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Oil and Gas Subsidies or Sensible Cost Recovery?

2 min readBy: William McBride

The oil and gas boom of the past 5 years or so is widely seen as the brightest spot of an otherwise moribund U.S. economy. In fact, a group of economists from Purdue University recently found that without this boom the U.S. economy would still be in recessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years. . Likewise, employment in the oil and gas sector has increased 40 percent since 2008 while overall employment has shrunk slightly.

The driving force is hydraulic fracturing (fracking) and other technologies that have opened up vast new resources throughout the U.S., including the Marcellus Shale in Pennsylvania and West Virginia, the Eagle Ford Shale in Texas, and the Bakken Shale in North Dakota. This is why you can earn $80,000 a year driving a truck in North Dakota, or $25 an hour waiting tables.

However, a new report from Taxpayers for Common Sense seems to suggest it’s all the result of “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. subsidies” that allow oil and gas companies to immediately deduct their investment costs. Titled “Effective Tax Rates of Oil and Gas Companies: Cashing in on Special Treatment”, the report finds that the effective federal corporate tax rate for oil and gas companies is 24 percent on average, “considerably less than the statutory rate of 35 percent, thanks to the convoluted system of tax provisions allowing them to avoid and defer federal income taxes.”

First, there is nothing special about a 24 percent effective tax rate. The average for all corporations is about 22 percent, according to the IRS, so if anything oil and gas companies pay an above average tax rateThe average tax rate is the total tax paid divided by taxable income. While marginal tax rates show the amount of tax paid on the next dollar earned, average tax rates show the overall share of income paid in taxes. .

Second, the particular “tax subsidy” the report refers to is intangible drilling costs, which as they explain merely allows companies to immediately deduct, i.e. expense, the costs of drilling. That is not a subsidy, it is the proper treatment of a real and legitimate business cost. The corporate tax is a profit tax, and profit equals revenue minus costs. Labor costs are fully and immediately deductible, so why not other costs?

Taxpayers for Common Sense would prefer these companies delay drilling cost deductions for years and years, because otherwise “these companies are financing significant parts of their business with interest-free loans from U.S. taxpayers.” No, in fact it is the government that is getting interest-free loans from businesses by requiring them to delay deductions for legitimate business costs. Unfortunately, that is normally the case for most investment, because that is the normal depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. system. The solution is to move towards expensing of all costs, not to remove expensing for this or that industry.

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