Oil Subsidies and the US Debt

Editor’s note: This post was written by Japhet Koteen, a community builder, urbanist, and real estate developer in Seattle. He wrote this post as part of a project for Taxpayers for Common Sense.

It’s not the trillions elected leaders are looking for today in Washington, DC, but I know where they can find $77 billion: outdated subsidies to the oil and gas industries.

Oil and gas are two of the largest, most profitable industries in history. Yesterday, the big five oil companies, ExxonMobil, BP, ConocoPhillips, Chevron, and Shell posted combined profits of over $35 billion for the year to date. Yet US law treats them like fledgling businesses in need of public support. Ending their preferential treatment could trim the federal debt by tens of billions of dollars over the next five years. Here’s how:

1.) End the “Volumetric Ethanol Excise Tax Credit” — The VEETC gives refiners 45 cents for each gallon of ethanol blended with gasoline. Because US ethanol is mostly made of corn, this subsidy drives up food prices. Clipping the VEETC would put $31 billion in the US Treasury (over five years, as in each figure in this article).

2.) Fix the Accounting Rule for “Intangible Drilling Costs” — Since 1918, a bizarre and illogical accounting exception has persisted in the tax code, allowing oil companies to include all expenditures incidental to drilling a well as “current expenses” rather than “capital expenses.” This elementary accounting mistake, canonized in law, makes all the difference at tax time: Congress’ Joint Committee on Taxation says ending this handout would supply the Treasury $9 billion.

3.) Correct Errors in “Oil and Gas Royalty Relief” — Oil and gas companies that drill on public lands, whether onshore or off, pay royalties for the fuel they remove, but the Deepwater Royalty Relief Act of 1995 mandated royalty-free extraction when market prices are in the basement. Clerical errors—or corruption?—at the famously mismanaged (and subsequently abolished) Minerals Management Service of the US Department of Interior left a batch of 1998 and 1999 contracts written to exempt drillers from royalties at all prices. The result has been a windfall for holders of those leases. Fixing the contracts would yield almost $7 billion for the Treasury.

4.) Stop “Expensing” Refining Equipment –The Energy Policy Act of 2005 let companies deduct as expenses half the capital cost of investing in certain equipment used to refine liquid fuels. As for drillers’ Intangible Drilling Costs (see #2) so for refiners, “expensing” capital costs dramatically lowers tax bills. The Energy Reform Act of 2008, extended this credit to include refineries that are processing fuel derived from oil shale. The Joint Committee on Taxation estimates that putting a halt to this accounting lie would direct $2.3 billion into public coffers.

5.) Deep Six the “Geological and Geophysical Costs Tax Credit” — Included in the Energy Policy Act of 2005 and modified in the Tax Increase Prevention and Reconciliation Act of 2005, this credit gives extractors a handout for their spending on the search for oil and gas deposits. Ending this subsidy would yield for the treasury about $700 million, according to the Joint Committee on Taxation.

Beyond these subsidies that specifically favor oil and gas are others, general business tax rules that allow energy companies to avoid paying their fair share of taxes:

6.) Bar “Last In, First Out (LIFO) Accounting” for oil and gas — LIFO permits oil companies to tally each barrel sold as though they had bought it at today’s price, even if they bought it for half as much. That rule understates their profits and slashes their tax bill. For example, if a company bought a barrel of crude 2 years ago at $35, and bought another last year at $75, then sold both barrels at today’s price of $100.  The actual profit would be $90, but under LIFO they can claim that both barrels cost $75 to buy, so their taxable profit is only $50. (More details here.) Barring LIFO would augment the Treasury by $11 billion from the oil and gas industries alone.

7.) Cut off the “Foreign Tax Credit” — The US tax code allows multinational companies to receive a 100 percent credit on their US taxes for foreign taxes paid. Many of the payments made to foreign government are not taxes, but rather royalties or access fees. These are a legitimate cost of doing business, which should be deducted from their income, but should not be eligible for the 100 percent credit. Requiring oil companies operating overseas to honestly report royalty and lease payments would add $5.2 billion to the Treasury.

8.) Stop abuse of the “Domestic Manufacturing Tax Deduction” — Designed to slow the offshoring of US manufacturing jobs, this law allows companies to deduct 9 percent of their income as an expense of doing business in this country. But oil and gas fields cannot move, so the Domestic Manufacturing Tax Deduction shouldn’t apply. Excluding them from the deduction would direct $6.2 billion to public coffers.

Ending a raft of other handouts in the tax code like the “Passive Loss Exemption”, and allowing “Expensing of Tertiary Injectants,” boosts the total savings to $77 billion over 5 years. Learn more about them here and here.

One other upside to this deficit-reduction strategy: it will won’t cut jobs or hurt consumers. Because the annual subsidies are only a tiny fraction of the profits, and have no effect on gas prices.

Again, the trillions of dollars of deficit and debt that Washington, DC, is currently debating won’t be wiped out by a measly $77 billion. But, you know, $77 billion here . . . $77 billion there . . . pretty soon, you’re talking real money.

Source for subsidies: “Subsidy Gusher: Taxpayers Stuck With Massive Subsidies While Oil and Gas Profits Soar,” prepared by Taxpayers for Common Sense, May 2011.