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Oil Levies Essay

1248 words - 5 pages

Oil Levies and the Law of One Price
Abstract
The Congress failed to deal with the American budget deficit in the mid-1980 by cutting spending. Their refusal to cut spending aims at reducing their budget deficits and protecting American oil producers against foreign competition which they perceive as ‘cheap’. Instead, they decided to impose a tax all the crude oil and other refined products they get from foreign countries to match declines in the prices of world oil. The proponents of the move argued that the implementation of such a policy would have little effect on the American economic activities. They claimed it will also provide price reliefs to the struggling American refineries ...view middle of the document...

This type of competition ensures the prices for American refined products are equal to the world’s prices even without referring to the prices of the American crude oil. In case the domestic American refineries think of raising their prices above those present around the globe, most of their customers will avoid them and shift to other refineries that may be operating in areas like Europe, the Caribbean, and Canada. Therefore, in such a case, the tax burden will be on the domestic refineries. A further $5 import tax will allow the domestic producers to raise the prices for equivalent amounts and eventually raise their profitability. However, such an import tax will leave the world prices of refined products with no changes thereby implying that the local American refineries will be unable to pass the high costs of crude oil to the customer. In turn, the profit margins refineries enjoy will reduce by a similar amount of tariff. Subsequently, after the imposition of such taxes, the importation of refined products will increase while the importation of crude oils and their use of the capacity of their domestic refinery capacities will decrease. The result will be that wholesale prices for refined products will remain virtually with no changes.
Q2. Effects of a $10 per Barrel Tariff
The levying of such a tax on the importation of refined products will make the domestic prices have elevation above world levels by $10/barrel in contrast to the $5/barrel levies on crude oil. The distributors of the refined products will then have to pay prices that equal the world prices in addition to taxes owed to their suppliers. Such a move will widen the American refineries profit margins while shifting the imports mix more towards crude oil than the refined products. The domestic oil refineries will also see their profit margins before tax rise by a similar amount to the tax set. However, as many users of the refined products compete indirectly or directly with distant suppliers of various products or services, the profit margins in the remaining economy will decrease. Thus, the production facilities in America will experience stiff competition from the foreign markets and will increasingly find it difficult to pass these high energy prices to the customers. The energy tax will hurt most industries that face stiff foreign competition from other energy intensive industries. Therefore, the consumers will seek to obtain foreign oil which is cheaper and if the taxes on crude oil obstruct its importation, they will find a replacement through the importation of refined products. In case the prices for importing refined products rises above the global price due to the imposition of the tax, any oil present in foreign products will be on...

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