Senior Fellow Kevin A. Hassett

Congressional leaders are swarming like a school of piranhas around some of the most successful U.S. businesses. The work of two Nobel Prize-winning economists suggests that these efforts will be profoundly damaging to the long-run health of our economy.

Years ago, Congress set rules for private-equity firms and oil companies to play by. Under those rules, these firms took risks and profited handsomely. Now that the profits are in, Congress is targeting them with specific taxes designed to take back the winnings.

The measures are almost comical. Back in 2004, Congress decided to encourage domestic output and enhance our competitiveness by granting companies that produce goods in the U.S. a lower tax rate on most items. Many companies saw their rate on items that qualified under the new policy drop to 32.9 percent this year from 35 percent then. This lower rate applied to oil industry profits, as well.

As Alan Viard, my colleague at the American Enterprise Institute, has noted, Congress, ever worried about appearances, exempted pornographers from the rate reduction back in 2004. This year, the lawmakers are trying to exempt oil companies, too, perhaps on the theory that oil profits, like videos depicting sexual acts, are obscene.

But the fact is, when businesses made their investments, they did so based on an existing set of laws. If taxes had been much higher in the U.S., they might well have chosen to locate their operations elsewhere.

Sympathy for Schwarzman?

If you are like me, you have probably had a hard time feeling much sympathy for private-equity firms, which are the current target of Congress, and especially for the partners who profited so much from the Blackstone Group initial public offering. Chief Executive Officer Stephen Schwarzman's share, for example, was worth about $9 billion the day the firm's stock began trading. Who cares if he pays a little more tax?

It is equally hard to find sympathy for the big oil companies that have profited so much from the surge in energy prices. Exxon Mobil Corp.'s net income last year was a lofty $39.5 billion, a big pile of money even by Schwarzman's standards. They could easily afford to share a little more of that with the U.S. Treasury. And that could hardly hurt the economy, right?

Wrong. The problem with this approach was demonstrated decisively by Nobel winners Finn Kydland and Edward Prescott. Their work emphasized the damage done when governments adopt policies that are inconsistent over time.

Chilling Effect

The problem with such policies is that companies begin to expect inconsistency from government, and that can have a chilling effect on investment and risk taking, and not just in the industries Congress is attacking today.

The Nobel-winning idea, sweeping in its importance, is simple to explain: a greedy government has an incentive to broadcast low tax rates to encourage big investments and, once those big investments are made, to change the tax rate and "seize the capital."

When governments do that, they inevitably promise new investors that the punitive rates are a one-time deal. Sure, Congress might say today, we are hammering oil companies and private-equity companies, but they are special. If you invest and succeed somewhere else, we will leave you alone.

Kydland and Prescott noted that investors will realize that betrayal in the past signals betrayal in the future. This insight has proven useful again and again for those hoping to forecast changes in capital spending. For example, after the Russian government took over oil giant Yukos several years ago, foreign domestic investment as a share of gross domestic product plummeted after having climbed steadily since the economy's liberalization in the 1990s.

Who's Next?

Higher tax rates seize a bit of a company's capital and will certainly arouse fear in investors that they may be next. Accordingly, Congress wouldn't just be raising taxes on private-equity and oil concerns, it would be increasing expected levies on anyone who thinks their new project might reap healthy returns in the future. While the damage might not be as bad as the Russian experience, it should be significant.

If government takes a good bit of the upside away and leaves the downside to investors, then it dramatically changes the calculus of investing. Squeezing extra taxes out of Schwarzman and his partners might seem like an innocent maneuver, but the economic consequences of such targeted seizures will be terrible.

We might as well hang a sign up in Washington that informs people that if they invest and succeed, we will treat them like pornographers.

If playing by the rules and winning is against the rules, nobody will want to play.

Kevin A. Hassett is a senior fellow and director of economic policy studies at AEI.