Windfall Profits Taxes in Name Only  | American Enterprise Institute

A handful of Democratic lawmakers have introduced new taxes on oil and gas companies in response to higher oil prices. The design of these taxes varies, but their goal is to tax the “windfall” profits of these companies. Despite their names, these taxes are far from true taxes on windfall profits and would have negative economic consequences.

Since the US attacks on Iran, lawmakers introduced three proposals meant to tax the windfall profits of oil and gas companies (Table, below). The first is the “Big Oil Windfall Profits Tax Act,” which taxes the difference between current average crude oil prices and the 2025 average crude price at 50 percent. The second is the “Iran War Oil Crisis Windfall Profits Tax Act,” which taxes the difference between crude prices and $75 at 100 percent. Third, the “Taxing Buybacks from Big Oil Windfalls Act” would raise the excise tax on stock repurchases to 25 percent for large oil and gas corporations. 

Windfall profits have a specific definition in economics: a sudden, unexpected, and temporary increase in profits due to macroeconomic and geopolitical phenomena. For example, an oil company that set up a new production facility a year ago when prices were closer to $70 would experience an unexpected windfall if it could start selling oil at $100 a barrel.

Textbook theory states that taxing windfall profits does not distort investment decisions because windfalls are unexpected returns to investments made in the past.

In practice, it is difficult to measure windfall profits. Oil companies can earn returns in excess of the return required to justify an investment for reasons other than a temporary, unexpected surge in oil prices, such as location-based rents, firm-specific know-how and patents, or an expected increase in oil prices.

These three proposals do a particularly poor job targeting windfall profits and would negatively impact investment.

The first two proposals are not taxes on profits at all. They are excise taxes on oil and other petroleum products produced in or imported to the United States. Excise taxes create a wedge between the prices that consumers pay and the prices (income) that producers receive. The party that bears the burden of tax depends on the structure of the market and the design of the tax. Producers may be able to pass some of the tax along to consumers. However, the two proposed excise taxes only apply to midsize-to-large producers, so the extent to which they could pass the tax along to consumers may be limited due to competition from smaller producers and importers, leading to lower returns to investment.

The price thresholds used by these excise taxes are a poor measure of windfall profits and introduce a tax asymmetry that will also punish investment. These taxes apply when oil prices exceed a certain threshold but do not provide relief below the threshold. This means there will be a tax even if there are no genuine windfalls. Consider an investment that makes sense at an average price of $70 a barrel (approximately the average Brent price in 2025), but the investor expects the price to swing between $45 and $95 over the life of the asset. Under the Whitehouse proposal, which is permanent, the investor would be taxed in the years the price exceeded $70 in real terms but would get no relief in the years the price was below $70 in real terms. As a result, the price the investor would realize would be below the price needed to justify the investment.

The proposal to raise the stock buyback tax is also poorly targeted. If corporations expect the tax to be permanent, it would directly discourage investment. Oil and gas companies that plan to return profits to shareholders in the form of repurchases would experience a significant increase in their cost of new investment. For example, a 24-percentage-point increase in the stock buyback excise tax would push the effective tax rate up by roughly 33 percentage points on a drilling project that is expected to yield a gross return of 9.5 percent.¹ If, however, corporations expect gas prices to fall and the tax to expire, they could retain earnings and completely avoid it.

Finally, the Sherman and Wyden proposals may be temporary, but their effect on investment would be permanent. Under a genuinely temporary tax, firms may delay or pause projects but would face no long-run disincentive to invest. However, enacting one today would set a precedent for a new tax the next time oil prices rise. The expectation of future taxes would reduce the expected return on investment today.

A textbook windfall profits tax would raise revenue without harming investment. These three proposals, in sharp contrast, would discourage it.

1 Assumes a discount rate of 5 percent.