Stop the War on Oil and Gas

Mackubin T. Owens

February 1, 2010

With the release of its budget for the next fiscal year, the Obama administration is continuing its assault on the U.S. domestic oil and gas industry.

Under cover of beginning to transition America to a cleaner, greener, more sustainable energy future, the administration in fact is hitting our top domestic energy producers hard – a hit that will hurt American consumers at the worst possible time.

Calling for an end to “subsidies” to the oil and gas industries, the administration’s budget raises taxes on oil and gas by $36.5 billion over 10 years. But current tax preferences for oil and gas producers are hardly subsidies. They are instead methods that allow private companies to keep more of the money they earn while those companies provide low-cost energy to the American consumer.

Low-cost energy drives down the cost of everything from food to manufactured goods. High-cost energy does the opposite. In this economy, why we would want to deny oil and gas companies the ability to invest for the long term—and provide affordable energy to people and businesses—is beyond me.

Fossil fuel energy producers are not exactly undertaxed. In 2008 alone, they paid $95.6 billion in total income taxes ($23.2 billion to the U.S. government at all levels, the rest to foreign governments) on an operating income of $164 billion. In addition to income taxes, oil and natural gas producers paid an additional $12.5 billion in U.S. production taxes.

For real subsidies, one would have to look at taxpayer support for “alternative” energy sources such as solar and wind, which remain unable to pass the market test. With respect to oil and gas, the biggest supposed “subsidy” that the new budget seeks to repeal is a manufacturing tax deduction for domestic oil and natural gas companies.

It is important to understand that this tax deduction was not a “loophole” created for the benefit of energy companies, but rather was established as part of legislation intended to spur job creation and stem the outsourcing of manufacturing jobs, the American Jobs Creation Act of 2004. This act applied to all domestic manufacturers. The Obama administration does not propose total repeal of this “loophole”; it will merely deny it to oil and gas companies.

Denying the manufacturing tax deduction to domestic fossil fuel producers manifests a serious misunderstanding of the nature of investment in the oil and gas industry, which requires a large outlay to be committed upfront with a slim chance of success. Industry representatives contend that denying the manufacturing tax deduction to oil and gas will reduce investment in the fossil fuel industry by 20% to 40% and cause domestic jobs to be lost to foreign countries.

In September 2008, the Institute for Energy Research published an analysis of a similar proposal to end the manufacturing tax deduction for oil and gas companies. Although conditions may have changed over the past year, the analysis confirmed that effectively raising new taxes on an industry reduces incentives for production, leading to fewer jobs and higher prices for consumers.

Another proposal in the budget would eliminate the “expensing” of intangible drilling costs, which make up about 70% of all drilling costs. These include the cost of labor, supplies, contractors and fuel.

Under current law, oil companies can write off these expenses against other income in the year those expenses are incurred, rather than depreciating them over time. Permitting such expensing is not a subsidy. If a company is not allowed to write off an investment in the year that it is incurred, it is basically being denied the right to write off the full cost of that investment, period. In addition, repealing expensing would hit smaller independent producers hard – since they are often not big enough to tap private capital markets for investment funds.

The Obama administration is playing an interesting game with respect to oil and gas. On the one hand, the President said in his State of the Union speech that it is time to make “tough decisions about opening new off-shore areas for oil and gas development”—a signal that the Democrats may be open to encouraging much-needed new domestic fossil fuel production. On the other hand, the administration’s tax policies would systematically and unfairly penalize oil companies in the pocketbook—and, by extension, hurt Americans throughout the economy.

Mackubin T. Owens is an adjunct fellow of the Ashbrook Center and a professor at the Naval War College. He is editor of Orbis, the journal of the Foreign Policy Research Institute.