Today’s Headlines: Is It Time For An Oil Tax?

A Proposed New Oil Tax

Low oil prices mean hardship for some and opportunity for others. Count the Obama administration among the opportunists. According to many reports, President Obama's upcoming budget intends to include a $10 tax per barrel of oil on all foreign and domestic supplies. The money will be used to invest in America's transportation infrastructure.

If there is ever a right time to institute an oil tax with minimal uproar from the public, this may be it. As of this writing, Brent Crude oil is just above $34 per barrel and West Texas Intermediate (WTI) is struggling to stay above $30 per barrel. (Two years ago, those prices were near $110 and $100 respectively.) The proposed tax would be phased in over five years, so the tax increases will slowly be absorbed and obscured by natural seasonal changes in gas prices.

While this is a tax imposed on oil companies, rest assured the costs would be passed on to consumers. The total effect could be as high as a 25-cent increase per gallon of gas.

It's fair to ask whether this is the best form of tax to solve infrastructure problems. However, the real question is: what aspects of transportation infrastructure will be supported with this money?

Not Maintenance, but Transition

Instead of a tax simply designed to patch and repair existing infrastructure, the administration looks at this proposal as a blueprint for a transition to a cleaner-energy future. Ed Rendell, the former governor of Pennsylvania and co-chair of Building America's Future, calls the plan the boldest transportation plan since President Eisenhower's establishment of the Interstate highway system.

Approximately $20 billion per year of the spending for this program is slated for "enhanced transportation options" that are primarily alternatives to driving and flying, with an emphasis on clean technologies. Another $10 billion per year is slated for state, regional, and local governments to invest in newer, cleaner, and smarter infrastructure technologies. Overall R&D efforts for clean transportation will take another $2 billion annually.

Note the absence of traditional road and bridge maintenance, although the administration pledges that the plan will, according to the New York Times, "provide for the long-term solvency of the Highway Trust Fund." Obviously, some repairs must take place, but the emphasis of this proposal is on newer and better transportation systems.

Who Should Pay?

All sides agree that America's transportation infrastructure is degrading and that the funds are not there to handle repairs. Currently, the federal gas tax contributes approximately $34 billion each year to the federal coffers, yet the government spends approximately $50 billion annually on collective transportation needs.

In essence, overspending by $16 billion annually still does not keep our highways, airports, railways, and waterways in sufficient shape. That does not even address the newer technologies necessary to move forward with improved transportation options. Realistically, taxes must fill the gap, but what is the most equitable method of raising them and how should they be spent?

The gas tax is user-based — the more gas you buy, the more you pay for the use of the highways. It not been raised since 1993, when the current tax rate of 18.4 cents per gallon of gas and 24.3 cents per gallon of diesel was set. Since then, mileage per gallon has increased while repair costs have increased, leaving less money to cover higher costs. Electric cars effectively get a free ride. The gas tax may need to be raised in the intermediate term independently from the administration's proposal, while use taxes eventually drift more to tolls or other per-mile systems and away from gas consumption.

It's More Than Just Gasoline

The focus is on gas and gas prices because that is the use of crude oil that most Americans deal with on a daily basis. However, according to 2011 information from Exxon Mobil, gasoline production accounts for less than 50% of the use of a barrel of oil. Approximately one-third goes to diesel and jet fuel production, and the rest is spread out through the economy as various products chemical feedstocks. Those feedstocks end up in everything from asphalt to lubricants to everyday plastics — even clothing. (Guess where polyester comes from?)

Thanks to these many uses, the International Monetary Fund (IMF) estimates that a $10 change in oil prices worldwide has an effect of 0.2% on gross domestic product (GDP). That may not hold true in the US market (by this logic, our GDP should be a full percentage point or more higher than it is) but the point is that an external tax that is separate of supply and demand has to be a drag on the economy almost by definition.

It is important to look at this tax as an investment, and we taxpayers should demand future return on that investment — assuming that we can agree on what the return should looks like. The President seems to argue that the criteria are an improved climate and cleaner forms of transportation and energy generation, with presumed job gains in green technologies that overcome any job losses. Do you agree?

The Takeaway

No matter how nicely it is dressed up or how strongly it is supported by the administration, it is highly unlikely that the proposed oil tax can make it through Congress in its current composition. For the sake of argument, let's assume that it does.

From an investment perspective, an oil tax would probably have a short-term effect on energy companies that may not have recovered by the time such a tax would be written into law. However, most of the extra cost would be passed on to consumers throughout the supply chain. The tax might have limited effect on stocks compared to the supply-and-demand issues that are pummeling oil stocks at the moment.

While the President's goal is to move away from fossil fuels, that transition will take a very long time — and oil will still be around in significant quantities. You may see a buildup of electric cars in the next ten years, but you won't see electric jet planes. Nor will there be an immediate replacement for petroleum derivatives in plastics and other commercial uses. Oil companies will continue their normal cycles of supply and demand with a little geopolitics thrown in to create turbulence.

Unless you want to try to time fears of a tax spooking investors — and we suggest against that — play energy stocks as you have been and consider them higher risk until the oversupply situation plays out.

Meanwhile, give the President credit in one aspect: our infrastructure really is deteriorating and we are going to have to pay for its improvement somehow. A tax increase is realistically inevitable; otherwise, transportation will deteriorate to the point where it begins to cause serious economic harm. We voters will eventually have to decide how that tax is paid.

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