Energy and tax reform

Oct. 2, 2006
The US oil and gas industry can improve both its standing with a hostile public and energy policy by seeking reform in an area not directly related to energy: tax policy.

The US oil and gas industry can improve both its standing with a hostile public and energy policy by seeking reform in an area not directly related to energy: tax policy.

The connection with energy is indirect but strong. Congress implements energy policy largely through the Tax Code. The Energy Policy Act of 2005, for example, created tax credits for purchases of hybrid vehicles, home energy-efficiency improvements, small producers of biodiesel and ethanol, and the manufacture of energy-efficient appliances and hybrid and alternative-fuel vehicles. It offered a deduction for fuel cells installed in buildings. It created tax incentives for the production of various kinds of energy. It offered so many tax incentives for so many kinds of energy and behavior that it’s impossible to tell what it actually did for energy, other than please people able to profit from the gimmicks.

Tax complexity

Compounding the confusion is an altogether incomprehensible and always-changing set of tax statutes. In fact, complexity partly explains why simplification efforts never progress very far. Because most US taxpayers understand little about how the government affixes its claims to their wealth, they naturally fear that change might deepen the bite. Meanwhile, special interests never rest, so tax law becomes ever more complex and opaque.

Energy policy implemented through tax incentives can only founder in tax law this messy. The oil and gas industry has a chance to make things better because the mess soon will worsen.

Since 1969, the US has operated a parallel income tax system to ensure that clever rich people don’t escape the financial obligations of citizenship. Now enshrined in the alternative minimum tax (AMT), the system is approaching an expansion likely to jolt many Americans out of their ambivalence toward tax law.

The AMT applies taxation rates lower than those of the normal income tax but allows fewer deductions and exemptions. Taxpayers who might be subject to AMT must calculate liabilities under both systems and pay whichever is greater.

When enacted in 1978, the AMT was supposed to apply to a relatively small number of very wealthy people. But that’s changing rapidly, reports Alan D. Viard, Federal Reserve Bank of Dallas senior economist and research officer. From Urban-Brookings Tax Policy Center data, Viard predicts in the bank’s August Economic Letter that the number of Americans subject to AMT under current law will jump to 4 million this year from 200,000 in 1990. In 2007, it will leap to 22 million.

Taxpayers newly susceptible to AMT aren’t millionaires. According to Viard, taxpayers with incomes of $200,000-500,000/year are most likely to pay AMT. In 2010 and 2015, the share of AMT taxpayers with incomes of $100,000-200,000 will become “quite high.”

Reasons are complicated for this rapid encroachment of taxation aimed at the very wealthy into the upper middle class. Unlike those of the regular income tax, the AMT’s brackets aren’t indexed for inflation. And tax cuts of recent years have caused AMT liability to exceed normal liability for growing numbers of taxpayers. That trend will accelerate as AMT exclusions enacted with some forms of tax relief expire. And in 2007 the tax-free threshold on the AMT rate schedule will drop.

In recent years, Congress has delayed the problem with short-term adjustments, many of which are expiring. It can continue doing so, of course. It also can repeal the AMT. But both options lower government revenue. They both increase in fiscal difficulty as AMT liability spreads.

Increasing discontent

Yet the spread continues, and growing numbers of taxpayers are finding themselves subject to complexities and tax surprises designed for much wealthier people. Discontent with the Tax Code can only increase in the next couple of years, putting tax reform once again at the center of politics in a presidential election.

For the oil and gas industry, that’s an opportunity. There’s no need to advocate one form of tax reform over others. It would please a disaffected public for the industry just to show shared interest in the need for change. If the effort succeeded, it also would improve energy policy.