Windfall Profits Tax: How To Kill Investment

Obama wants to take a "reasonable share" of "windfall profits" from US oil companies. If you have read this blog before, you know that I try to point out the way politicians use language, redefinition and fuzzy logic to disguise and truth. These two are classic examples and show the danger in allowing politicians to do this unchecked.

"Windfall Profits"
The Wall Street Journal did a very nice job on its editorial page last Monday discussing the profit margins of various companies and industries versus Exxon Mobil and Big Oil.

They cited:
Exxon Mobil = 10% .... and the Big Oil Average = 9%
Electronics Companies = 14.5%
Pharmaceuticals = 18.4%
Google = 25%

From this, let's give Obama the benefit of the doubt and say that his definition of windfall profits does not simply mean high profit margins. He hasn't suggested a windfall tax on Google...yet. So what does he mean??? He seems to imply, as does the language, profits that seem high versus some nebulous or historic benchmark. So, if windfall profits should fairly be taxed at a different and higher rate, we have to understand what triggers improvements in profits. What causes a company's or industry's profits to be above the "norm?"

What Triggers "Really High Profits?"

1. Risk: Modern Portfolio Theory (MPT) states that risk and returns are highly correlated. The higher the risk, the higher the potential return... and, the higher the potential for loss. Every Nobel Laureate in Economics, financial planner, venture capitalist and entrepreneur knows this well. The Nike founders and early investors made a fortune. But for every Nike, there are 100+ companies that went under and investors lost everything. To take on this risk of losing it all, the potential return has to be substantially above the norm. Otherwise, everyone would invest in P&G stock.
   
2. Innovation: Media companies have had a terrible past 5+ years... especially newspapers. This is "old media". On the other hand, Google has continued to grow rapidly. Google is nothing more than a media asset that innovated and changed the world. Further, like in point #1, the Google founders and funders took on massive risk in order to reap "windfall profit."
   
3. Cyclicality: Then there are business that have huge fixed costs and move with the cyclical macro-economic trends. When things boom, they boom. When the overall world economy falls, they record huge losses. When Obama singles out Big Oil, he forgets that the entire commodities sector has been on fire. Everything from agricultural crops to coal have risen dramatically. World demand is incredibly high. Prices and profits are the mechanism by which demand adjusts and the ROI on substitute products becomes viable making new investment rational. BTW, in the 90s when oil was $11 a barrel and gas was under a dollar, I didn't hear any politician offer taxpayer dollars to bail out Big Oil.
   

Imagine The Damage
Imagine the damage to risk taking, innovation and cyclical industry investment if above average profits were capped via higher taxes. Innovation and infrastructure would move overseas. Silicon Valley would be nothing more than a place with great weather. And let's not forget Barack's Hollywood buddies. Because of innovation (creativity) and risk taking, blockbusters like Titanic and smaller movies like Shakespeare In Love reap incredible profits. That is why even low odds of success draws film funding. Does he want a windfall profits tax on every Hollywood box office winner?

Oh... That's What He Means!
What Obama really means is twofold. First, it is politically expedient to demonize Big Oil... logic and consistency be damned. It gets him votes. Second, by justifying taking more taxes ("a reasonable share"), he gets to further fund his redistribution of wealth and nanny state programs. The federal government gets to control a bigger piece of the pie. Politicians get to become more powerful.

Mr. Obama....

Profits Reward Risk Taking
Profits Fund Innovation
Profits In Good Years Make Up For Bad Years

Windfall profits happen when you buy a lottery ticket...
not when you invest in a business!

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