What Biden’s Budget Gets Wrong about Expensing for Intangible Drilling Costs

French philosopher Voltaire once famously described the Holy Roman Empire as neither holy, nor Roman, nor an empire. The latest presidential budget includes a section calling for the elimination of a handful of supposed subsidies, such as expensing for intangible drilling costs (IDCs), which the budget characterizes as “wasteful spending… on Big Oil.” Much like the Holy Roman Empire, this part of the President’s budget has a problem of nominative accuracy: expensing for intangible drilling costs is not a subsidy, it is not particularly for Big Oil, and even further, the drilling costs themselves are hardly intangible.

What is the provision as it exists today? As described in the Green Book (the Treasury Department’s explanation for budget provisions), intangible drilling costs “include all expenditures made by an operator for wages, fuel, repairs, hauling, supplies, and other expenses incident to and necessary for the drilling of wells and the preparation of wells for the production of oil and natural gas.” It does not include purchases of items with a salvage value, like heavy equipment. Expensing means companies can deduct their intangible drilling costs immediately when they are incurred, instead of deducting the costs over time.

Expensing for IDCs is a deduction for costs incurred, which is natural under a corporate income tax that taxes profits (revenues minus costs). Just as a fast-food joint would be able to deduct the costs of repairing a griddle, an oil producer ought to be able to deduct the costs of repairing an oil derrick. And just as a fast-food joint ought to be able to deduct a fry cook’s wages, an oil producer ought to be able to deduct a surveyor’s wages.

If companies must instead spread deductions for costs out over time, they effectively face a taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. penalty, as deductions in the future are worth less than deductions today, meaning in real terms they are not able to deduct their full costs. Expensing for IDCs prevents such a penalty and is consistent with neutral tax policy.

The President’s budget frames the section as targeting “Big Oil.” But “Big Oil” is already partly barred from benefitting from the expensing provision. Oil and gas producers can be split into two categories: integrated producers and non-integrated producers. Integrated producers are what one might colloquially describe as Big Oil: large companies with operations at each stage of the oil and gas market that extract oil (upstream), refine it, distribute it, and sell it at retail to the final user (downstream).

Meanwhile, non-integrated independent producers are only involved in the upstream stage of the value chain. Only non-integrated independent producers can fully expense their IDCs. Integrated producers, namely Big Oil, can only expense 70 percent of IDCs, and must spread deductions for the remaining 30 percent of IDCs out over five years. So, far from a subsidy, Big Oil faces a disadvantage relative to independent producers.

Expensing for IDCs does not provide a subsidy. But does expensing for IDCs give costs in the oil industry an advantage relative to similar costs in other industries? The name of the provision itself unfortunately contributes to some misconceptions. In 2021, Rep. Katie Porter (D-CA) made headlines at a congressional hearing criticizing the tax treatment of oil companies, and expensing for IDCs in particular. She argued that expensing for IDCs is a benefit that “does not apply to other expenses that other companies have.” But what expenses do other companies have that are comparable to intangible drilling costs?

One might first think of intangible asset purchases as a comparison. Intangible assets under Section 197 include patents, brand names, trademarks, goodwill, and other non-physical assets. The tax code treats intangible assets differently than physical assets (like physical property, plant, and equipment) with the justification that they retain value over time and do not physically depreciate—companies typically must deduct the cost of purchasing such assets over 15 years.

Contrasting the expenses included in “intangible drilling costs” with intangible assets shows how intangible is a misnomer in the case of IDCs. An oil producer hiring a truck to transport supplies to a well is clearly not analogous to, say, a company buying up the intellectual property rights to a beloved children’s cartoon character, or the trademark of a fast-food brand. To stick with the fast-food company example, the analogous cost to trucking supplies to an oil well would be trucking ingredients from a distributor to the restaurant—an everyday operating cost of doing business.

Intangible drilling costs are called “intangible” to distinguish them from tangible drilling costs, namely drilling equipment, but it would be more accurate to call IDCs operating drilling costs. Allowing companies to fully expense operating costs is an uncontroversial feature of the tax code across industries, and IDCs are just how operating costs are categorized in the context of oil and gas extraction.

Consistent principles ought to apply across the tax code. In the case of intangible drilling costs, companies should be able to claim full deductions for the costs they incur.

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