See Mancke, R. B. The Long Run Supply Curve of Crude Oil Produced in the United
States. Antitrust Bulletin. Winter 1970. Kaplan, Seymour. Energy Economics:
Quantitative Methods for Energy and Environmental Decisions. McGraw-Hill, New York.
1983. p. 67. More recent econometric studies tend to show less elastic supply curves. For
example, Hogan (1989) estimates a long run supply curve of 0.58. See Hogan, William W.
World Oil Price Projections: A Sensitivity Analysis. Energy and Environmental Policy
Center. John F. Kennedy School of Government. Harvard University, 1989.

from .2 to .4; it used a value of 0.31 in its calculations.37 Reflecting this uncertainty
production losses are estimated under three alternative elasticity scenarios: a price
elasticity of oil supply of +0.2 (short run), +.5, and +.8.
Table 5 presents estimates of annual domestic oil production that was lost in
response to the WPT based on conventional assumptions. Note that unlike Tables
3 and 4, data are presented in calendar years to conform with the reporting of
production and tax data. Estimates were prepared for the period 1980-1986. From
1986-1988 there are no output effects because the WPT liability was zero in those
years. (The WPT was zero because market crude oil prices were below inflation
adjusted base prices.) For perspective, the annual estimates of production losses are
compared to the actual levels of domestic oil production and imported oil.
These estimates indicate that the windfall profit tax caused domestic oil
production losses in every year but 1986, when crude prices declined below adjusted
base prices resulting in zero WPT. Over the entire 1980-1986 period, it is estimated
that, depending on the assumed supply curve price elasticity, the WPT reduced
domestic oil production from between 320 million barrels (1.2% of domestic
production) and 1,268 million barrels (4.8% of domestic production). The effect of
reducing domestic oil production was to increase the level of imported oil. Columns
(3), (6) and (9) show the estimated production losses caused by the WPT, as a % of
the actual level of imported oil, under the assumed three supply curve elasticities
range from 3.2% of total imports to 12.7% of imports for this period, depending on
price elasticity.

37 Applied Management Sciences, Inc. The Nonconventional Liquid Fuels R&D Analysis
System: A Microcomputer-Based World Oil Market Model. February 1, 1985. Prepared for
the Department of Energy.

Table 5. Estimated Reduction in Domestic Oil Production in
Response to the Windfall Profit Tax
,ps = +.2,ps = +.5,ps = +.8
Million% of Total% ofMillion% of Total% ofMillion% of Total% of
barrelsdomestic outputImportsbarrelsdomestic outputImportsbarrelsdomestic outputImports
Yea r (1) (2) (3) (4) (5) (6) (7) (8) (9)
1981 77.0 2 .1 4.8 194.0 5 .2 12.1 310.0 8 .3 19.3
g/w1982 58.0 1 .6 4.6 145.0 3 .9 11.4 232.0 6 .2 18.2
leak1983 41.0 1 .1 3.4 103.0 2 .7 8.5 164.0 4 .4 13.5
://wiki1984 36.0 1 .0 2.9 101.0 2 .6 8.1 161.0 4 .2 12.9
http1985 35.0 0 .9 3.0 71.0 1 .8 6.1 114.0 3 .0 9.8
1986 0.0 0 .0 0.0 0 .0 0.0 0 .0 0.0 0 .0 0.0
1986 320.2 1 .2 3.2 794.5 3 .0 8.0 1 ,268.8 4 .8 12.7
Author’s estimates based on data published by the Department of Energy and the Internal Revenue Service.P
Es denotes price elasticity of domestic oil supplies. This measures the responsiveness of domestic oil supplies to changes to the domestic price of oil. For example, an elasticity
.5 means that as the price of oil increases by 10%, the quantity of oil supplied increases by half that or 5%.

If lag effects are discounted, the largest output effects were in 1981. That year
the estimated loss in domestic oil production in response to the WPT ranged from 77
million barrels (2.1% of total domestic output) to 310 million barrels (8.3% of
output), depending upon the assumed price elasticity. As a fraction of total imports,
these constituted 4.8% and 12.1%, respectively.
Estimated annual production losses declined steadily between 1981 and 1986.
This was due to the combined effect of declining market prices and increasing base
prices over this period. In 1986 production losses were estimated to be zero because
average market oil prices were below average base prices (the average windfall profit
was negative in each of these years). It is important to note that the estimates in
Table 5 assume that the production losses occur in the same year as the tax increase.
In reality there may be lags in the effect of the WPT on domestic oil production. To
this extent, the aggregate production losses estimated over the 1980-1986 period are
probably more meaningful than the losses estimated for any one year.
On this basis the WPT increased oil imports and made the United States
somewhat more vulnerable to sharp oil price increases or complete oil supply
embargoes from foreign oil producers. If accurate, these estimates suggest that oil
production losses in response to the WPT may have been from 3% to 13% of total
oil imports.
Economic Efficiency and Resource Allocation
The efficiency effects of the WPT on the allocation of resources are less clear
than some of the other economic effects. From an economic perspective, excise
taxes distort the price system’s ability to efficiently allocate resources among
competing economic sectors. But the windfall profit tax had little if any effect on oil
prices simply because such a tax cannot be forward shifted i.e., producers are not able
to pass the tax forward by increasing prices to refiners because refiners would merely
substitute imported oil. The reason for this is that oil prices in the United States are
a given — they are determined or established in the world oil market in which the
United States is only one of many producers.
In the long run, a permanent excise tax reduces the rate of return in the taxed
sector and resources are allocated toward the non-taxed sectors. But the WPT was
a temporary tax when it was enacted, and it was repealed two and one-half years
before expiration. It is difficult to say whether this is a long enough period of time
to cause resources to be reallocated in any significant way.
The other complicating factor was the decontrol of oil prices. It is a
fundamental economic law that, generally, price controls cause serious distortions
and create allocational inefficiencies. Oil price decontrol on January 28, 1981, when
the WPT was about 10 months old, completely removed these distortions and
inefficiencies. In all probability, decontrol with a WPT was less distorting than
controls without a WPT.
The efficiency effects of the WPT also hinge on the question of whether oil
production creates costs — these are called external costs — that society incurs but
that producers do not account for. If the business of producing oil domestically

creates these external costs, then an economically appropriate policy would have
imposed some type of excise tax on oil production. The WPT that was in effect was
not inconsistent with this policy and, to this extent, may have contributed to
economic efficiency.
The WPT, however, may have distorted the way resources were allocated within
the oil industry. Since the tax was imposed on oil production — i.e., upon its
removal and sale — extraction (and other upstream operations) was penalized and
other aspects of the business (refining and marketing, the downstream operations
become relatively favored. Thus it created financial incentives to shift resources
from exploration and drilling to refining and marketing.38
There may have been additional distortions within the oil-producing sector as
a result of the structure of the tax. Under WPT, different tax rates and base prices
applied to taxable oil, depending upon its classification in one of three tiers as
described in Table 1. These differences seemed to favor oil from newer wells as
opposed to oil from older wells, and oil produced from small wells and by
independents, as opposed to oil produced from larger wells and by integrated
producers. While this was probably done to minimize the adverse effects on supply,
the structure of the WPT created artificial tax incentives based on the age and
infrastructure of production and who owned the oil.
In addition to the above distinctions, the following categories of oil were tax
exempt: (1) oil produced from a property owned by a state or local government or
any political subdivision of a state government; (2) oil produced by educational
institutions or charitable medical institutions; (3) oil produced from wells in certain
regions of Alaska; (4) oil owned and produced by certain American Indian tribes; and
(5) front-end tertiary oil and royalty oil.
Even so, it must be underscored that the distortions under the windfall profit tax
with decontrol were probably less than the distortion under full price controls without
a WPT.
The Burden of Tax Compliance and Administration
After 1986, the WPT imposed little or no tax liability on oil producers because
oil prices were below the threshold base prices that triggered it. Oil producers were
obliged to comply with the paperwork requirements of the law, however, and the
Internal Revenue Service (IRS) was compelled to administer the system despite the
fact that the tax generated no revenue.
The oil industry maintained all along that the WPT was an extremely
complicated tax to comply with and to administer. The IRS and the General
Accounting Office (GAO, now the Government Accountability Office) both agreed

38 These incentives were more than offset by other factors, including environmental
regulations, low rates of return, and other factors inhibiting the flow of capital into refining
and marketing. For a discussion see CRS Report RL32248, Petroleum Refining: Economic
Performance and Challenges for the Future, by Robert Pirog.

with the industry’s claim, and the eight-year experience with the tax also tended to
support this.39
The process of complying with the WPT involved a complicated system of
interactions between a variety of oil industry entities and a variety of separate tax
laws and energy regulations. The windfall profit tax was imposed on oil producers
when taxable crude oil was removed from the oil-producing property. Any individual
or business with an economic interest in an oil-producing property was considered
as a producer and subject to the tax. There were four kinds of producers —
independent producers, integrated oil companies, royalty owners (landowners), and
tax-exempt parties. According to a 1984 GAO report, there were about 1 million oil
producers (persons, institutions, and businesses) in the United States in 1984.40
Operators were the approximately 18,000 persons in the business of managing
oil properties. The property operator supplied the relevant information to the agent
who withheld the tax. The operator had to determine the proper tier, how much oil
was sold, and who had the economic interest. Sometimes there were hundreds of
people having a fractional economic interest in a single oil-producing property. Even
determining the proper tier was no easy task. According to a 1982 GAO report,
considerable uncertainty surrounded the concept of oil property, thus making it
difficult to classify oil into tiers.41
The withholding agent had to compute and withhold the windfall profit tax
based on the information supplied by the operator. The withholding agent, also
called the first purchaser, was usually an integrated oil company, but it could also
have been an independent producer or refiner.
To compute the windfall profit tax amount, the agent subtracted from the
removal price the base price and the corresponding state severance tax (if any). This
computation required the following steps: (1) knowing the category of oil; (2)
determining the removal (selling) price; (3) adjusting the corresponding base price;
(4) subtracting the state severance tax; and (5) testing for the 90% net income

39 In a several reports, the GAO stated that the WPT was a complex tax. For example, in a
1984 report the GAO states: “The tax is very complex in design and operation and requires
interaction among producers, operators, and withholding agents.” See U.S. General
Accounting Office. Response to Questions About the Windfall Profit Tax on Alaskan North
Slope Oil. GAO /GGD-85-12. December 10,1984, p. 1. See also: U.S. General Accounting
Office. IRS’s Administration of the Crude Oil Windfall Profit Tax Act of 1980. GAO/GGD-
84-15, June 18, 198; and U.S. General Accounting Office. Uncertainties About the
Definition and Scope of the Property Concept May Reduce Windfall Profit Tax Revenues.
GAO/GGD-82-48, May 13, 1982.
40 U.S. General Accounting Office. IRS’s Administration of the Crude Oil Windfall Profit
Tax of 1980. Report to the Chairman, Subcommittee on Commerce, Consumer, and Monetary
Affairs, House Committee on Government Operations. GAO/GGD-84-15, June 18, 1984.
Washington, 1984. p. i.
41 U.S. General Accounting Office. Uncertainties about the Definition and Scope of the Property
Concept May Reduce Windfall Profit Tax Revenues. Report to the Secretary of the Treasury.
May 13, 1982. GAO/GGD-82-48. Washington, p. 14.

limitation.42 Even some of the basic steps in this computation could be complex. For
example, in 1983 there was some controversy over how to determine the “removal
price” in the case of certain Sadlerochit oil in an Alaskan North Slope reservoir.
Three different methods were used by the oil companies. The IRS had to issue
several rulings before the matter was settled.
Having computed the tax liability, the first purchaser deducted this from the
purchase price to be paid to the operator, and deposited the money in a Federal
Reserve Bank. Integrated producers were required to deposit twice per month;
independent producers were required to deposit every 45 days. The tax payment
process did not, however, end there. In the event of overpayment or underpayment,
due primarily to the net income limitation and underwithholding respectively, this
required either refunds or additional payments.
Throughout this compliance process many tax return forms and information
forms were required. The process was further complicated due to the numerous
exceptions to the basic general rules and due to possible interactions between the
windfall profit tax rules, the personal and corporate income tax rules, energy
regulations, and state and local tax and energy laws.
The windfall profit tax also appeared to be a significant administrative burden
for the IRS. The tax statute itself encompassed 13 sections in 25 pages of the 1986
Internal Revenue Code.43 In addition, the IRS had to promulgate dozens of separate
regulations, revenue rulings, letter rulings, and information releases to enforce it.
Furthermore, there had been statutory amendments to the WPT in virtually every tax
bill enacted between 1980 and 1988.
The IRS acknowledged the administrative burden of the tax in 1981 hearings
before the House Subcommittee on Government Operations. A 1984 GAO report
seemed to support this when it referred to the tax as “perhaps the largest and most
complex tax ever levied on a U.S. industry.”44 Fortune magazine referred to the tax
as one of “the most monumental excises ever levied in U.S. history....”45
Reasons for Repeal of the Windfall Profit Tax
As was discussed in the background section, the crude oil windfall profit tax
was repealed in August of 1988 — two and one-half years before the legislated
termination date in January 1991. There was no one reason for repeal of the tax.
Rather, repeal was caused by the confluence of several factors and conditions from

42 The net income limitation restricted the windfall profit tax liability to no more than 90%
of the net income per barrel of oil. Net income was defined in terms of taxable income per
barrel, with some adjustments.
43 U.S. Code Title 26, Internal Revenue Code Sections 4986-4990.
44 U.S. General Accounting Office. IRS’s Administration of the Crude Oil Windfall Profit
Tax. p. 1.
45 Chapman, Stephen. Government’s Windfall from Windfall Profits. Fortune, March 24,

1980. p. 60.

1987-1988. Yet, the anti-WPT sentiment was fairly widespread and numerous bills
were introduce to repeal the tax.46
The Congress became convinced that the tax was a complex and costly tax to
comply with and to administer. It was a compliance burden to the oil-producing
industry and an administrative burden for the Internal Revenue Service even though,
after FY1986, the tax generated little or no tax revenues. It is doubtful that the
Congress would have repealed the WPT had it been generating significant revenues
at that time or had it been expected to generate significant revenue in the future. The
fact that the tax was generating little or no revenue, however, made the argument that
the tax was a burden easier to accept.
Another apparent reason for the repeal of the WPT was the recognition that the
tax kept domestic oil production below what it would have been without the WPT
and increased petroleum imports above the level of imports without the WPT.47 This
made the United States more dependent upon foreign oil and therefore more
vulnerable to either a price upsurge or a supply disruption. Petroleum imports were
growing. From 1985 to 1986, there was a sharp increase in the share of oil use being
met by imports. Oil imports as a percent of total U.S. oil consumption increased from

32% to nearly 38% — one of the largest annual increases on record. Moreover,

projections showed this degree of dependence rising to over 50% by 1990, a
projection which has been realized.48 Today, petroleum imports account for nearly
60% of consumption and are projected by the Department of Energy to rise to nearly

70% by 2025.

Finally, the domestic U.S. oil industry was experiencing difficult economic
conditions due to the collapse of oil prices in 1986. Crude oil prices dropped from
about $30 per barrel in the fall of 1985 to just over $10 per barrel in the summer of
1986. After 1986, oil prices were volatile but basically increasing. At the time of
repeal, oil prices were about $18 per barrel. Prices increased during the Persian Gulf
war of 1992 but collapsed again in the fall/winter of 1998/1999.
There was little question about the effect of the rapid price decline on the U. S.
oil-producing industry. It had a strong negative effect on oil producers (i.e., drillers,
operators, and landowners with an economic interest in oil) in general, and the small
independent producer in particular. According to industry data, earnings from
exploration/production operations of selected companies in the first half of 1986
declined by about 60% from the first half of 1985.49 This decline mirrored, roughly,

46 There were 18 such bills in the 100th Congress.
47 See, for example, U.S. Congress. Senate. Energy Taxation Issues. Hearings before the
Subcommittee on Energy and Agricultural Taxation of the Committee on Finance, 100th
Congress. January 30, 1987.
48 CRS Report 87-779, Oil Import Taxes: An Economic Analyis of S.694, The Economic
Security Act of 1987, by Salvatore Lazzari.
49 Beck, Robert J., and Glenda E. Smith, “Unparalleled Drop in Crude Prices Reduces
Earnings for OGJ Group,” The Oil and Gas Journal, vol. 84, no. 35, Sept. 1986, pp. 17-22.

the percentage decline in crude oil prices. After that, profits started to recover,
especially for independents.50
Declining profits from oil production sharply reduced drilling and exploration
expenditures and employment. In the long run, oil production was expected to
decline significantly. Two states in particular, Texas and Louisiana, were hit hard by
low crude oil prices. In these states, oil and oil dependent businesses (such as banks
and other financial institutions) became bankrupt, large numbers of employees were
laid off, and revenues to State and local governments plummeted. According to the
Bureau of Labor Statistics, the oil and gas extraction industry nationwide lost about

130,000 jobs from the second quarter of 1985 to the second quarter of 1986.51

Between 1982 and 1988, this industry lost about one-third of its jobs.52 However, the
collapse of oil prices helped some segments of the industry such as independent
refiners and marketers.
The Congress came to view the windfall profit tax as a burden on an industry
that was becoming severely depressed due to the sharp drop in oil prices and due to
the volatility in oil prices. Repealing the WPT did not reduce industry tax payments
so it was of little actual economic benefit at that time because oil prices were below
base prices and there was no tax liability to producers. However, higher oil prices in
the future might have exceed base prices and the WPT would have been triggered.
At the very least, repealing the WPT reduced business costs and improved industry
profitability somewhat by eliminating the compliance burden of the tax.
Opponents of repeal basically made the following arguments: (1) the oil
industry’s income is an economic rent or monopoly profit to a highly concentrated
industry which society, through taxation, should share in; (2) the oil industry benefits
from other tax subsidies which have traditionally kept effective income tax rates very
low; (3) if oil prices rise above base price levels, then the tax would generate
additional revenues which are badly needed to reduce large federal budget deficits;
(4) the administrative apparatus is already in place and it makes little sense to
eliminate the tax now, given that the tax is temporary. This final argument in favor
of retaining the WPT was, in effect, a counterargument to those who have criticized
the tax as a compliance and administrative burden. The point was that, even
admitting its complexity, the WPT system was already in place. Much of the costs
of administering the tax were fixed costs — they had been, in large part, already
incurred, since most of the regulations had been promulgated. Given that the IRS
had already incurred the fixed costs of running the WPT system, and given that the
system would only be in effect for seven more years, they argued it made little sense
to eliminate it.

50 Beck, Robert J. “Without Texaco, OGJ Group Earnings Increase 25.1% in 1987.” Oil
and Gas Journal, vol. 86, March 28, 1988. p. 6.
51 U.S. Department of Labor. Bureau of Labor Statistics. Monthly Labor Review, vol. 109,
no. 8, August 1986. p. 6.
52 U.S. Department of Labor. Bureau of Labor Statistics. Monthly Labor Review, vol. 111,
no. 3, March 1988. p. 72.

Windfall Profit Tax Legislation in the 109th Congress
There are currently 14 bills in the 109th Congress to impose some type of WPT.
These fall generally into one of two categories: those that impose an excise type of
WPT and those that would impose an income type. In addition, the bills differ in the
way the WPT receipts would be used. Some bills would allocate the receipts to offset
the cost of supplemental spending bills targeted to aid victims of Hurricanes Katrina
and Rita. Others would allocate them to the highway trust fund to compensate for
any losses from the proposed commensurate reduction in motor fuels excise taxes to
offset the WPT. Several bills would appropriate the proceeds for the Low-Income
Home Energy Assistance Program, which gives grants to poorer households to offset
high energy bills and for residential weatherization.
Excise Tax Type of WPT
The excise tax type of WPT would generally impose an excise tax equal to 50%
of the windfall profits not reinvested in either (1) oil/gas exploration and drilling, (2)
refineries, (3) renewable electricity property, or (4) facilities for producing alcohol
fuels or bio-diesel. Windfall profit would be defined as the difference between the
market price of oil (at the wellhead) and a base price of $40/barrel, which would be
adjusted for inflation. The bills that would impose this type of tax are S. 1631, H.R.
3752, H.R. 4203, H.R. 4248, H.R. 4449, H.R. 4263, S. 1981, and S. 2103. S. 1631
(Dorgan) was offered as an amendment to S. 2020, the Senate’s version of tax
reconciliation now in conference, but it was ruled out of order.
Three of the WPT bills are variations on this type of tax. For example, H.R.
2070 (Kucinich), H.R. 3664 (Kanjorski), and H.R. 3544 (DeFazio) would impose a
graduated excise tax with the rates — 50%, 75%, or 100% — dependent on the
extent to which profits exceed a reasonable level, as determined by a specially
created board or commission. Also, the tax would be imposed on the windfall profit
from and natural gas (and products thereof). These bills differ, however, on how the
tax’s proceeds would be used.53
Income Tax Type of WPT
The income tax type of WPT would impose a 50% tax on the excess of the
adjusted taxable income of the applicable taxpayer for the taxable year over the
average taxable income during the 2000-2004 period. The 50% tax would apply to
crude producers and integrated oil companies with sales in 2005 or 2006 above $100
million. The tax would be temporary and apply to petroleum products as well as
crude oil. The two bills that would take this approach are S. 1809 (Schumer) and
H.R. 4276 (Larson) in the House. Senators Schumer and Reed sponsored S. 1809 as

53 H.R. 3544 (DeFazio) would impose price controls on gasoline, ban drilling in the Arctic
National Wildlife Refuge, mandate minimum levels of inventory of crude oil and petroleum
products, ban the export of Alaskan oil, and facilitate the draw down of the Strategic
Petroleum Reserve. H.R. 2070 (Kucinich) would fund income tax credits for the purchases
of fuel-efficient passenger vehicles, and to allow grants for mass transit.

an amendment to S. 2020 (S.Amdt. 2635, and S.Amdt. 2626). In both cases, the
amendments were ruled out of order.
A variant of the income tax type of WPT is H.R. 3712 (McDermott). This bill
would impose a 100% tax on any profit above a 15% rate of return from the sale of
crude oil, natural gas, or products of crude oil and natural gas. Revenues would be
used to fund a program of gas stamps, which would be similar to the current federal
food stamp program;
Economic and Policy Issues
This is not the first time policymakers have proposed a WPT on crude oil. In
just two months from the beginning of July 1990 to August 1990, domestic oil prices
(the spot price of West Texas Intermediate) nearly doubled increasing from just over
$16 per barrel to nearly $32 per barrel. This was sufficient to prompt policymakers
to call for reinstatement of the 1980 windfall profit tax.
These bills raise a number of economic and policy issues. The remaining
sections discuss some of the more important economic issues surrounding proposed
legislation, and draw relevant policy implications. The final section discusses
alternative policy options.
Current Market Conditions. The first issue is the difference between the
current market conditions and those when the 1980 WPT was imposed. As noted
above, the 1980 WPT was imposed as part of compromise to decontrol crude oil
prices — a quid-pro-quo. From a control regime level of about $6/barrel, crude
prices were allowed to rise gradually to market levels (as influenced strongly by
OPEC), which at that time were about $24/barrel. By contrast, today there are no
price controls on crude oil and prices are determined in a generally competitive
market, one in which the United States is a price taker, and one in which OPEC plays
a relatively smaller (but still important) role. Crude oil prices have increased for
significantly different reasons than was the case in the 1970s.
Also, on August 8, 2005, President Bush signed a comprehensive energy policy
bill (P.L. 109-58) that provides over $2.5 billion in energy tax breaks (over 11 years)
to the domestic oil and gas industry. Some have questioned the wisdom of providing
additional tax subsidies to the oil industry at a time of high crude and petroleum
product prices, and have proposed either reducing or eliminating these subsidies in
lieu of the WPT.
The Question of Windfall Profits. Of course the fact that current high
prices are due to reasons different than in the 1970s does not belie that there may be
windfalls. Crude prices marched steadily upward during 2004 (averaging $37/barrel)54
and reached new highs in 2005. The price of West Texas Intermediate (WTI)
reached $55/barrel in October 2004, a 60% increase over the January 2004 price of
$34/barrel. Prices reached $60/barrel during the summer of 2005 and peaked at

54 As noted the new highs are when measured in nominal terms (i.e., in current dollars). In
real terms, the all time high was above $90/barrel reached in April 1980.

nearly $70/barrel in August 2005.55 After a short stay in the high $50's, prices
hovered in the high $60's for several months, and in early 2006 stood at about
$65/barrel.56 Petroleum product prices have also spiked and continue to remain high.
Increases in crude prices, in effect increase the value of oil reserves, and increase the
revenue from the sale of domestically produced oil just as any higher market price
for a commodity makes inventories or other stock of that product more valuable.57
The extent to which recent high petroleum prices have increased profits has
been reported in the press and is discussed in two recent CRS reports; it is not
discussed here.58 A more intractable issue is whether any increased recent profits are
true windfalls, and whether windfalls accrue to both crude oil and refinery products.
The sharp and rapid increases in prices, if they are realized as higher profits, would
be a pure windfall in the sense that they are an unforeseeable, unanticipated gain that
accrues to owners of the Nation’s stock of oil reserves. Most of any additional
revenue and profit would accrue to the major oil companies since they own most of
the reserves and produce the bulk of the oil in the United States. In a sense they are
unearned: little or no additional cost or effort is incurred in generating this additional
income; oil that would have been produced at $26 or $37 per barrel, can now be sold
for $62 per barrel or more. In another sense they are earned: increased profits are
the reward for the risks the industry takes to provide petroleum products to
As an illustration, using domestic oil production of 5.5 million barrels per day,
a doubling of crude oil prices from $35/barrel to $70/barrel would generate an
additional $70 billion in annual revenue to oil producers. If the baseline started at
$10/barrel and prices rose to $70/barrel and stabilized at that rate for one year,
revenues would increase by about $120 billion. Profits would also increase, but not
by the increased revenue because income taxes — federal, state, and local — would
have to be paid on the windfall. Thus, even without a windfall profit tax government
tax revenues would increase commensurate with any oil industry windfall. This is
because as profits of the oil producers increase so does taxable business income.
Since there is little or no cost incurred in generating the added profits, then all of the
revenue gains likely would be taxable. At a marginal tax rate of 35% — the marginal
corporate tax rate — the federal government would gain about 35% of any oil
industry windfall.59

55 In August 2005 prices on the futures market, for the near term contract, reached
$69.81/barrel, the highest price ever recorded on the Nymex exchange.
56 September 2005 also witnessed the biggest one-day surge in oil prices on record:
57 An example is the stock of homes. As the price of new homes increases — due to
inflation, increase in relative prices, or other reasons — the value of the existing stock of
homes also increases so that homeowners experience a windfall.
58 See CRS Report RL33021, Oil Industry Profits: Analysis of Recent Performance, by
Robert L. Pirog.
59 The marginal statutory rate is the appropriate rate to use in this instance rather than the
marginal effective tax rate. The marginal rate includes the effects of intangible drilling costs

In addition to the higher profits accruing to oil producers, there appear to be
additional profits accruing to refiners, but these increases have been smaller than the
profits accruing to producers. But these profits are not true windfalls as they are in
the case of crude oil. While refinery margins and profits can and have increased, even
sharply, they are due to the constraints on the supply capacity — essentially the
supply or cost curve — of the refinery industry.
Another problem is one of timing. There is no question that producers and
refiners could reap enormous windfall profits if the recent price upsurge is sustained.
But it is not a certainty that the recent price spike will be sustained. Recently crude
oil prices, while still high, declined somewhat from their peak of nearly $70 per
barrel. Even though they are high there is no guarantee that they will not fall,
possibly precipitously, and become losses in the near future if crude and product
prices decline. And barring any other problems abroad, or natural disasters, prices
would be expected to decline somewhat further. It should be remembered that oil
prices declined from a high of over $30 per barrel in the early 1980s to about $10 per
barrel at their low point in the spring of 1986. From 1986-1999 oil prices averaged
about $17.00 per barrel, but fluctuated between $12 and $20 per barrel — the
fluctuations including the most recent four-year period have been even greater.
Domestic crude oil prices reached a low of about $8/barrel in December 1998, among
the lowest crude oil prices in history after correcting for inflation. From this volatile
behavior of oil prices derives the volatility of oil industry profits, and it is not clear
that there will be a persistent windfall profit over the longer run.
Economic Implications. Depending on how the tax were structured,
reinstating the windfall profit tax might make the United States more dependent upon
foreign oil. This is likely to be a more serious problem today than in 1980 because,
unlike then when the United States was importing about 40% of its petroleum use,
the nation is now importing close to 60%.
As the above analysis suggests, a windfall profit tax in the form of an excise tax
— H.R. 3752, and S. 1631 — could reduce domestic oil production and increase the
demand for imported oil and petroleum products. In economic terms, oil producers
would view the tax as an increase in the marginal cost of domestic oil production.
During the 1980s, the marginal cost (the incremental cost) of producing every barrel
of taxable crude oil was higher with the WPT than without it. In consequence, the
WPT reduced the supply of domestic oil to some extent; at every possible market oil
price, it is estimated that domestic oil production was lower with the WPT than it
would have been without it. The tax increased the marginal cost of producing
domestic oil, thereby reducing domestic production and increasing the demand for
oil imports both in the short run and long run. This is a result of the fact that oil
imports to the United States are a residual, the difference between aggregate demand
for oil and aggregate domestic oil supply. Any condition or factor which either
reduces domestic supply (such as higher industry excise taxes) or which increases the

59 (...continued)
and other tax provisions which enter into the calculation of the tax on income from the
marginal investment. In the windfall profits tax situation in the text, there is no marginal
investment, hence these oil and gas tax incentives/subsidies do not enter into the calculation.

aggregate demand for oil (such as higher national income) will increase oil imports.
Crude oil prices might increase somewhat as the demand for imported oil increases,
because the export supply of oil to the United States is somewhat elastic. The size
of the effect would depend on the magnitude of the excise tax and the price
elasticities of oil demand and supply in the United States, as well as the oil export
supply to the United States.
Reinstating the windfall profit tax would probably raise the question of the
burden and cost of compliance and administration of the tax, which was an important
rationale for repeal of the tax in 1988. This issue seems to become more of a concern
when WPT revenues don’t live up to expectations. Unless the tax were greatly
simplified, or unless a large amount of revenue were generated from the tax, past
experience suggests that this could be a serious problem in reinstating the WPT.
Many analysts believe, based on market fundamentals, that the recent oil price
upsurge will not be a lasting one, and since oil prices have been highly volatile in
recent years, there is no way to judge whether WPT revenues would be large enough
to justify the alleged high costs of compliance and administration.
Alternative Policy Options
If, instead, an excise tax were to be imposed broadly on both imported as well
as domestically produced oil (as proposed in the early 1980s by the Reagan
Administration) much greater price effects would be expected — the price of crude
oil in the United States would tend to be much higher than under the WPT on
domestic oil alone. This is because the tax is imposed on imports, which are the
marginal source of oil supplies and therefore the benchmark for crude oil prices. In
this case, the tax would both increase the marginal costs of oil imports (an upward
shift in the oil import supply schedule) and cause a slight movement along the
schedule due to increased demand for oil imports, and thus have a bigger price effect.
An excise tax holiday — suspension of the 18.4¢/gallon tax on gasoline —
combined with an equal revenue WPT on oil would be completely counterbalanced
or offsetting. Eliminating the gasoline tax would cause refiners to reduce prices over
time by the amount of the tax (or somewhat less depending on tax incidence, which
depends on the ratio of price elasticities of the demand and supply schedules), but the
WPT on all crude oil (which remember is actually an excise tax) would be shifted as
a higher price of crude oil bought by refiners, thus offsetting the decline in product
pri ces. 60
From an economic perspective, the only tax that would be relatively neutral in
the short run — that would have no (or few) price effects and other economic effects
— would be a pure corporate profits tax, since this tax does not affect marginal
production costs, and cannot be shifted in the short run. Thus, to the extent that a
surtax on the corporate income of crude oil producers on their upstream operations
could approximate such a tax, this would not raise crude oil prices and would not

60 Eliminating the gasoline tax would deny the Highway Trust Fund of its principal source
of revenue unless some adjustment were made. See CRS Report RL30497, Suspending the
Gas Tax: Analysis of S. 2285, by Salvatore Lazzari.

increase petroleum imports in the short run. While the current corporate income tax
is not a pure corporate profits tax, a surtax for oil companies would arguably be an
administratively simple and economically effective way to capture estimated oil
windfalls in the short run. In the long run however, all taxes distort resource
allocation and even a corporate profit tax (either of the pure type or the surtax on the
existing rates) would reduce the rate of return and reduce the flow of capital into the
industry, adversely affecting domestic production and increasing imports.

Technical Appendix
The algebraic formula for the WPT liability is as follows:
Tt = J [Ptm - Ptb (1+ Bt-2)](1- s ) (1- c )
Tt = the WPT in $/barrel, in time t (e.g., in the 1st quarter of any year),
J = the WPT tax rate in percent (see Table 2 in the text),
Ptm = the market (removal) price of domestic crude oil at the wellhead at time t,
Ptb = the base price corresponding to the type of oil produced, as specified by law (see
Table 2)
B = rate of inflation, as measured by the GNP deflator, so that Bt-2 is the GNP deflator
lagged two quarters,61
s = the rate of State severance tax, if any
c = the rate of federal corporate income tax

61 Except that for Tier III oil, the base price increases by 2% per year, so that the quarterly
inflation adjustment for Tier III base prices is Bt-2 + .005.