Posts Tagged ‘Jay Rockefeller’

Real World Graduation: Question 34

RealWorldGraduation_Question_34  <– PDF

Suppose you are 21 years of age and have $1,000 to invest. Which of the following investment strategies offer the greatest long-term financial benefits?  Assume that the Prime Rate (the interest rate the Federal Reserve charges to the largest banks) is 5.2%.  The banks in turn will lend money at 3 to 10% above the Prime Rate, depending on the credit-worthiness of the applicant.   All of these investment strategies are legal in all 50 states.

a) You lend your $1,000 to an individual who promises to pay you 25% per year ($250 per year) interest on the principal. At the end of 10 years, you will receive $3500, $1000 of which is your original loan, and $2500 is interest on the loan. The average annual return to you on this loan is 25%.

b) You lend your $1000 to a corporation. The corporation agrees to repay you $600 the first year, $400 the second year, and $200 in the third year.  In all, you will receive $2200 over the three years, $1000 of which is the original loan amount, and $1200 is interest.  The average annual return on this loan is 40%.

c) You give your $1000 to a corporation, and they agree to pay you $100 per month (indexed for inflation) for life beginning when you turn age 50. Suppose your current median life expectancy is 57 years (meaning that people your age have a median life span of 57 more years).  This means that half the people now aged 21 will die before they reach 78, and half will live to 78 or longer.  If you fall in the median range for life expectancy, you will collect for 28 years starting on your 50th birthday.  Indexing for inflation means that if inflation of the currency causes the dollar to be only half as valuable as it is now, the corporation will compensate you by paying $200 per month, i.e., you will receive $100 in today’s buying power, not just $100.  Assume that you are now 21 and you expect to live to be 78 (the median life expectancy).  Then, you will receive the equivalent of $33,600 in present-year dollars, all of it in interest.  The average return over the 57 years between now until time of death is 58.9% (although you will collect it only for the last 28 years of your life).

d) Go to the Off-Track Betting Parlor next Tuesday and bet the entire $1000 on horse #3 in the fourth race.

e) Each of the first three options have varying benefits and risk, so it would be wise to split the $1000 among the first three options (not necessarily equally).

(The answer is on p. 2 of the PDF.)

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On Tax Subsidies for Oil Companies

On Tax Subsidies for Oil Companies <== PDF version

The U. S. Senate voted on 17 May 2011 against a bill that would have abolished about $20 billion over the next ten years in various tax subsidies to the major U. S. oil companies.  Most of the Democrats favored ending these subsidies, but the bill failed 52-48.

There was a hearing before the Senate on 12 May, in which politicians berated several oil company executives, ostensibly for reporting large profits in the last quarter.  Exxon-Mobil, for example, posted a quarterly profit of approximately $11 billion.  The politicians get away with this nearly-annual grandstanding because $11 billion is a lot of money, and oil companies are easy targets for those looking to score easy points with the public.  After all, the public is not particularly pleased with the price of gasoline at about $3.85 per gallon of regular.  But as usual, in all this posturing, most of the facts about the price of gasoline are left out.  It turns out that a significant fraction of the price paid at the pump is actually federal and state excise taxes.  While the federal excise tax is about 18 cents per gallon (14 cents for the ethanol mixed types), the amount of state excise tax varies by state from 26 cents per gallon in Alaska to 66 cents per gallon in California.  Here is the approximate breakdown of the components that go into a price of a gallon of gas at today’s prices, using a median value of 48 cents per gallon for state excise taxes.

63.5%: the total price of crude oil, including exploration, leases, research and development, production, logistics, royalties, and income taxes on gross profit

12.5%: federal and state excise taxes

8%: transportation (from mining site to refinery, andrefinery to gas station)

9%: refining crude into gasoline (or diesel)

0.5%: gross profit to retailer (out of which he must pay his income taxes)

6.5%: net profit to oil company

We see here that the total taxes imposed by the federal and state governments exceed by a margin of about 2:1 the profit to the oil companies.  Likewise, the oil companies have considerable expenses: they have to pay for the leases, and then the royalties; then they pay income taxes on the gross profit, all of which is of course built into the price of the raw material.

Keep in mind that the U. S. consumption of gasoline is about 140 billion (140,000,000,000) gallons of gasoline per year.  When you think of it, this is a lot of work.  The oil companies and the others in the supply chain have to locate it, drill it, transport it in special ships or pipelines, refine it, then store it and ship it again in special containers.  If gas is $4.00 at the pump, the oil company net profit is about 26 cents.  But it comes to seemingly big oil company profits; 26 cents on 140 billion gallons is $36 billion annual (on sales of gasoline alone).

Senator Harry Reid admitted that repealing these $4 billion annual subsidies will have little short term affect on the price of gas, which seems certain.  It seems to me that these tax subsidies should be repealed, but not out of envy at oil company success or some nebulous populist sentiment that the Democrats continue to advance.  I favor a repeal of these simply because in the long run, they serve to distort the true price of a gallon of gas.  First, they no doubt come with a long series of conditions and regulations, which may serve to distort the priorities of the oil companies.  It is no secret that many decisions are made with a view to how a corporation’s tax position will be affected, even if those decisions are contrary to what is in the long-term business interest.  If the long-term interest of the oil companies is to provide reliable energy at a sustainable profit, it seems that the interest of the people coincides with the oil companies, since a profitable economy depends on energy. Second, a general support by the taxpayer distorts the true return on investment; it may affect the allocation of research and development, which in turn may cause the oil companies, experienced in many aspects of energy production, from developing alternates.  Third, these subsidies politicize the basic function of capitalism; if the taxpayers end up subsidizing corporations, their representatives (Congress) will assume powers to inordinately regulate their businesses; I refer to the political game of what public leases can and cannot be developed.  It is not certain that such meddling benefits the taxpayer (witness the present price of gas).  Last, I am opposed to any corporation using its influence to weasel special favors from the politicians at taxpayer expense; why should a corporation receive welfare payments from the taxpayer?  But I make this statement in general for all corporations, not just the oil companies.

I mentioned “grandstanding” earlier, and now I give an example.  At one point in the 12 May 2011 hearings, Senator Jay Rockefeller told the oil company executives that they were “out of touch”: that although they were “good people”, flying around on Lear jets and the like resulted in those oil executives becoming too isolated from the sentiments of his constituents, namely the average folk of West Virginia.  This is a rather odd charge from the great-grandson of John Rockefeller of Standard Oil fame.  But in his defense, at least he did not accuse the oil company executives of engaging in every kind of corrupt practice and driving all the honest competitors out of business the way his great-grandfather did.

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