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The Unintended Consequences of Stripping Big Oil 'Subsidies'

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Every time black gold spikes and gasoline prices soar, we get calls from Washington, DC decrying the Big Oil's profits. Capitol Hill hearings usually follow.

So it is no surprise that four dollar plus gasoline and $147 oil triggered the introduction of a bill to raise the taxes and strip so-called subsidies from Big Oil. Or that lawmakers have summoned the executives of Chevron, Shell Oil USA , BP America , ConocoPhillips and Exxon Mobil to raise their hands in the committee rooms of the US Capitol once again.

So does "big oil" pay their share in taxes and should its subsidies be removed? I caught up with Pete Sepp, the executive vice president of the National Tax Payers Union, to get his assessment on new legislation proposed on Capitol Hill.

LL: Did you run analysis of the Democrats new legislation on the big oil companies? What did you find?

PS: Unfortunately, what the Senate Democrats call new legislation is actually a retread of a proposal that's raised numerous concerns in the past. It would repeal several tax provisions that have been portrayed as "subsidies" for oil and gas companies that are often cited as amounting to $4 billion per year.

Yet, well over half of that amount concerns two provisions of the Tax Code that are widely available to many types of companies, not just the oil and gas industry. They are the section 199 deduction (mainly offered for domestically-based manufacturing job creation) and the "dual capacity" credit (which allows a write-off from U.S. taxes for taxes paid to foreign governments).

Although there are some parts of the package that involve repealing narrower tax provisions, these two elements help to show more clearly the political angle President Obama raised in his State of the Union Speech when he noted that oil and gas companies are "doing just fine." The implication is at some point companies that are "too successful" in the eyes of government no longer deserve protections in the tax system that others get. That's always been a contentious feature of tax law—witness progressive income tax rates—but this is taking arbitrary policy to a new level.

The important takeaway here is that Section 199 and dual capacity wouldn’t need to exist for any firm if it weren’t for a terribly burdensome corporate tax system. As our most recent annual study on tax system complexity noted, individuals and companies spent an estimated 7.6 billion hours this year complying with U.S. income tax laws. The value of this time, according to our calculations, is over $227 billion.

LL: How does this measure up to other countries?

PS: Pretty terribly. Our study cited research from PricewaterhouseCoopers and the World Bank group, which looked at compliance time burdens as well as total tax rates for a typical company in each of 183 countries. The U.S. placed a poor 66th out of 183 for compliance burdens and a dismal 124th for total tax rate.

Rather than tackle the vital job of reforming our tax system from top to bottom, policymakers create provisions like Section 199 and dual capacity to reduce the anti-competitive sting. Now they want to tinker with the tinkering they originally enacted by singling out oil and gas for punitive treatment. That’s the opposite of tax reform, which should be across the board.

LL: Would there be any "unintended consequences" if the "tax subsidy" for oil was removed?

PS: As I noted previously, since much of the provisions at stake are available to many industries, it would be a mistake to call them “subsidies.” We are not talking about subsidies in the traditional sense of the word.

It’s often been said that companies don't pay taxes, people do—in the form of higher prices, fewer job opportunities, and lower stock returns. More than a few studies have been conducted on this point, as it applies to oil and gas.

For example, the Congressional Research Service noted in 2010 that proposals similar to what are being put forth today would raise some revenue, but "may have the effect of decreasing exploration, development, and production, while increasing prices and increasing the nation’s foreign oil dependence.” (“Oil Industry Tax Issues in the Fiscal Year 2011 Budget Proposal,” Robert Pirog, Specialist in Energy Economics, 3/24/2010).

Other studies have put a finer point on the matter. One by LSU Professor and Economist Joseph Masonfound that repealing dual capacity and section 199 for oil and gas would by his estimate, mean "extensive economic losses to the U.S. economy for the next decade, including $341 billion in decreased economic output, almost $68 billion in wage cuts, and initial losses of over 154,000 jobs in 2011."

Daniel Yergin of IHS CERA actually used the term "unintended consequences” in a study from 2010 when he wrote, “The unintended consequences of proposed changes would likely accelerate the shrinking position of U.S. companies internationally, which would be bad both for the U.S. economy and for energy security" (“Fiscal Fitness: How Taxes At Home Help Determine Competitiveness Abroad” Report, 9/2010).

When Congress was debating health care reform legislation in 2009 and 2010, it was often said that lawmakers were determining the fate of one-sixth of our economy. It could be said that energy policy affects six-sixths of the economy! Just about every good or service depends upon stable, affordable energy supplies, and in the foreseeable future, that will still involve traditional energy sources like oil, natural gas, and coal. So that’s a lot of potential for unintended consequences.

LL: The hearing on Thursday is more than just tax deduction vs. subsidy. This is the politics of big oil and the profits they make.

How much in taxes do these companies pay the United States from their "record profits"?

PS: By most estimates, a considerable amount. Taking into account all revenues, including taxes and royalties, oil and gas firms here put between $90-$100 million a day into government coffers. Analyses of data from Standard and Poor’s come up with a percentage paid of around 40 percent, compared to an average of about 25 percent for others.

Using older numbers from the Energy Information Administration, in 2008, oil and gas firms’ income tax expenses were a little shy of $30 billion and total pre-tax income was almost $65 billion. That's a 45 percent effective rate.

And as for record profits, my colleague Andrew Moylan explained that recent data pegs oil and gas industry profits at 5.7 cents on the dollar. This is compared to the average for manufacturing at 8.5 cents on the dollar.

LL: Sen. McCaskill describes the oil industry tax breaks as "low-hanging fruit" when it comes to helping cut the deficit. Is it?

PS: If revenue for deficit reduction is a concern, it might be more important for the Administration and Congress to agree on oil and gas development, rather than argue over tax hikes. As CRS recently noted, the U.S. has the largest combined proven reserves of all three of these resources in the world.

Development would benefit the federal government, in the form of increased royalties and other tax payments from the boost in economic activity from an industry that directly and indirectly involves some 9 million people. In the long run, those revenues might actually dwarf what would be raised through the short-term tax increase under consideration today. Wholesale tax reform could also help generate revenue through greater efficiency, competitiveness, and economic growth.

Furthermore, if Congress wants to clear away real energy subsidies such as loan guarantees and spending programs, it will find support from a coalition of nearly 30 groups NTU organized earlier this year.

As the organizations stated in a joint letter to Congress:

“Instead of promoting a reliable and affordable energy industry, the subsidy-first energy policy that has prevailed the past three decades has created whole industries dependent on government and focused as much on ensuring their share of taxpayer largesse as they are on developing energy. This is no longer acceptable.”

The real low-hanging fruit, in our opinion, is growing on the spending side of the federal budget tree. To her credit, Senator McCaskill is cosponsoring a measure with Senator Bob Corker (R-TN) to establish a statutory cap on federal expenditures—higher than historical norms at 20.6 percent of GDP, but a start at least. Where could savings be found? Everywhere, including entitlements and defense. And, the effort can be bipartisan. Last yearNTU joined with the left-of-center US Public Interest Research group to identify $600 billion of intermediate-term spending reductions.

One item? Ending the ultra-deepwater natural gas and petroleum research program!

A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."

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