Thursday, June 19, 2008

Windfall Profits - Apples and Oil

Several times over the past few months I’ve heard that the oil companies should not be singled out for a windfall profits tax because their return on sales is only about 8.5%. They whine that several other industries have much larger returns.

I’m certainly not an economist, but this doesn’t sound right.

Suppose I sell apples at my roadside stand. I sell 100,000 apples a year at a dollar a piece (I’ll keep the numbers simple to make this easier – on me). My return is 10% so I normally make about $10,000 a year. Half my sales are from apples I grow and harvest the other half I buy at market value from other farmers.

Luckily I live in an area where people eat their apples religiously believing that it keeps down their health care costs. So when an apple blight in Brazil quadruples the price of an apple, my sales are unaffected. The cost of apples I buy to resell goes up, but the price I charge for each apple rises correspondingly, so now my annual sales are $400,000. I’m still making my 10% of sales so suddenly I’m raking in $40,000 a year. That is an extra $30,000 a year for doing absolutely nothing.

Suppose that for the 50,000 apples I used to pay 80 cents each to buy, I’m now paying $3.20. People are pretty much willing to pay whatever they have to so they can have their daily apple, so I just pass these costs along (maybe a little larger markup since I deserve to get more per apple since the apples are worth so much more). My overhead costs didn't go up, but I can make a much larger profit. I can put some of this money back into the business (a new truck, a new tractor, repave the parking lot, etc,) and still be making extra money.

But what about the 50,000 apples I grow? Although my costs to grow them did not change at all, each apple is worth 4 times as much. I’m raking in a ton of money with no additional effort since I can now sell them for the same price as I sell the apples I buy from other farmers.

I’m also not a tax expert, but I'll bet there are significant tax breaks to offset my additional profits and decrease the taxes I would otherwise pay. This may be where my example breaks down since I guess I would have to pay taxes on my increased profit for each apple. But if this were a non-renewable resource (my apples are a renewable resource since I can grow more apples next year), I bet there would be significant tax breaks that increase as the value of the resource being sold goes up, such as depreciation. So I can probably avoid a lot of taxes because I am selling a resource that by market valuation costs a lot more to replace.

Oh yeah, the value of my farm also just increased dramatically since my orchards can now generate higher revenue.

So when the oil companies cry that their profits are not excessive, tell them you’ll agree when your boss quadruples your salary and you don’t have to do anything extra to earn it.

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