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Lawmakers should stop looking to the energy sector for more federal revenue

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After a remarkable rise in America’s energy production and the creation of more than one million jobs, oil and natural gas companies are wrestling with a new challenge: holding on to those gains.

Production has shot up 60 percent in the past decade, providing a greater single boost to the U.S. economy than any other business sector. Thanks to hydraulic fracturing — fracking — and sophisticated information technology, energy production has increased so much that the United States is, remarkably, the world’s leading oil and natural gas producer.

That advantage could be cut short, however, if Congress singles out the industry by removing certain provisions of the tax code. This would harm our economy and hurt consumers by raising energy prices. Unfortunately, both ends of Pennsylvania Avenue show an inclination to raise taxes on energy companies.

{mosads}White House officials indicate that while they will push for steep cuts in personal and business income tax rates, they are willing to raise new revenue by scrapping some deductions, such as those used by oil and gas producers. Never mind that tax incentives have fueled investments in shale production and deep-sea drilling that have led to abundant supplies of oil and gas, more jobs, and lower prices for consumers.


Some might say: “Get rid of tax loopholes and deductions. We must be pragmatic.” Yet one doesn’t have to be an economist to understand that when energy-related tax allowances are removed, tax liabilities rise and investment in oil and gas production drops.  

Incentives such as the intangible-drilling deduction and the special percentage depletion allowance have encouraged energy firms to invest hundreds of billions of dollars in the advanced technologies needed to tap shale formations. 

The depletion allowance is analogous to depreciation when the quantity of a potential resource is unknown, such as the amount of recoverable oil and gas from a shale formation. Producers use it to recover capital investments over time. The depletion allowance is also available to producers involved in mining, timber, geothermal steam, and other natural resource recovery. Percentage depletion per se is unobjectionable, though one may ask if it is overly generous or not generous enough.

Revealingly, for virtually every other industry, some tax reformers support immediate expensing – that is, a full deduction – of capital investments in the year made. thereby getting rid of the complex (and fairly arbitrary) depreciation schedules that allow businesses to recover the costs of new plant and equipment over time horizons that vary by the kind of asset acquired. Immediate expensing would unleash many new investments and spur economic growth.

By the same reasoning, the oil and gas industry’s depletion allowance should be immediate too.

In many cases, what some members of Congress and oil critics call an “oil subsidy” is neither a subsidy nor a tax allowance only for the oil and gas industry because it applies to many industries.

Given that taxes are likely to be one of the big political issues of the next few years — and maybe the biggest — it’s worth understanding who really pays how much. U.S. oil and gas firms pay about $70 million a day on average in federal taxes, rents, and royalties. From 2011 to 2015, deductible oil and gas income-tax expenses (as a share of pretax net income) averaged 37 percent, more than the 25.8 percent for other major industrial companies.

Policymakers looking to eliminate loopholes and allowances should take note: raising effective tax rates on the oil and gas industry by denying credits and deductions available to most other businesses could send us down the wrong path, and it might not be possible to correct course fast enough.

Only in Washington is abstaining from collecting revenue called a “tax expenditure.” It’s not the government’s money. Moreover, as Adam Smith wrote, the wealth of a nation is enhanced by removing all systems of preference and restraint. “Neutral” reform that lightens the tax burden across the board is pro-growth; eliminating deductions selectively and punitively is not.

William F. Shughart II, research director of the Independent Institute, is J. Fish Smith Professor in Public Choice at Utah State University’s Huntsman School of Business.

The views expressed by contributors are their own and are not the views of The Hill.

Tags Adam Smith Budget Corporate finance economy Energy fracking taxes William Shughart

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