Eight Days Into His Term, Reagan Scrapped Oil Price Controls for Good

Most of Washington, handed a ten-year-old mess, would have formed a task force. A task force would have commissioned a study. The study would have recommended a phased, multi-year review, and a hearing schedule would have been announced with great solemnity.

Ronald Reagan took the oath of office on January 20, 1981. On January 28, eight days later, he signed Executive Order 12287 and ended federal price controls on crude oil and refined petroleum products. Not phased. Not studied. Ended. If you want to know what a president looks like when he actually believes something he said in the campaign, there it is, in a document short enough to read over breakfast.

The surprise is not that he did it. The surprise is how long the country had put up with the alternative. Let me tell you the story from the beginning, because every generation seems to rediscover the idea that you can fix a price by decree, and every generation pays for the discovery with a line at the pump.

It starts with a freeze in 1971

The villain of this story is not a single party. On August 15, 1971, President Richard Nixon went on television and announced a 90-day freeze on wages and prices across the American economy. Congress had given him standby authority the year before, in the Economic Stabilization Act of 1970. The same speech closed the gold window and added a tariff surcharge on imports, and the freeze was the headline that most families remember.

The country was worried about inflation, and a freeze looked like the thing a decisive leader would do. It was popular at first. It always is. Then came the sequels, called Phases, and the controls grew into a system with exemptions, categories, boards and forms. By the time most wage and price controls were allowed to lapse in 1974, the economy had been through an expensive lesson in why shop owners stock up when they expect a ceiling, and why shelves empty when a ceiling is too low.

But oil kept its controls. And that is where the trouble compounded.

The embargo and the two-tier price

In October 1973, in the wake of the Yom Kippur War, Arab oil producers announced an embargo on shipments to the United States and some other countries that had backed Israel. Oil prices roughly quadrupled over the following months. Americans saw it at the pump, and in many places they saw it as a line of cars stretching around the block.

Washington's answer was to control more, not less. Congress passed the Emergency Petroleum Allocation Act in November 1973. It set up a system for allocating fuel and holding down prices. The program grew a hierarchy: oil from wells that had been producing in a past base year, called "old oil," carried a low controlled price. "New oil" produced above that base level, and oil from small marginal "stripper" wells, could sell closer to market. In theory, this gave producers an incentive to find more.

The Energy Policy and Conservation Act, signed by President Gerald Ford on December 22, 1975, kept the system going. The law did several things. It created the Strategic Petroleum Reserve. It set the first fuel economy standards for cars. And it extended the controls, with a blended price ceiling and a schedule that would let authority lapse in the early 1980s. A bill sold as a path to energy independence also held in place the very machinery that was discouraging domestic production.

A related program, called the entitlements program, tried to equalize costs among refiners, some of whom had access to cheap old oil while others had to buy expensive imported crude. The effect, as critics noted at the time, was that refiners received something like a subsidy for each barrel of imported oil they brought in. Read that again. A program passed in the name of reducing dependence on foreign supply made foreign oil a little cheaper to buy than it would have been. That is not a conspiracy. It is what happens when you try to be fair with someone else's money in a market you have broken.

Why a ceiling creates a shortage

Let me slow down and give you the logic, because this is the core of the argument, and I'd like you to be able to make it to the next person who brings up price controls at a family dinner.

One: when a price is set below what the market would charge, buyers want more of the good than they would otherwise buy. It is cheaper, so people drive a little more, fill the tank earlier, and top it off at half.

Two: at the same low price, sellers have less reason to supply. Marginal wells are not worth drilling or pumping. Importers send cargoes elsewhere.

Three: the gap between the quantity people want and the quantity available is a shortage. You cannot repeal it by announcing that it should not exist.

Four: when money cannot ration the good, something else will. Time rations it. Queues ration it. Connections ration it.

Here is a hypothetical to see the numbers. Suppose the market would settle at $1.50 a gallon, and the government sets a ceiling at $1.00. At $1.00, drivers want 120 gallons, but stations can supply only 100. The shortage is 120 − 100 = 20 gallons, one gallon in every six wanted (20 ÷ 120). Nobody sells at $1.50, because it is illegal, so the 20 missing gallons are rationed by who gets to the pump first.

Now price the line. A driver who waits 45 minutes, which is 0.75 of an hour, and whose time is worth $20 an hour, has paid $15 in time. If the tank holds 15 gallons, that is another $1.00 a gallon. The "controlled" price of $1.00 turns into an effective price of $2.00, higher than the free-market price, and the extra dollar goes to nobody. It is a pure loss, the sound of a thousand idling engines. Those numbers are made up, but the arithmetic is the point.

I have a bone to pick with anyone who says price controls protect the working family. Who has time to wait 45 minutes? The shift worker with a boss at the plant door does not. The person with the flexible schedule does. The poor and the hourly paid pay the most when the price is paid in time.

1979 and the line around the block

The system's fragility showed in the spring and summer of 1979. After the Iranian revolution disrupted Iran's output, supply tightened and the lines were back. In a number of places, drivers were limited to alternate days according to whether their license plate ended in an odd or even number.

Part of the pain was built into the allocation rules. Fuel was assigned to regions according to historical patterns of use. But the country had moved. Suburbs were growing, and people were driving more in some places than the formulas assumed. The result was that supply went where the old data said it should go, not where the cars were. A market would have sent the gasoline toward the highest bidders, which is to say toward where it was most needed. A formula sent it toward where it used to be needed.

President Jimmy Carter, who had called the energy problem "the moral equivalent of war" in a 1977 address, did something that deserves credit. On April 5, 1979, he announced a plan to phase out price controls on domestic crude oil in stages, ending in the fall of 1981, and he asked Congress for a tax on the resulting windfall. A Democratic president saw the problem and began to dismantle the machinery. Give him his due. It was a policy reversal that cost him with his own party's base.

The windfall profit tax

Congress passed the Crude Oil Windfall Profit Tax Act, which Carter signed in April 1980. It was an excise tax on the difference between the market price of domestic crude and a base price set by the government. The theory was that once controls came off, producers would receive a windfall they did not deserve, and the public should capture a share.

Look at the logic. First, the government held down the price for a decade. Then, as it lifted the ceiling, it announced that the producers' gain from a higher price was ill-gotten and should be taxed. A tax on production is also a tax on the incentive to produce. The tax was meant to raise a lot of revenue. Then the price of oil fell, and revenue fell short of the advertised amounts. Congress repealed the tax in 1988.

That is the pattern of the whole story: a rule meant to produce fairness, followed by a second rule to correct the first, followed by a third rule to repair the second.

January 28, 1981

Now the scene returns to Washington. Carter's phased decontrol was already underway, with the controls scheduled to expire by the fall of 1981 anyway. Reagan did not wait. His executive order eliminated the remaining controls on crude oil and refined products immediately, and it ended the allocation and entitlements machinery that went with them.

It was a lesson in what a clear principle can do. Reagan had campaigned on the proposition that the federal government had no business setting the price of oil, and he acted on it in his first full week. The order stands as a reminder that some of the best reforms are subtractions. He did not create a new agency. He wound one down.

What did the critics predict? That prices would soar, that the poor would suffer, and that lines would form. What happened was the opposite. World oil prices peaked around the time of the decontrol and then fell through the 1980s, with a steep collapse in 1986. The long lines of the 1970s did not return in the same way.

The honest objection

I promised to give the other side its best argument. Here it is. A skeptic will say that Reagan was lucky. The decline in oil prices had many causes, they will say: a recession that cut demand, conservation after the shocks, new supply from the North Sea and from Alaska's North Slope, which began flowing through the Trans-Alaska Pipeline in 1977, and a decision by some producers to pump more. Decontrol cannot take all the credit. And at the moment of decontrol, some families faced higher bills for heating oil and gasoline in the middle of a harsh economy, a hardship that was real.

That is a fair point on the details, and I do not claim decontrol alone drove prices down. But the objection supports my side. Why did conservation and new supply appear? Because prices were allowed to carry a signal. A decade of ceilings had told producers not to drill and told drivers not to worry. Once the price could speak, people responded. Higher prices in the early years told homeowners to insulate and told companies to explore. That is not luck. It is the mechanism by which free prices correct a scarcity, and it is the subject of I, Pencil and the price system, how nobody plans your breakfast, a post worth reading if you want to see how a pencil gets made with no central planner.

And on hardship: if government wants to help a low-income family with a heating bill, the honest way is to say so and write a check, which Congress did in 1981 by creating the Low Income Home Energy Assistance Program. That is transparent and targeted. A price ceiling hides the cost, breaks the market and leaves the poor in the line.

What the story teaches now

The general lesson reaches beyond oil. Every time prices jump, a loud voice demands that someone fix them by law. The same instinct appears in debates over price gouging laws sound fair and then the shelves go empty, over rent, over groceries and over any good that has become expensive. The argument for ceilings has always been that the price is unjust. The argument against has always been that a shortage is worse.

There is also a link to inflation. The price controls of 1971 were a response to rising prices, and they papered over a monetary problem rather than fixing it. It took a hard-nosed Federal Reserve to break the spiral, a story told in How Paul Volcker broke inflation and why it hurt so much. And the quiet way that inflation works as a tax is the subject of Inflation is the one tax that never needs a vote in Congress. Put them together and you get a picture: governments that print too much and then try to forbid the symptom.

For the producer side of the story, The Texas Wildcatter Who Spent Twenty Years Cracking the Shale Code shows what happened when a free market was allowed to reward a man who spent two decades solving an energy problem. And if you want to know where your own energy dollars go, Trace Your Family's Energy Dollar From the Meter and Pump to the Grocery Bill follows them from the meter to the grocery bill.

The bottom line

• Federal oil price controls began in the early 1970s, were extended by the 1975 energy law, and gave the country shortages and gas lines. They did not give it cheap fuel.
• A price ceiling below the market price creates a shortage, and a shortage is rationed by time and connections, which hurts hourly workers and the poor the most.
• Reagan's Executive Order 12287 of January 28, 1981 ended the controls immediately. The windfall profit tax that followed from the same era was repealed in 1988.
• When a politician promises to hold down prices by law, ask what happens to supply, and ask who waits in the line. Then tell your representatives you would rather have a free price than a free-for-all at the pump.