Wednesday, May 17, 2006

Another Attempt to Punish Big Oil

In the latest act of political vengeance on the oil and gas industry, legislation sponsored by Rep. McDermott (D-WA) and Senator John Kerry (D-MA) would exempt these industries from participating in the tax benefits under section 199 of the Code. (A story on this appears on the Tuesday, May 16 edition of the BNA Daily Tax Report.)

Section 199 was enacted in 2004 to provide tax incentives for domestic production activities by allowing a deduction (ranging from 3 percent in 05-06 to 9 percent in 2010) from qualified production activities income. When our previous incentive system for taxing export income was found to be a discriminatory trade practice by the WTO, Congress decided to come up with something different. Instead of targeting exports, it includes all kinds of domestic production activity within the scope of this benefit. (Some taxpayers do get shut out, though – self-employed entrepreneurs – more to come on this in a later post.)

Section 199 is complicated and cumbersome to apply – it would be much better to simply lower tax rates and call it good. I would be happy to see it gone from the Code and to substitute instead lower tax rates for everyone. But for the time being, this is the world in which we live.

Kerry and McDermott are howling that these tax benefits will go to big oil and gas companies, which are now hugely profitable owing to recent spikes in commodity prices. So, they would like to take away these benefits in an effort to impose higher tax rates upon them.

Politicians have been relentless in their pursuit of ways to punish these companies for being profitable. The have tried windfall profits taxes (roundly criticized by many, including my colleague Ernie Goss in a recent post:

and the removal of eligibility for the LIFO inventory method (which I covered in “Not on Your LIFO: Stealth Taxes on Oil, here:

Policymakers should remember: Oil was only $10 just a few years ago, and these companies were hurting then. These cycles ebb and flow. There will probably be lean years again in the future. It makes no sense to change tax policy for this industry when their golden period may well be for a limited time only. McDermott’s argument that oil companies were not part of the export subsidy provisions that section 199 replaced is also not persuasive – neither are most of the taxpayers who will benefit from this provision.

Let’s change the scenario a little. Suppose that wheat farmers in Washington State had a good year and grew a decent crop after seven lean years, and that wheat prices go sky high due to drought elsewhere. A wheat farmer may be sitting on 100,000 bushels of wheat that is worth maybe $5 a bushel instead of $3. Would anyone suggest imposing a special tax on their “windfall” or taking away some deductions to increase their tax rates? I don’t think so. (And since farmers are "my people", I should certainly hope not!)



Ankur (THE consultant) said...

Slightly unrelated, but is there a concept of dynamic taxation?

your tax-rates/slabs/etc. should ideally be a function of a lot of things: industrial outlook-past, present & future, economic outlook, prices, demand etc.

so if crude is @ 70, the tax rate should reflect that. if its @ 10, so should be the consequent effect on the tax rate.

i am hoping (and correct me if i am wrong) that this'd lead to a smoother output vs. time graph for each sector. which should reduce the gdp volatility (atleast from this aspect).

the only downside is the probable cost of setting this system in place.

ofcourse, since we are gonna take into account future outlook as well, the new taxes on oil are incorrect.

Ed Morse said...

To the extent we focus on an income tax system, we have a similar feature through graduated rates. But you have much more dynamic taxation than is displayed in the rates, as there are all the phase-outs of tax benefits that occur. Over time, variation in income tends to work to the disadvantage, particularly for individuals subject to these phaseouts and relatively steeper graduated rates. Thanks for the comments.