What Is a 'Windfall' Profit?

[dnalexander]

What Is a 'Windfall' Profit?
Wall Street Journal
August 4, 2008

The "windfall profits" tax is back, with Barack Obama stumping again to apply it to a handful of big oil companies. Which raises a few questions: What is a "windfall" profit anyway? How does it differ from your everyday, run of the mill profit? Is it some absolute number, a matter of return on equity or sales -- or does it merely depend on who earns it?

Enquiring entrepreneurs want to know. Unfortunately, Mr. Obama's "emergency" plan, announced on Friday, doesn't offer any clarity. To pay for "stimulus" checks of $1,000 for families and $500 for individuals, the Senator says government would take "a reasonable share" of oil company profits.
[Barack Obama]

Mr. Obama didn't bother to define "reasonable," and neither did Dick Durbin, the second-ranking Senate Democrat, when he recently declared that "The oil companies need to know that there is a limit on how much profit they can take in this economy." Really? This extraordinary redefinition of free-market success could use some parsing.

Take Exxon Mobil, which on Thursday reported the highest quarterly profit ever and is the main target of any "windfall" tax surcharge. Yet if its profits are at record highs, its tax bills are already at record highs too. Between 2003 and 2007, Exxon paid $64.7 billion in U.S. taxes, exceeding its after-tax U.S. earnings by more than $19 billion. That sounds like a government windfall to us, but perhaps we're missing some Obama-Durbin business subtlety.

Maybe they have in mind profit margins as a percentage of sales. Yet by that standard Exxon's profits don't seem so large. Exxon's profit margin stood at 10% for 2007, which is hardly out of line with the oil and gas industry average of 8.3%, or the 8.9% for U.S. manufacturing (excluding the sputtering auto makers).

If that's what constitutes windfall profits, most of corporate America would qualify. Take aerospace or machinery -- both 8.2% in 2007. Chemicals had an average margin of 12.7%. Computers: 13.7%. Electronics and appliances: 14.5%. Pharmaceuticals (18.4%) and beverages and tobacco (19.1%) round out the Census Bureau's industry rankings. The latter two double the returns of Big Oil, though of course government has already became a tacit shareholder in Big Tobacco through the various legal settlements that guarantee a revenue stream for years to come.

In a tax bill on oil earlier this summer, no fewer than 51 Senators voted to impose a 25% windfall tax on a U.S.-based oil company whose profits grew by more than 10% in a single year and wasn't investing enough in "renewable" energy. This suggests that a windfall is defined by profits growing too fast. No one knows where that 10% came from, besides political convenience. But if 10% is the new standard, the tech industry is going to have to rethink its growth arc. So will LG, the electronics company, which saw its profits grow by 505% in 2007. Abbott Laboratories hit 110%.

If Senator Obama is as exercised about "outrageous" profits as he says he is, he might also have to turn on a few liberal darlings. Oh, say, Berkshire Hathaway. Warren Buffett's outfit pulled in $11 billion last year, up 29% from 2006. Its profit margin -- if that's the relevant figure -- was 11.47%, which beats out the American oil majors.

Or consider Google, which earned a mere $4.2 billion but at a whopping 25.3% margin. Google earns far more from each of its sales dollars than does Exxon, but why doesn't Mr. Obama consider its advertising-search windfall worthy of special taxation?

The fun part about this game is anyone can play. Jim Johnson, formerly of Fannie Mae and formerly a political fixer for Mr. Obama, reaped a windfall before Fannie's multibillion-dollar accounting scandal. Bill Clinton took down as much as $15 million working as a rainmaker for billionaire financier Ron Burkle's Yucaipa Companies. This may be the very definition of "windfall."

General Electric profits by investing in the alternative energy technology that Mr. Obama says Congress should subsidize even more heavily than it already does. GE's profit margin in 2007 was 10.3%, about the same as profiteering Exxon's. Private-equity shops like Khosla Ventures and Kleiner Perkins, which recently hired Al Gore, also invest in alternative energy start-ups, though they keep their margins to themselves. We can safely assume their profits are lofty, much like those of George Soros's investment funds.

The point isn't that these folks (other than Mr. Clinton) have something to apologize for, or that these firms are somehow more "deserving" of windfall tax extortion than Big Oil. The point is that what constitutes an abnormal profit is entirely arbitrary. It is in the eye of the political beholder, who is usually looking to soak some unpopular business. In other words, a windfall is nothing more than a profit earned by a business that some politician dislikes. And a tax on that profit is merely a form of politically motivated expropriation.

It's what politicians do in Venezuela, not in a free country.

[frawin]

Excellent Post David, well written and great explaination and subject matter. I have found that most people who complain about the Oil Company profits know little or nothing about Market Cap, have never looked at the Oil Company Annual Reports to see what the expenditures are and know nothing about the risk level. Sometimes I wish that the top 5 oil companies would shut down and let the nayayers find out what their gasoline supply would be. The mergers in the oil industry have distorted the profit picture, people don't know, understand or care that the big three oil giants in the US are made up of what used to be probably 30 oil companies . The mergers were done for the companies to be big enough to take the risks and have the capital to do the big investment projects that have and will be required. Again, great post, and well written. The windfall profits proposed by Queen Nancy, Scary Harry and Obama is just to get votes for their Socialistic programs.
Uncle Frank and Proud to be

[frawin]

David, you have matured very well. i remember driving down to Uncle Ray's at Osage Beach and meeting your dad and getting Dennis and bringing him back to Howard while your mother was going to be in the Hospital having you. We have a long standing joke about that with Dennis. Aunt Myrna and I weren't married yet but she was with me and we stopped to gas up on the way home, Aunt Myrna told Dennis she was going to the restroom and asked Dennis if he wanted to go, he said he didn't need to but he would go with her and watch if she wanted him to. I told Aunt Myrna that I was shocked about what the little guy said, but I let it go until I saw your Mother sometime later, I asked what Dennis meant, she started laughing saying sometimes the locks didn't work on the station restrooms and Dennis would stand outside and watch, if any came up he would tell them his Mother was in there. I was pleased to know my 3 1/2 year old nephew wasn't that perverted. Then he went on and got perverted by being a lawyer.
Uncle Frank

[Diane Amberg]

If this windfall profits thing is such a hot button, I wonder why the Republicans and McCain aren't out their vocally refuting it in loud voices. Or did I miss something?