White House may try to repeal other industries' tax breaks

Nick Snow
OGJ Washington Editor

WASHINGTON, DC, Sept. 11 -- US President Barack Obama’s administration is studying whether to propose repeals of tax breaks for other industries besides oil and gas, a US Department of the Treasury official told a US Senate subcommittee on Sept. 10.

Alan B. Krueger, assistant US Treasury secretary for economic policy, mentioned the examination during a hearing by the Senate Finance Committee’s Energy, Natural Resources, and Infrastructure Subcommittee on the White House’s Fiscal 2010 oil and gas tax proposals.

The examination reflects an administration policy that taxes should be neutral across all businesses unless exceptions are in the national interest, Krueger said. “The Volcker commission subcommittee chaired by Martin Feldstein is looking into incentives for other industries,” he said.

Paul A. Volcker, who was Federal Reserve chairman during 1979-87, chairs Obama’s Economic Recovery Advisory Board. Feldstein, who was White House Council of Economic Advisors chairman during 1982-84, is one of the board’s 15 members.

When a subcommittee member, Jim Bunning (R-Ky.), asked Krueger if the administration was currently singling out the oil and gas industry as it seeks tax incentive repeals, however, the Treasury official replied, “That is correct.”

Testing sentiment
Asked following the hearing if it appeared that the White House is using oil and gas as a test of sentiment for repealing more business tax preferences, American Petroleum Institute Chairman J. Larry Nichols told OGJ: “That’s what the man the said. It’s the first time I’ve heard anyone from the Obama administration admit it.”

Nichols, who is Devon Energy Corp.’s chief executive, said he was not particularly surprised. “This is the biggest tax-and-spend administration in history,” he said.

“It sounds like the administration is waiting on some other committee to decide what to do. Meanwhile, it didn’t have any trouble going after the oil and gas industry,” a second trade association leader who testified at the hearing, Independent Petroleum Association of America Chairman Henry G. (Buddy) Kleemeier, told OGJ on Sept. 11.

Kleemeier, who is Kaiser Francis Oil Co.’s chief executive, said he was disappointed there were not any Democrats at the hearing besides the subcommittee’s chairman, Jeff Bingaman (D-NM), as he and Nichols explained how badly the White House’s oil and gas tax incentive repeal proposals would damage the industry. “We’re fighting this hard because it’s bad public policy,” he said.

In his opening statement, Bingaman said the White House has gone beyond proposals to repeal a manufacturers’ tax break for large integrated oil companies and to impose an excise tax on new federal Outer Continental Shelf production. These proposals enjoyed broad bipartisan support when they became part of the Finance Committee’s tax bill in 2008, but the measure fell one vote short of cloture once it reached the Senate floor, he noted.

‘Would go further’
“I continue to believe those proposals have merit,” Bingaman said. “But the president’s budget proposal would go further, in that it would disallow the Section 199 deduction for all oil and gas producers, not just the largest integrated firms. I have concerns about that expansion, and believe it will require careful study. I also understand that the administration is refining the OCS excise tax proposal and I look forward to working with them in doing so.”

Bingaman said Obama’s proposed oil and gas tax changes also place on the table several preferences that have been part of the federal tax code for nearly a century in some cases. The most significant of these are disallowing expensing of intangible drilling costs (IDCs) and requiring them to be capitalized instead; prohibiting percentage depletion for oil and gas firms and requiring cost depletion instead; and increasing the period over which independent producers amortize geological and geophysical costs to 7 from just 2 years, Bingaman said.

Congress will need to consider whether each of these proposals causes more than a negligible increase in consumer prices, would decrease domestic production, and would adversely affect local economies and cost jobs, he suggested.

Nichols noted that they would: “We believe these proposals are antijobs, anticonsumer, and antienergy. They will depress investment in new domestic oil and gas projects, weaken the nation’s energy security, and slow the economic recovery,” he said in his written testimony. “In addition, the proposals jeopardize the jobs of millions of industry workers across the country a time when so many Americans are unemployed and economic recovery remains uncertain.”

In written testimony, Kleemeier said, “The Obama administration’s budget request would strip essential capital from new American natural gas and oil investment by radically raising taxes on American production. American gas and oil production would be reduced. It runs counter to the administration’s clean energy and energy security objectives.”

‘More, not less’
Kleemeier told OGJ that he remains astonished at Obama administration statements that developing and producing less domestic oil and gas is in the nation’s best interest. So, apparently, does Nichols. “I have never heard anyone, before the Treasury Department produced its Green Book, say that the United States produces too much oil and gas. Every president since Richard Nixon and before Barack Obama said we need to produce more, not less,” he told the subcommittee.

But Krueger said the administration believes it is no longer enough to address US energy needs simply by finding more fossil fuels, and that dramatic steps toward becoming a clean energy economy must be taken. “The tax subsidies that are currently provided to the oil and gas industry lead to inefficiency by encouraging an overinvestment of domestic resources in this industry…. [The tax subsidies also] result in distortions within the industry by favoring investment in nonintegrated firms,” he said in his written testimony.

“Tax provisions that encourage investment in a specific industry may be justified in cases where they address a positive externality associated with either production or consumption of certain goods. Private market decisions can be inefficient when market prices do not reflect the full social costs,” the Treasury official continued.

Oil and gas prices, for example, do not reflect environmental harm caused by the release into the atmosphere of greenhouse gases associated with production, Krueger maintained. The price of oil also does not reflect risks associated with US dependency or the costs of traffic congestion, he said. “Tax provisions can address this problem by incorporating the social costs into the price of the resources,” he said.

Removing federal tax preferences would have little adverse impact on oil and gas prices, production, and employment, Krueger said. “The relatively small share US share of global [oil] production means that any change in domestic production will have a limited impact on the world supply,…[which the Treasury Department estimates] would fall by less than one-tenth of one percent due to the elimination of these tax subsidies,” he said.

Price impacts
Even if additional costs to domestic oil companies were fully passed on to consumers through higher gasoline prices, “which is highly unlikely because prices are set on the world market, the cost would be equivalent to less than 1¢/gal,” Krueger indicated. He conceded that a change in domestic producer costs could cause production to move from US independents to domestic and foreign integrated oil companies, but added that total oil finding and lifting costs would rise by less than 2%.

“Of course, the increase in costs would not translate into a one-for-one decrease in production,” he said. “Based on estimates of short and long-run supply elasticities, we estimate that the decrease in domestic production due to these proposals will be less than one-half of one percent, even in the long run.” Oil production employment would fall by a similar percentage, he added.

Since gas is a North American instead of global commodity in the US market, Krueger said impacts from removing tax preferences would be larger, but still modest. Estimates by the Treasury Department’s Economic Policy Office said the subsidies are equal to about 1% of total gas industry revenues over the last 2 years, suggesting that their removal would result in about a maximum 1% price increase, he said. Consumers probably would reduce demand by less than 0.5% as a result, he suggested.

“Over the long term, employment in the natural gas production and supply industry could change by an amount similar to the change in production. As in the case of oil, eliminating the distortionary influence of the tax preferences for gas will result over time in new jobs being created in other sectors,” said Krueger. “And, like oil production, the natural gas industry is highly capital-intensive relative to the US economy as a whole, suggesting these tax subsidies are not effective means for domestic job creation.”

He said policies that reduce US dependence on oil, such as a carbon cap-and-trade system or investing in clean energy technologies, are more effective in reducing US vulnerability to an oil price shock and promoting energy security. “To the extent that current tax subsidies for the oil and gas industry encourage the over-production of oil and gas, they divert resources from other, potentially more efficient investments, and they are inconsistent with the Obama administration’s goals to reduce GHG emissions and build a new, clean energy economy,” he said.

Other observations
Subcommittee Republicans had reservations. “I worry about the impact on jobs in my state from raising taxes on oil and gas companies,” said John Cornyn (Tex.), and the subcommittee’s ranking minority member, Orrin G. Hatch (Utah) observed: “You can pour trillions of dollars into developing energy alternatives, but without oil and gas, we won’t be economically competitive for decades.”

Two other witnesses expressed views similar to Krueger’s. “No one has made a credible case that subsidies are necessary,” said Stephen P.A. Brown, a nonresident fellow at Resources for the Future. “The prices of oil and gas are high enough to attract investment. If production falls because incentives are repealed, prices will rise enough to attract investment.”

Calvin H. Johnson, a law professor at the University of Texas at Austin, said, “Indeed, an increase in the price of oil and gas, if any, would help us conserve energy, and adjust to alternative energy sources and high energy prices in the future. The government should get out of the business of subsidizing oil and gas, especially via the tax system.”

The two industry witnesses contended that the costs to the nation would be high. Nichols said, “The proposals will make it more difficult, and more expensive, to meet our country’s energy needs; will undermine our goal of energy security; will reduce jobs, investment, and government revenues from our domestic energy sector; and frankly are punitive to an industry that represents a significant part of the US economy.”

A sixth witness, Kevin Book, a managing partner at Clearview Energy Partners LLC, said Congress should especially consider unintended consequences when considering the proposals. “A deepwater production tax could push activity back, which would reduce revenues,” he said.

Federal lawmakers should move carefully, Book said. “After all, at this point in our nation’s economic history, it seems equally irrational to demonizing the taxes that will fund government operations as it does to demonize the fossil energy that will power our economic recovery,” he said.

Contact Nick Snow at nicks@pennwell.com.

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