Should Congress end tax breaks for oil companies?

The knee-jerk reaction would be that companies that are making handsome profits don't need subsidies. But this issue is more complex than that.

The question to ask is “What is the the subsidy supposed to accomplish, and what is the impact of removing it?” It isn’t a question of whether a company making billions in profits “needs” a subsidy. Even companies that make billions of dollars evaluate projects on a case-by case-basis. Some of those projects may have poor economics, and companies won’t use billions in profits to subsidize projects with poor paybacks.

So the question is, “Is the subsidy encouraging the company to do something that we would like them to do, and that they otherwise would not do? Is the net impact to create more jobs and tax revenues?” Those are the questions that should be asked, and if the answer to those questions is “No”, then that subsidy would appear to be a waste of money.

In the case of oil company subsidies, two things are important to note. First is that some of the subsidies -- for instance Section 199 of the tax code -- is a manufacturer's tax deduction available to all manufacturer's in the U.S. Google and Microsoft get it. The big ethanol companies get it. Oil companies get it at a lower rate than those other companies (9% for Google and 6% for ExxonMobil) and yet it is called an oil company subsidy. So one should really understand the nature of the subsidies.

But the second thing is that Senate Democrats recently requested an analysis of the impact of removing the subsidies. While they touted this analysis as showing gas prices wouldn't go up, an actual reading of the memo showed just the opposite as I covered here:

http://bit.ly/kDT4bh

The bottom line is whether to get rid of the subsidies depends on what we are trying to do. It may be that we end up importing more oil, as the memo I dissected suggests. But it really requires an understanding of the nature of the subsidies, what they are intended to accomplish, and whether they are actually accomplishing it before one can determine whether they should be eliminated.

The question asked really has two components: (1) What are the tax "subsidies" that Congress is considering repealing? (2) How will the increased costs of a tax hike to oil companies increase gas prices?

(1) With the exception of Intangible Drilling Costs (IDCs), the tax "subsidies" represent deductions that all US manufacturing companies receive. The largest is the domestic manufacturing deduction (section 199) which was enacted to encourage productive economic activities in the US. Arguably, oil production activities are not "manufacturing" and perhaps never should have been favored by the legislation in the first place. (Many oil companies were surprised when it was included.) But refining and chemical operations are no different that any another manufacturing activities and there is no principled reason to exclude them.

IDCs reporesent costs necessary to bring oil fields into production(such as roads, drainage, infrastructure, surveys, etc.) that in most cases would be capitalized and recovered as the field produced oil. For decades, these costs have been viewed as similar to R&D costs, which can be expensed for other industries.

(2) Oil is a global commodity. So is gasoline. A marginal increase in the cost of the production in one location will have little or no effect on the price of the product to the end user.

The real ecnomic effect will be on the decisionmaking process for oil companies when choosing where to invest their capital. Exploration and development of oil fields is a massive, expensive, and extremely risky endeavor: companies can spend tens of billions of dollars over decades on a prospect with about a 30% chance of success. They make their investment decisions based on the risk-weighted return on investment; if taxes go up in the US, that makes it more expensive to drill in the US, which, at the margins, may make a prospect in another country more attractive. So the net effect--if any--will be to reduce exploration and development in the US.

"According to research from the Tax Foundation, the industry paid $26 billion in corporate income taxes in 2008, and accounted for almost $92 billion in government revenues when you combine income, excise and other levies."
The above is from www.investors.com.

BHO said when confronted by the news that raising the capital gains takes actually reduces federal tax revenues, "Somethings are just right to do." This issue has nothing to do with revenue but it has a lot to do with ideology. BHO said, "Under my cap and trade program electric relates will necessarily skyrocket." Perhaps the Dems know as taxes are raised on oil companies the price of energy goes up which will fulfill BHO promise and they can blame the oil companies.

It's been said that companies don't pay taxes, I think this is true. Oil companies will simply pass the additional tax burden onto customers.

As transportation goes, the net effect will be that people with means will either live with the increases or purchase fuel efficient vehicles and people with very limited means will suffer terribly having to purchase the pre-owned gas guzzlers that were just shed.

In other areas, increased costs shipping and operating equipment (like farming and construction) will also drive up the costs of everyday goods. Everyone bears this cost, but the effected companies will simply pass the costs on their customers as well.

One additional thing is that this excuse will likely produce excess. I'm betting that cost increases will not be directly proportionate to the change in costs. Oil companies will raise costs slightly more than the cost of the new taxes and fuel consumers will raise costs slightly more than the additional cost of fuel. This multiplication will produce a net effect on the economy much worse that the cost of the taxes. I personally think when it all shakes out, the government will not realize a net gain unless they closely monitor the increases to prevent gouging. However, many will see the additional regulation as adding insult to injury.

In all, the largest impact is to poorer people who will bear the brunt of the price in the end because they have fewer alternatives and resources. Their food and transportation costs will increase and they will be least able to absorb or deflect the costs.

Of course the oil companies will say it would be a disaster if they lose their tax breaks - what else do you expect them to say?

But the government needs to have the backbone to do the right thing and end the tax breaks.

A number of factors affect the price of oil but the primary one is good old supply and demand. If demand is high and supply is tight, prices rise, and that is a condition of the present market. While the U.S. has seen a growth in demand in the past year as its economy has begun to rebound, the real growth is in developing countries, especially China. Demand is growing faster than supply.

A second factor affecting oil prices is uncertainty. Oil is bought and sold months before it is expected to be delivered. If traders are uncertain that the oil will be there to be delivered when it is required, then they bid up the price to lock in their share of supply. The protests and street battles taking place in the Middle East where so much of the world’s oil either originates and/or must transit through, has added to the uncertainty.

A third factor affecting the price of oil is the relative strength or weakness of the dollar. Currently the dollar is weak. And with the U.S.’s deficit, and the anticipated lack of political will to tackle it and the long-term debt, the dollar is likely to remain weak for some time to come. Whatever the other positive or negative effects of a weak dollar, since oil is traded on the market in dollars, a weak dollar means oil producers require more of them for each barrel of oil.

U.S. policies can affect all three factors. Continued high prices could dampen or even contribute to reversing the modest economic growth the U.S. is experiencing, then, as happened two short years ago, U.S. demand for oil would fall and to the degree that U.S. demand places pressure on the oil market, prices should fall. Continued or expanded instability in the Middle East, and/or direct action to intervene, by the U.S. alone or in concert with allies, could also affect the supply of oil positively or negatively depending upon the results.

The U.S.’s pain at the pump is in no small part its own making. For years we have forgone oil exploration and production in the areas of the U.S. most likely to contain our largest remaining conventional reserves. And while President Obama is certainly correct, that drilling in the U.S. would not make us energy independent, it would reduce our dependence. Every time the price of oil increases dramatically we have the critics of more drilling argue, that “even if we began drilling now, it would be a decade before the oil was flowing.” In addition they claim, that increased domestic supplies would only reduce prices by some small amount – the amount changes but it is always too small to make a big difference in price.

While, it may take a decade to tap some of the oil in the most difficult regions but we could see oil flow from other areas in two to five years. More to the point, if we had begun drilling in ANWR in 1980 , we would have been pumping oil for 20 years now. And if we had started drilling when George H.W. Bush was President in 1990 during the first Gulf War, we would have been up to to a million barrels of oil a day from ANWR for a full decade by now. The point is to start now so the same arguments aren’t repeated and used to prevent drilling five years or a decade from now when prices spike again. If not now, when, if not here where?

The second half of the argument underappreciates the inordinate effect that new oil supplies entering the world market from the U.S. would have. Though an additional 2 million barrels a day from ANWR and the OCS would only be a drop in the bucket of world oil demand, because it is coming from the stable U.S. it would reduce the uncertainty that impacts global oil prices. This would have an outsized moderating influence on high prices and the volatility in the market – beyond that the simple addition of the oil would have. In commodities markets, where oil comes from counts.

I have written more about this topic, here:
http://environmentblog.ncpa.org/presidents-policies-feed-oil-price-fire/

I don't think most of us know what these tax breaks are and what benefit we derive from them. So perhaps I should not be writing on this subject at all. But my reaction is that a predictable economic and tax system is needed by companies that make long term investments, such as oil drillers are forced to do. Therefore changing tax policy will impact their decisions, and uncertainty will slow allocation of resources whose return is uncertain.

Therefore I don't support tampering with the tax system. While I am generally sympathetic with the Democrats on many things, I think this call for taxing oil is political.

yes subsidies should be temporary not permanent. Oil company arguements are scare tactics to protect their entrenched positions. Let's eliminate the subsidies and reap the benefits. If prices continue to rise it will cause us to use alternatives, but more alternatives will put a ceiling on future prices and help decrease the price of alternatives.

What is the oil industry's profit in dollars per gallon versus all government taxes per gallon?

Only if we want to see the economy take a double dip. Sure, oil companies are among the most profitable in the world. They have goods that the vast majority of people (especially in the US) consider a necessity. They're also among the world's largest employers, so hurting their profitability will also come down on their payrolls.

Meanwhile, guess which companies AREN'T among the world's most profitable companies, or have the largest payrolls? Alternative energy! Yet the government continues to throw good money after bad in an attempt to support this non-starter. I say cut the green subsidies first. At least oil companies make money for their employees, their shareholders, and the government. Lest we forget that they HELP other companies and employees make money through shipping, let alone allowing everyday folks to get to work. And I wonder how much revenue the federal government can attribute to that nice little "gas tax" everyone pays at the pump.

Dock David Treece, Actually, oil companies are not among the most profitable, at least in terms of how accountants and investors measure profitability. Given your title, you should know that (and I'm sure you do). :-) (BTW, I'm on your side in this debate, and I agree that increased corporate taxes generally would cause a double-dip.)

For the rest of you, oil companies do make huge amounts of absolute profit, but that's only because they have huge top-line sales (because *EVERYBODY* who isn't living in a cave has to buy energy). The actual profit margin for these companies is far smaller. In the USA, Exxon earns less on a gallon of gas than the state and federal governments do (http://www.dailymarkets.com/economy/2011/04/27/gasoline-taxes-vs-exxon-profit...).

If your logic is that we should tax profitable companies (Jeeva, I'm looking at you), then we should really be looking at companies like Apple, Microsoft, Google, etc. Those companies are *FAR* (!!!!) more profitable than the oil companies.

Sure, we must do. When Oil companies rank in top 10 richest companies in the world, why we must need to believe that they will not stand the tax? Even small business pay tax.