Editorial: Addressing budget blunders

March 1, 2010
Under rhetorical assault from a government hunting taxable prey, the oil and gas industry must sharpen its arguments for stability of the US fiscal regime.

Under rhetorical assault from a government hunting taxable prey, the oil and gas industry must sharpen its arguments for stability of the US fiscal regime.

While introducing his budget proposal for fiscal 2011, President Barack Obama declared, "We will not continue costly tax cuts for oil companies, investment fund managers, and those making over $250,000 a year. We just can't afford it." The budget itself attacks a series of important tax preferences in a section labeled, "Other Revenue Changes and Loophole Closers."

The propaganda tricks at work here make two politically potent implications. One is that the industry enjoys great relief in its overall tax burden. The other is that relief principally benefits large oil companies, in the scorned class of investment fund managers and wealthy individuals. Both implications link to small truths but deceptively ignore larger contexts.

More taxes

If the oil and gas industry enjoyed special tax relief, it wouldn't pay more taxes than others. But it does. According to a 2009 US Chamber of Commerce study using Energy Information Administration data, income taxes as a share of net income before income taxation in 2007 amounted to 40.4% for the oil and gas industry and 26.7% for all manufacturing companies.

Furthermore, most of the provisions targeted by Obama are timing preferences, not "breaks" depriving the government of large sums of money over multiple years. The expensing of intangible drilling costs (IDCs), for example, enables a producer to write off in the year of occurrence outlays for items with no salvage value. The alternative is to book the costs in an asset account to be written down incrementally over lives of related revenue streams. With expensing, the producer receives an immediate reduction in tax liability. But the reduction isn't available for the affected property in future years. Current-year expensing defers, not eliminates, tax liability.

Congress implemented preferences like IDC expensing to encourage drilling investment, recognizing that resource development generates wealth, enlarges the tax base, and expands energy supply. Comparable provisions motivated by those aims but now under threat include percentage depletion and accelerated amortization of geological and geophysical (G&G) costs. With minor exceptions, they, like IDC expensing, only defer tax liability.

Percentage depletion can result in a true reduction in tax liability over the life of a property. This happens when accumulated charges to depletion exceed the total investment in a property. Percentage depletion is so limited, however, that the amount of reduced tax liability overall is small. The same can be said for another so-called loophole under fire: the deduction for tertiary-recovery injectants.

In fact, the limits on percentage depletion refute Obama's implication that he's cutting tax breaks for fat cats. Only small independent producers can use percentage depletion, subject to income and production limits. Similarly, only independent producers can make full use of IDC expensing. And the proposed G&G provisions would apply to independents an extended amortization period already in effect for major producers. Several other provisions identified for repeal are important primarily to independent producers, not major oil companies.

But majors don't escape harm. The industry-specific "loophole" closers would deny oil and gas companies use of the manufacturer's tax credit, adopted in 2004 to help US industries compete internationally. Other provisions of the proposed budget would hurt large oil and gas companies along with counterparts in other businesses.

Complicated arguments

These are complicated arguments. Attracting attention to them is difficult. A place to start is the president's flawed pair of assertions. His budget's effect would be less to eliminate "breaks" than to raise taxes on one large and important industry. And the burden would fall more heavily on independent producers, which drill most US wells and which respond to fiscal distress by curtailing operations, than on big companies, which have opportunities elsewhere.

Adoption of the budget would slash US oil and gas drilling, suppress domestic energy supply, and chase capital and jobs out of the country. Obama should consider consequences like these before he makes politically motivated and economically indefensible proclamations about what the US can't afford.

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