May 18, 2011 | Commentary on Energy and Environment

Stop Picking Energy Winners and Losers with the Tax Code

When the government decides to favor a technology with subsidies, it’s a good bet that subsidy “winner” is a loser in the marketplace.  Political decisions to provide subsidies distort the marketplace at the expense of economic growth and prosperity. That’s exactly what has happened--and what continues to happen--with America’s energy tax policy. Reversing this practice will benefit American consumers and taxpayers.

Special tax treatment can come on the production side or the consumption side. On the consumption side, the Energy Policy Act of 2005 and American Recovery and Reinvestment Act provide tax rebates for hybrid and electric vehicles. Currently, policymakers are pushing to expand and extend tax credits that subsidize the production vehicles powered by natural gas and other credits that support refueling infrastructure.

These are just two examples of energy tax provisions that benefit a specific group of producers.  Our federal government has woven a complicated web of energy tax policy over the past few decades. Such preferential tax treatment causes a number of problems.

First, special tax credits for cherry-picked technologies artificially reduce the price for consumers.  This makes them seem far more competitive than they actually are. Rather than increase competition, the artificial market distortion gives these technologies an unfair price advantage over other technologies. The more concentrated the subsidy or preferential treatment, the worse the policy is because the crowding-out effect for other technologies is larger.

If subsidized technologies are market viable, then the tax break merely offsets private-sector costs for investments that would have been made either way. This creates industry complacency and perpetuates economic inefficiency by disconnecting market success from production costs.

Furthermore, when the government becomes involved in the decision-making process, it increases the business incentive to send lobbyists to Capitol Hill to make their pitch why their industry needs those tax credits. Industries will plead that they need five years of tax credits then they’ll be good to go on their own. Five years later, they’re asking for five more years. These specific carve outs reduce the incentive for producers to be cost competitive with technologies that do not rely on help from the government.

The reality is, if electric vehicles, natural gas vehicles or any technology is profitable, it won’t need preferential tax treatment. The market is much better than bureaucrats at sorting out the good ideas from the bad. Subsidies only centralize power in Washington and allow lobbyists and politicians to decide which companies will produce.

The other argument industries employ when demanding tax breaks is the old “other industries get them, so we should too.” This is not a good reason to apply more industry-specific tax cuts; it’s a good reason to remove those already in place.

Lately, high gas prices and high profits for oil companies have tempted some lawmakers to propose removing “subsidies” for oil and gas companies.  The problem is, the tax provisions they target are not special interest subsidies at all.

Take the domestic manufacturer’s tax credit. It applies to any number of U.S. producers—clothing manufacturers, road builders, electricity generators, water companies and more. Making oil and gas production companies ineligible for this credit neither removes a subsidy nor closes a tax loophole.  It merely imposes a targeted tax hike on oil and gas producers.

The same is true for foreign tax credits and deferral of foreign income. These are two critical features of a worldwide tax system that prevent the U.S. corporate income tax from double taxing—and further crippling—the international competitiveness of U.S. companies. Broadly available tax provisions are not oil subsidies.

Peeling back the industry-specific tax credits and evenly applying lower taxation to all energy sources will allow the best technologies to reach the marketplace, which will ultimately benefit the consumer.  It sounds easy enough.  But given the cycle of politicians picking winners and then those winners donating to the same politicians come election time, it’s a difficult end to achieve.

Nick Loris is an analyst at The Heritage Foundation.

About the Author

Nicolas Loris Herbert and Joyce Morgan Fellow in Energy and Environmental Policy
Thomas A. Roe Institute for Economic Policy Studies

Related Issues: Energy and Environment

First appeared in Blue Dog Research Forum