Sunday, May 01, 2011

Clarification About Oil Company "Subsidies" and Oil Companies "Not Paying Their Fair Share" of Taxes

From the American Petroleum Institute:

"Contrary to what some in politics and the media have said, the oil and natural gas industry currently enjoys no unique tax credits or deductions. Since its inception, the U.S. tax code has allowed corporate tax payers the ability to recover costs and to be taxed only on net income. These cost recovery mechanisms, also known in policy circles as “tax expenditures”, should in no way be confused with “subsidies”, i.e., direct government spending."

Read the details here.  

In addition to the misunderstanding that oil companies somehow receive direct subsidy payments from the government like the payments some farmers receive (sometimes for NOT growing certain crops), there is also the misunderstanding that oil and gas companies are "not paying their fair share" of income taxes.  The assumption here must be that other companies or U.S. industries are paying "their fair share" and oil companies "get off easy."  

The chart above is based on data from the API and shows that oil companies face a much higher income tax burden as a share of before-tax earnings (41.1%) compared to other S&P Industrial corporations.  Keep in mind that oil companies pay a higher effective tax rate than even the highest corporate marginal income tax rate of 35% because they are also paying state income taxes and foreign income taxes.   And there are also royalties, bonuses bids, excise taxes and other transfers to governments that aren't even included in the 41.1% tax expense rate. 


At 5/01/2011 10:32 AM, Blogger PeakTrader said...

Do you want to be an oil producer?:

US Democrat details plan to cut energy tax breaks
Apr 28, 2011

"On Tuesday, U.S. Attorney General Eric Holder voiced concerns about some "disturbing" developments in energy markets that the Justice Department will probe.

Both parties want to capitalize on voter angst over high gas prices.

Senator Max Baucus said he wants to end a manufacturing deduction used by energy companies and trim a credit that companies get for royalties paid to foreign governments for exploration.

Baucus also proposes to add an excise tax on certain leases in the Gulf of Mexico and backs new incentives for consumers and manufactures to buy and make fuel efficient vehicles.

White House economic adviser Gene Sperling said on Tuesday part of the subsidies to the oil industry could be used for deficit reduction and some could be used for research and development of renewable energy."

At 5/01/2011 11:11 AM, Blogger Benjamin said...

The innovation shown in the private oil- and gas-drilling sector is to be admired, not taxed.

We should reduce our federal civilian and military agencies, and tax oil- and gas-drillers even less.

What the private sector has done with shale gas dwarfs any "security" we derive from the federal government.

At 5/01/2011 11:45 AM, Blogger Buddy R Pacifico said...

In the one of the articles from the American Petroleum Institute artcle cited it states:

"Repealing LIFO deems a sale of inventory to occur and generating a significant tax gain. Therefore there is an assumed tax bill without any corresponding cash gain being generated."

International accounting standards are not allowing LIFO, or Last In First Out, expensing of inventory for tax purposes. If oil companies have to pay taxes on profits from $25 a barrel oil, then the tax meter soars even more. It will be interesting and quite a battle in Congress to reconcile this issue.

At 5/01/2011 5:36 PM, Blogger Gregory (Greg) P Turco said...

I'd like this graph more if it were not from the Petroleum Institute. I can't trust that they are comparing with the rest of the industry fairly.

At 5/01/2011 5:40 PM, Blogger Pulverized Concepts said...

How does the government confiscation of oil company funds make gasoline cheaper?

At 5/01/2011 8:01 PM, OpenID rjhaffke said...

To say a subsidy is only a subsidy if it is in the form of a “direct government spending” is not an accurate statement. Rather, a subsidy is a form of government support extended to an economic sector (or institution, business, or individual), generally with the aim of promoting an activity that the government considers beneficial to the economy and society at large.

Also, I'm not sure how the API gets away with claiming the industry has no unique tax credits or deductions.

Here is a brief list of specific tax subsidies enjoyed by the industry:

1) Percentage depletion
2) Expensing of intangible drilling, development, and exploration cost
4) Expensing of refinery investments
5) Incentives for small refiners to comply with EPA sulfur regulations
6) Credits for enhanced oil recovery costs
7) Marginal production tax credit
8) Blenders credit for ethanol
9) Manufacturing tax deduction
10) Deductions for foreign royalty payments
11) Enhanced oil recovery tax credit
12) Passive losses tax shelter

At 5/01/2011 8:07 PM, Blogger Mark J. Perry said...

Note: The percentage depletion allowance may ONLY be taken by
independent producers and royalty owners and NOT by
integrated oil companies.

At 5/01/2011 8:21 PM, Blogger Paul said...


You might be technically correct about the definition of "subsidy" but rest assured you will never hear Obama interchange the word with "tax credit" or "deduction." The Alinskyite's wordplay is designed to make the average voter think the federal government is writing welfare checks to Halliburton while Johnny Lunchbucket is struggling to keep a roof over his head.

We're talking about a man who just a couple weeks ago used the Orwellian phrase "spending reductions in the tax code" when he meant "tax hikes."

At 5/01/2011 8:54 PM, Blogger randian said...

Depletion isn't a subsidy. It is functionally equivalent to ordinary depreciation, and is intended to compensate for the loss of value as a well is pumped dry.

Expensing, rather than depreciating, investments merely moves the relevant deductions forward, it doesn't reduce the total tax bill of any company netting less than $300k a year (very small companies).

Blender's credit is an ethanol subsidy, not an oil subsidy. I'd be happy to be rid of it, and every other ethanol subsidy.

Deductions for foreign royalty payments are clearly not subsidies. Royalty payments are ordinary business expenses. Ordinary business expenses are always deductible unless the tax code says otherwise.

The "passive losses" tax shelter isn't a tax shelter. It simply allows you to deduct your oil partnership losses in full from ordinary income, rather than limiting it to $25k a year as with individuals. Given that oil companies generate passive losses in the hundreds of millions of dollars a year, that restriction is clearly absurd when applied to a large company. The restriction was created in TRA 86 to stop real estate and oil & gas partnerships whose only economic value was in the tax losses. Companies like Exxon do not invest millions of dollars in a well in order to get a fraction of that back in tax deductions.

At 5/01/2011 9:07 PM, OpenID rjhaffke said...

I agree that we can nit-pick about which deductions and credits are and are not deductable for integrated oil companies.

My point was that the statement made by the API that there are no specific tax credits or deductions for the industry is simply factually wrong. There is no empirical information to back that claim up.

We can discuss accounting methods of depreciation and you're right it merely moves the expense forward, but it is also preferential treatment to the industry, I'm not saying it's right or wrong, but they do receive preferential tax treatment. All industries lobby to get specific methods of accounting to reduce current tax liabilities, but to claim the oil and gas industry doesn't benefit from specific tax credits and deductions is incorrect.

The ethanol blenders credit is indeed an oil company subsidy. The bill states that the "blender" gets the tax credit i.e. oil companies.

At 5/02/2011 6:19 AM, Blogger juandos said...

Well PT the part you left out might possibly be the most important part: "Plan not likely to pass Republican-controlled House?...

"Also, I'm not sure how the API gets away with claiming the industry has no unique tax credits or deduction"...

Doesn't every industry have unique or specific deductions that apply to them rjhaffke?

I know farmers and truck driver have or 'had'...

At 5/02/2011 8:30 AM, Blogger morganovich said...

don;t oil companies have a large number of unique and specific TAXES that apply to them as well?

on balance, this "special treatment" causes much higher taxes.

if oil companies were treated just like any other company, their tax rates would be MUCH lower.

At 5/02/2011 8:57 AM, Blogger natsfan said...

I do not think that the deductions listed by rjhaffke as afforded to oil and gas companies are unique. Certainly percentage depletion, the manufacturing deduction and IDC are not. The same or similar deductions are found for many other industries in the code. In fact these are often less favorable for oil and gas (see percentage depletion and the mfg deduction) than other industries. Also, the credits identified are phased out and no longer relevant. The refinery deduction is phasing out and actually supplanted by bonus depreciation that allows for 100% for all corporate taxpayers with few limitations. The reference to foreign royalties does not make any sense, so I am not sure how that applies (royalties are always deductible as a cost of business).

At 5/02/2011 11:47 AM, OpenID rjhaffke said...

IRC section 901 (or classifying foreign royalty payments as a foreign tax payment) is most certainly applicable here because it is a tax credit to the industry that no other industry enjoys, I'll see if I can explain it more clearly.

Royalty payments are a regular expensable item per GAAP. What's different is that oil & gas companies get to take a direct tax credit (or Subsidy) against their tax liability equal to the amount of foreign royalties paid (within the limitations of Sec 907). The point of the foreign credit is to allow companies to not be double taxed on income earned abroad and it is arguably a positive and well deserved credit. However, the classification of a "royalty payment" as a "tax payment" is not allowed by any other industry. Other industries pay their royalties and expense them, oil & gas companies pay their royalties, expense them, and then get a direct tax credit as well.

While in some cases the funds might go to the same government entity as oil is nationalized in most foreign countries, a "royalty payment" is completely different fundamentally from a "tax payment".

A royalty payment is not a form of taxation but rather compensation to the owner of the resources for the specific economic benefit gained from extracting the resources. To classify this as a tax payment and take a tax credit is a specific oil & gas subsidy.

How is that not applicable to the bogus statement made by the API that oil & gas has no unique tax deductions or credits?

At 5/02/2011 5:29 PM, Blogger morganovich said...

This comment has been removed by the author.

At 5/02/2011 5:33 PM, Blogger morganovich said...

rganovich said...

"However, the classification of a "royalty payment" as a "tax payment" is not allowed by any other industry. "

generally, royalties are classified as an operating expense or lumped into cost of goods sold.

doesn't this have the exact same effect?

both come out of pretax income and reduce tax liability.

this rule seems like it just makes an oil company's income statement work just like anyone else's.

how is this any different on the pretax income line than a drug company paying a royalty to the university that did the original research?

At 5/03/2011 12:05 AM, OpenID rjhaffke said...

Both do not come out of pre-tax income, the expense does, but the credit is a direct deduction off the total tax liability dollar for dollar for what was paid as the royalty.

The differennce in your example of the drug company paying a royalty to a university is that the drug company only gets the expense off pre-tax income, and not the credit of their end tax bill. The oil & gas industry gets both because they got their "royalty" payments classified different than any other company's royalty payments for tax advantages...

Good conversation though, I'm glad we all agree that the API blatently lied about not having "specific tax deductions and credits"

At 5/03/2011 4:36 AM, Blogger natsfan said...

In response to rjhaffke there is more here to understand on the foreign tax credit issue. Section 901 is the statute that allows all taxpayers to claim a foreign tax credit for foreign income taxes they pay to foreign governments on their foreign income. It is used to prevent double taxation on those earnings. It is also true that taxpayers must show that the income tax paid to the foreign government is an income tax as defined by the US and not just because it is labeled as such by the host country. It is also true that royalty payments should not be creditable for US foreign tax credit purposes. To protect this from happening, Congress instituted section 907 and Treasury issued the dual capacity regs under 1.901-2A. The dual capacity regulations require that companies that pay income tax as well as other fees to a government prove that the amounts for which they are claiming a credit are not some other type of fee. In other words oil and gas companies are required to prove that no amount of the credit being claimed is a royalty payment to the foreign government. Essentially they have to prove a negative. I know that there are many who like to say that these companies are claiming a credit for royalty but it 1) disregards the fact that the rules are set up to prevent that; 2) ignores the fact that there has been no proof that this royalty as tax issue actually happens and 3) ignores the fact that the IRS could deny this credit on audit or the Treasury could change the reg if it was so wrongly used. This rule may be unique, but I am hard pressed to understand why this should be considered a subsidy.


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