S. 940. The Latest Example of Tax Policy-as-Political-Weapon

May 18, 2011

As we have long advocated, the tax code should do only one thing, that’s raise a sufficient amount of money to fund government programs with the least amount of harm to the economy. So we’ve been frequent critics of legislative attempts to use tax credits to micromanage favored industries or sectors of the economy. But we are equally distressed when legislators try to use tax policy as a cudgel to punish industries that have fallen out of political favor.

The latest example of tax policy-as-political-weapon is the “Close Big Oil Tax Loopholes Act” (S. 940) introduced this week by Senator Robert Menendez (D-NJ) and a host of other Senate Democrats. The main purpose of the bill is to deny large integrated oil companies the use of five provisions in the tax code.

These five provisions are:

  • A foreign tax credit if such company is a “dual capacity” taxpayer,
  • The tax deduction for income attributable to domestic production of oil, natural gas, or primary products thereof,
  • The tax deduction for intangible drilling and development costs,
  • The percentage depletion allowance for oil and gas wells, and
  • The tax deduction for qualified tertiary injectant expenses.

While this legislation is flawed on a number of accounts, there are three worth mentioning.

First, it won’t lower the price of gasoline. Since most of the sponsoring Senators also supported the increase in the federal tobacco tax in 2009, they should understand the basic economic principle that when you raise taxes on something you get less of it. So the effect of raising taxes on the production, exploration, and drilling of domestic oil by eliminating these tax provisions, will likely be less production of domestic oil. Thus, the legislation would actually increase our dependence on foreign oil and, not surprisingly, increase the price of gasoline at the margin – outcomes completely at odds with purported purpose of the bill.

Second, it exposes oil companies to double taxation on their foreign earnings. One of the inviolate principles of sound tax policy is that a dollar of income should be taxed only once as close to the source as possible. In keeping with this principle, the U.S. tax code affords multinational firms a credit for income taxes paid to other governments on their foreign earnings. Oil companies are frequently subject to extra layers of taxation in countries such as Norway (the total income tax for oil companies is 78 percent) and Saudi Arabia (the total tax for oil firms is 85 percent) so the tax code allows these “dual capacity” taxpayers to deduct more than the base rate of tax. Eliminating this well-established (and well-litigated) provision will subject these companies to U.S. tax on income that was already highly taxed abroad.

Lastly, as I have written before, denying oil and gas companies the domestic production deduction sets a very bad precedent on many levels. First, it would deny the deduction for the oil companies but keep the deduction for all of the industries that use petroleum products such as the automakers, asphalt layers, tire companies, rubber toy manufacturers, or makers of synthetic clothing. Moreover, once such a provision is denied for one industry for punitive reasons, what is to stop lawmakers from using the same tactics against other disfavored products such as fatty foods, sugary drinks or alcoholic beverages.

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