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The Windfall Tax Proposal and the State Economy
The debate over the governor’s proposed oil tax on refineries does not address the much larger costs driving energy prices to these levels as the result of the state’s regulations and policies. We recently estimated these additional regulatory costs at about $50 billion annually to households and employers and growing when California prices are compared to the averages in the other states.
The state agencies understand how to reduce these costs. Testimony presented at the Energy Commission’s November 29 workshop indicates that the largest daily gasoline price drop on record came in early October. This steep drop was not the result of state agency actions but the result of Governor Newsom overruling the agencies and allowing early production of the lower cost winter formulations to counter the supply shortages that had led to the price spikes. An unceasing flow of new regulations and taxes has fueled the relentless rise in California energy prices. The only instance of regulatory easing since the state’s current policies began in 2010 is also the only time Californians have seen some relief in this upward
climb in costs.
The governor’s proposed tax, however, continues the policies that have led to the state’s high energy costs by adding on to the costs of a product that is already taxed at the highest rates in the nation. If approved, this proposal would also be the fourth major tax increase resulting from legislative action this year even as the prospects of renewed recession appear to be growing.
And by continuing the policy approach that has led to California’s high energy prices, this proposal carries the risk of increasing prices even more, both directly from the effects of the tax and from increased risk of supply shortages in the future:
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The proposal is unlikely to provide significant relief to households and employers. Compliance with California regulations and as critically the effect of those regulations shutting off the state from global supplies produced a cost premium averaging $1.24 higher than the average price in the other states in 2021, a period of reduced demand and prior to this year’s price spikes. The proposed tax would only deal with a small portion of this cost premium, and does nothing to address the much larger price increases coming from the state’s higher fuel taxes, regulatory costs of compliance, and overall higher costs of operating a business.
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The proposed tax is in essence a price control, and price controls have well defined effects both in the literature and real world experience such as the gasoline price controls enacted under President Nixon in the 1970s. The primary outcome relevant to California’s situation is that price controls limit supply, both directly in immediate markets and longer term by reducing the incentives for capacity investments. In this respect, the proposal is totally at odds with the repeated investigations into the causes of California periodic gasoline price spikes, including investigations as early as 1999, 2000, and 2004 when the cost and supply consequences of the state’s regulations first became apparent. These and subsequent investigations are consistent in three respects: every new price spike leads to yet another round of calls for investigations, those investigations report the same conclusions on why the state’s prices are so high, and those results are ignored and the state imposes more taxes and regulations that lead to more and higher price spikes in the future.
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Supply is the problem. The state’s regulations limit what alternative supplies can be brought into the state even during emergencies. Existing state policies including the proposed tax only serve to make the supply problem worse. The primary factor identified in the previous investigations leading to price volatility is the effect of the regulations limiting supply. The state’s higher taxes and California-specific compliance costs raise the general level of fuel prices overall, but restrictions on supplies that can be sold in the state lead to situations where even minor refinery outages can produce supply shortages and consequent spikes in fuel prices. These supply problems began as the state’s fuel regulations first eliminated the independent refiners who no longer could operate profitably under the growing compliance costs, and have grown as additional
refineries have passed this cost threshold. The proposed tax would provide yet another disincentive for capacity investments, adding to but likely accelerating existing state policies implementing the provisions of Executive Order N-79-20 to shut down the remaining refining capacity in the state.
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Given the nature of the agencies involved in the state energy policies, the proposed tax in many respects draws on the pricing model and approach used in state regulation of utilities. These regulations set the rates utilities can charge for their services. The key difference is that existing rate-setting in essence establishes both a minimum and a maximum ensuring the regulated utilities earn an adequate return on their investments and costs. The state retains an interest in ensuring those businesses continue as viable operating entities and that their capital borrowing costs are stabilized through adequate revenue streams. The proposed tax instead serves only to set a maximum price, and ignores the fact that revenues within the oil and gas industry historically are highly variable. For example, SEC filings indicate the net income for the 5 largest
refinery operators in California varied widely over the past 6 years, with losses in 2020 nearly matching net gains in 2021. The key difference, unlike the case for other energy providers, is that state policy as contained in Executive Order N-79-20 is to eliminate refineries in the state rather than continue them as viable operating entities. The core consequences will be higher price volatility as an already constrained supply is reduced further.
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