Oil Subsidies in the Dock

January 17, 2007 • Commentary
This article appeared in the National Review (Online) on January 17, 2007.

The well‐​choreographed “100 Hour” congressional Democratic blitzkrieg turns to the subject of Big Oil on Thursday when Pelosi & Co. will make quite a to‐​do over H.R. 6, the “Creating Long‐​Term Energy Alternatives for the Nation Act,” or “CLEAN Energy Act” for short, a proposed $14 billion cut over ten years in the subsidies going to the petroleum industry. Free marketeers should have zero complaint in theory. There is no identifiable market failure that might cause private actors to significantly under‐​invest in domestic oil production. In practice, however, the Democrats are simply transferring subsidies from one energy sector to another with no net reduction of taxpayer funds going to corporate in‐​boxes. Moreover, they are sneaking in energy‐​tax increases under the rhetorical cover of a war on subsidies. Accordingly, there is little reason for conservatives to get particularly excited.

The case for oil subsidies is laughably thin. Proponents argue that the more you subsidize oil production, the more oil you’ll get, and that, after all, is a good thing for consumers when gasoline prices are around $2.25 a gallon. Unfortunately, there’s simply not enough unexploited oil in the United States that might be exploited as a consequence of those subsidies to greatly affect world crude oil prices. Tufts economist Gilbert Metcalf, for instance, demonstrates that even if domestic production subsidies were worth 10 percent of the current price of oil (and they are worth no more than about 3 percent today), the increased production that might result would only reduce oil prices by 0.4 percent. Even if reducing foreign oil dependence is the main objective, Metcalf shows that domestic production would only increase by a trivial 0.2 percent were domestic subsidies to increase threefold‐​above current levels.

Some on the Right, of course, would argue that any taxation of corporate activity is counterproductive in that it unfairly taxes earnings twice (once when booked by corporate accountants and then again when those earnings are disbursed to stockholders). From this perspective, tax breaks simply allow companies to keep what is best left to them in the first place and should not be thought of as a subsidy. A variation of this argument holds that the less government takes in the better, so all tax breaks (and tax cuts, for that matter) are worth embracing.

While there is something to be said for both arguments, they ignore the fact that targeted tax breaks and preferences distort the economy by making some investments artificially more attractive than others. The end result is that some sectors are starved of funds while other sectors are awash with more money than they can efficiently use. From an economic standpoint, it makes little difference whether government taxes your money and gives it to corporation X or employs the tax code to direct funds to corporation X. In both cases, government is using its power to artificially manage private investment flows, and economists of all stripes frown on this sort of thing in the absence of some clearly defined market failure … which again, we do not have.

In short, eliminating — or at least, cutting back on — federal subsidies to the oil and gas business is a fine idea. But that’s not exactly what the Democrats have in mind.

The most significant part of the bill — from both a budget and political standpoint — is the call for about 40 companies producing oil and gas from the Gulf of Mexico to voluntarily pay a “conservation resource fee” to the federal Treasury. Back in 1998 and 1999, those companies signed leases to drill in certain federally‐​owned deepwater reserves without any requirement that royalties be paid. If the oil companies in question don’t voluntarily agree to pay the proposed “conservation resource fee,” the bill would prohibit them from getting leases to drill on federal land in the future. The Congressional Budget Office (CBO) estimates that almost a third of the bill’s savings — $4.35 billion over ten years — would come from those fee payments alone. A similar tightening of the royalty payment rules from other federal lands will bring in an additional $210 million over ten years.

In principle, there’s nothing wrong with renegotiating leases. Contracts, after all, are renegotiated in private markets all the time. If Party A refuses to renegotiate with Party B, there is no reason why Party B must commit to doing future business with Party A. If the taxpayer is being unfairly taken advantage of, there’s nothing wrong a call for renegotiation.

One might argue, however, that the economy would be ill‐​served by imposing ever‐​steeper royalties (taxes) on oil and gas extraction from federal lands, particularly when Exxon Mobil, for example already pays more taxes to government at all levels than they do profits to private stockholders.

The suspicion that the Democrats are primarily interested in taking even more money out of the oil companies’ hide and not with any existential concern for tax justice is reinforced by a provision of the bill that would impose a similar “conservation of resources fee” on all non‐​producing oil and gas leases in the Gulf of Mexico as well. This is a naked tax hike of $1.75 billion over a ten‐​year period unadulterated by any cover story about equity or tax fairness.

The Democrats are on better ground, however, when they call for the elimination of preferential tax treatment afforded intangible domestic drilling expenses (primarily labor and material costs associated with finding and exploiting oil and gas fields). Normally, those expenses would be capitalized and the costs allocated as income is earned from the well over its useful life. Instead, current law allows firms to deduct those expenses in the first year while corporations may deduct 70 percent of the costs and depreciate the remaining 30 percent over five years. The Joint Committee on Taxation estimates that eliminating those preferences for intangible drilling expenses would save the taxpayer $7.6 billion over ten years. The bill also calls for increasing the amortization period for geological and geophysical expenditures from five years to seven, a reasonable tax change that yields a barely remarkable $104 million to the treasury over ten years.

Surprisingly enough, the Democrats’ oil‐​subsidy search‐​and‐​destroy operation is far less brutal than advertised. An ambitious and intellectually rigorous bill would have also targeted the accelerated depletion allowance provided to small oil producers (about another $7.6 billion over ten years), preferential expensing for equipment used to refine liquid fuels ($830 million over five years), accelerated depreciation for natural‐​gas distribution pipelines ($560 million over five years), accelerated depreciation for expenditures on dry holes (with unclear budgetary implications), and the exemption from passive loss limitation for owners of working interests in oil and gas properties ($200 million over five years).

The Democrats’ somewhat dodgy anti‐​subsidy crusade, however, collapses into ashes with the proposed “Strategic Energy Efficiency and Renewables Reserve” tacked on to the bill. In short, all fiscal gains to the Treasury associated with the above will be handed back out again to corporations like GE, British Petroleum, and you‐​name‐​the‐​industrial‐​conglomerate engaged in energy efficiency and renewable energy businesses. But the same arguments against handouts to “Big Oil” can be as easily marshaled against handouts to Big or Little Fill‐​In‐​the‐​Blank. And with energy prices this high, there are ample incentives for investors to spend money on oil and gas production, renewable energy, energy conservation, or other energy exotica.

The Republican abandonment of economic principle and subsequent love affair with K Street lobbyists gave the Democrats a wonderful opportunity to launch a politically winning total war on corporate welfare. Pity that they don’t seem interested in taking advantage of it.

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