STOP THE DAMAGE FROM TAX REFORM

It should be clear by now that Congress committed serious errors for altogether proper reasons when it passed the Tax Reform Act of 1986. Exalting such worthy principles as neutrality and fairness, tax reform failed to treat all taxpayers alike, or even fairly. For U.S. oil and gas producers, tax reform has come to mean capital starvation. Die-hard tax reformists see no problem here. To them, producer bankruptcies and a plummeting rig count mean simply that drilling can't hold its own on

Oct. 7, 1991

3 min read

For U.S. oil and gas producers, tax reform has come to mean capital starvation. Die-hard tax reformists see no problem here. To them, producer bankruptcies and a plummeting rig count mean simply that drilling can't hold its own on the "level playing field" they aimed to create for investment capital.

It's not an easy position to dispute, whatever the dire consequences for oil producers and U.S. energy security. Oil and gas prices have exhibited more moving room on the downside than otherwise since 1986. If that's all that mattered, maybe capital should steer clear of drilling ventures. But prices aren't all that matter. Since 1986, costs of drilling have fallen more than prices have. On the basis of revenues vs. costs, drilling ventures are more attractive now than they were before. Yet drilling continues to sag. Something besides price is hurting drilling-something such as reformed U.S. tax law.

THE AMT TRAP

In an article on p. 58, Craig G. Goodman, vice-president of governmental affairs for Mitchell Energy Corp., describes several ways in which U.S. tax and fiscal policies distort drilling investments. Most damaging is tax reform's application of the alternative minimum tax (AMT) to the main tax mechanisms for drilling cost and capital recovery - current-year expensing of intangible drilling costs (IDCs) and the remnants of percentage depletion.

In theory, producers can recover AMT tax payments through credits when and if they become so profitable that their regular income tax exceeds AMT tax. But most producers aren't that profitable. To the extent they can not recover AMT payments, and lost-opportunity costs associated with them, producers pay taxes on drilling capital.

In his article, Goodman points out that in a given drilling investment, a regular taxpayer earns greater after-tax returns than an AMT (lower profit) payer. Moreover, the percentage of net revenues taken by government under current law increases as crude oil prices decline, So much for fairness and neutrality.

Goodman took the analysis another step in testimony last month to the House ways and means committee on behalf of the Independent Petroleum Association of America and several other industry groups. He said tax reform hurts U.S. competitiveness, U.S. producers must compete in their own country with non-U.S. producers not so heavily taxed. And the AMT makes a drilling venture in the U.S. less attractive to a U.S. producer than the same venture would be elsewhere.

TAX REFORM'S DAMAGE

As it applies to drilling outlays, therefore, the reformed tax code does not serve the interests of fairness or neutrality. It hurts U.S. competitiveness. And it erodes the capital base from which federal income tax revenues, not to mention domestic oil and gas production, are derived.

Last year Congress acknowledged the existence, if not the extent, of the problem. It approved minor AMT relief as part of its omnibus budget reconciliation bill. But another year of drilling doldrums despite buoyant oil prices proves that more needs to be done. IDC expensing and percentage depletion are essential means by which taxpayers in a uniquely risky extractive business recover costs and capital. By subjecting them to the AMT, the U.S. is taxing away its drilling industry. Congress must recognize the damage-to the industry, to energy security, and to future tax revenues-and make it stop.