Oil Subsidies in the Dock

Yesterday, Congress summoned the heads of BP, Shell, Chevron, ConocoPhilips, and ExxonMobil to defend the prices they’re charging at the pump and the subsidies they are receiving from the federal government. The former issue is of less interest to me than the latter.

The main issue is the so-called Section 199 tax credit passed in 2005. The credit is available to all domestic manufacturers - not just to oil and gas companies - and it allows the oil industry to write-off $13.6 billion over ten years that might otherwise be sent to the federal treasury. While a good case could be made to get rid of Section 199 in toto – the feds shouldn’t be in the business of artificially making some business activities more economically attractive than others – limiting that deduction for oil and gas companies and oil and gas companies only will compound the underlying economic distortion and encourage investors to put relatively less money in oil and gas production and more money in other industrial sectors. How is that a good thing with oil prices topping $100 a barrel?

Oil companies are already paying a staggering tax bill. In 2006, for instance, big-bad ExxonMobil faced an effective tax rate of 44 percent on a profit margin of around 11 percent, a figure that actually understates things because corporate revenues sooner or later find their way to oil company employees, contractors, shareholders, and those who do business with the same, and that revenue is taxed again via the personal income tax.

“So what?” you ask? Well, the more you tax “Big Oil,” the less return investors will get on money plowed into oil production. The less return on investment, the less investment there will be. Less investment equals less production, and less production equals higher prices. This is fact, not theory. Analysts at the Congressional Research Service report that the 1980 Crude Oil Windfall Profits tax reduced domestic oil production by 3-6 percent and increased oil imports by 8-16 percent for exactly that reason.

If the Congress were really interested in ending oil and gas subsidies, it could eliminate preferential tax treatment afforded intangible domestic drilling expenses, increase the amortization period for geological and geophysical expenditures from five years to seven, end preferential expensing for equipment used to refine liquid fuels, close the exemption from passive loss limitations for owners of working interests in oil and gas properties, and eliminate accelerated depreciation allowances for small oil producers, natural-gas distribution pipeline investments, and expenditures on dry holes. Such a plan would reduce – rather than compound – economic distortions produced by the tax code and deliver about $8.3 billion for the Treasury over 10 years. Congress is presumably less inclined to offer such a plan because those subsidies are far more important to “Little Oil” than they are to their “Big” brethren, and it’s the former – not the latter – that has most of the political clout in Washington.

Regardless, if getting rid of subsidies is such a good thing, then why does Congress propose to take those subsidies away with one hand but to reallocate them to the renewable energy business with the other? If renewable energy is economically competitive, it doesn’t need the subsidy, and if it’s not economically competitive now – with energy prices setting records across the board – then what makes anyone think that federal subsidies will make any difference? After all, they never have in the past. Ethanol has been lavished with government subsidy for 30 years, yet ethanol is still about $1.20 per gallon more expensive than conventional gasoline on wholesale markets last week after we adjust for the differential in energy content between the two. Nuclear energy has lived off a plethora of federal subsidies for five decades now, yet rather than being “too cheap to meter,” it’s still more expensive than any other conventional source of electricity once we account for the cost associated with building the reactor. Examples of similar subsidy boondoggles are legion.

Getting rid of energy subsidies is a fine thing, and Democrats are right to argue that those subsidies are even less warranted at a time when energy prices – and thus, energy profits – are relatively high. Too bad they aren’t serious about translating their rhetoric into legislative reality.