Energy and tax reform

Dec. 10, 2007
A wisp of hope drifts around the murk of energy legislation under development in the US.

A wisp of hope drifts around the murk of energy legislation under development in the US. It’s a federal tax system on the verge of self-destruction.

As the first session of the 110th Congress approaches its end, Democratic leaders are desperate to pass an energy bill. Because reconciliation of disparate measures passed by the House and Senate requires a political fight no one seems to want, the House leadership has been circulating revised legislation they hope can pass.

The discussion draft first jettisoned then reimposed tax increases on the oil and gas industry. But it retained a martial approach to energy markets, with toughened fuel-economy standards for new motor vehicles and aggressive mandates for fuels from biological and other renewable sources.

Hamstringing markets

Like all such intrusions, these measures would hamstring markets and reward uncompetitive energy sources. They should be resisted. Current experience with mandates for ethanol in vehicle fuel—with the extraordinary pressure on corn prices, increases in diesel demand, and erosion of federal tax receipts—shows what happens when politicians make fuel choices for consumers.

An essential tool of governmental fuel manipulation is the tax regime. No one will sell mandated fuels that lose money. When the government requires sales of uncompetitive fuels, therefore, it must compensate the sellers. The handy way to do this is to provide tax breaks, such as the 51¢/gal tax credit for ethanol blenders and $1/gal credit for producers of biodiesel. The Energy Policy Act of 2005, in fact, is a cornucopia of tax breaks for suppliers of politically preferred fuels and vehicles. It’s also an affront to market efficiency.

The tax tool’s future, however, is in doubt. Two politically intolerable tax increases loom, calling attention to the need for systemic reform.

Next year, unless Congress acts, hoards of middle-class taxpayers will find themselves newly subject to the alternative minimum tax (AMT). Congress enacted the levy to ensure that the very wealthy pay income tax. But it didn’t account for inflation, which over time has pushed liability thresholds into lower and lower incomes. And in 2010, again unless Congress acts, income tax bills for many voters will leap as rate cuts enacted in 2001 and 2003 expire.

In anticipation of the AMT trap, House Ways and Means Committee Chairman Charles Rangel (D-NY) has proposed what he calls tax reform. It’s really a huge tax hike on Americans earning above $200,000/year to offset what Rangel sees as revenue losses from repeal of the AMT. While Rangel’s economically poisonous measure deserves no serious consideration, it does perform two useful services. With its prospective increase in marginal tax rates—those applying to new increments of income—of nearly 5 percentage points, the initiative calls attention to flagging US competitiveness in a crucial area. And it gives a needed push to tax reform as a political issue.

Reform is overdue. The US tax regime is unfathomable, largely because Congress has added layers of credits, deductions, exclusions, and other adjustments over the years to advance political agendas and enrich friends. For many Americans, compliance with tax law requires guesswork or payment to tax experts whose interpretations often differ. The ambiguity makes a sham of the rule of law and is reason for simplification to have occurred years ago.

Pressure for change

With millions of Americans facing two painful tax increases—one in an election year and the other as a new President faces off-year congressional elections—pressure will grow for fundamental change, such as with a flattening of rates or national sales levy in place of income taxation. Either move would involve elimination of most or all deductions and credits, which in turn would deprive politicians of a vital lever of fuel control.

Oil and gas companies should welcome tax reform as a way to liberate markets and give fuel choice back to fuel consumers. Yes, reform would deprive them of some tax breaks. But the reward would be an energy market more resistant than it has been to distortion by the government and to corruption by special interests.