Taxing successful energy sources and subsidizing unsuccessful
ones: That's the essence of Washington's energy policy mistakes
during the 1970s and early 1980s. These mistakes are about to be
repeated in the tax title to the Senate energy bill. This section
would raise taxes by an estimated $21 billion over 10
years--including $13 billion from the oil and natural gas
sector--and spend much of it on tax breaks for alternative energy
sources like ethanol and wind power. As before, this approach will
likely backfire and raise prices while reducing energy security.
Overall, this tax title makes an anti-consumer energy bill even
worse, and if it reaches the President, he should veto it.
The Wrong Weapon in the Energy
The tax title of the energy bill proposes a number of tax code
changes, the effect of which would be to raise taxes on companies
working to expand domestic oil and natural gas supplies. This
includes measures eliminating or reducing some existing deductions
against income from energy production, most notably the
manufacturer's deduction under the American Jobs Creation Act of
2004. This deduction against income, which applies to domestic
industries, would now exclude major oil companies. The change would
raise taxes on new oil and gas production by about $10 billion.
Other tax changes would bring the total tax increase on oil and gas
companies to an estimated $13 billion.
The push for energy legislation has been sparked by consumer
anger over high gasoline prices, but these measures will not offer
any relief at the pump. The current tax code has nothing to do with
recent increases in energy prices, so Washington-style tinkering
with the code will not benefit the driving public.
It should also be noted that the underlying assumption that the
domestic oil and gas sector is currently undertaxed may be popular
political rhetoric but is not supported by the evidence. By many
measures, energy companies face tax rates comparable to or higher
than those of other industrial sectors. For example, the average
effective tax rate for major integrated oil and natural gas
companies is 38.3 percent, which is actually higher then the
average rate of 32.3 percent for the market as a whole, according
to the Tax Foundation. And these taxes have risen along with oil
Unfortunately for consumers, tax increases, such as those in the
Senate legislation, would likely reduce supplies and increase
prices in the years ahead by discouraging investment in new
domestic drilling for oil and natural gas. America's demand for
energy is growing along with its economy, and so it will need more
domestic oil and natural gas supplies. Raising taxes on energy
would move America in the opposite direction, because it would
raise the cost of capital for exploration and production, making
some domestic energy projects less viable.
These provisions also undercut the energy security rationale
behind the bill. The tax crackdown on domestic oil producers
confers an additional comparative advantage on OPEC and other
non-U.S. suppliers whose imports are not subject to most of these
The bottom line is that these tax measures would reduce domestic
supplies of oil and gas and require increased imports to fill the
void. Assuming demand continues to grow, these provisions would
also increase prices for consumers.
Back to the 1970s?
That is the lesson of the infamous windfall profit tax (WPT) on
oil firms imposed under the Carter Administration in 1980 and
repealed under the Reagan Administration in 1988. In 1980, anger at
"big oil" over high prices helped lead to this punitive tax, but
the consequences of this tax was not what its supporters had hoped.
According to the Congressional Research Service, "The WPT reduced
domestic oil production from between 3 and 6 percent, and increased
oil imports from between 8 and 16 percent. This made the U.S. more
dependent upon imported oil."
The only difference between the WPT and the tax hikes in the
current Senate energy bill is that the latter have different names
and operate somewhat differently, but the end result of such
measures would be the same.
Another way of thinking about tax increases is that no matter
where a product is taxed--whether at the retail level or further
upstream at the producer level--tax increases will raise the cost
of that product. The Senate has been wise enough not to raise the
federal gas tax, especially at a time of $3 per gallon prices, but
a tax hike on the producers of motor fuels would filter down in the
form of higher prices anyway. This is the exact opposite of what
the American people want.
Worse yet, these tax provisions are in a bill filled with other
costly provisions, the sum total of which may boost the price at
the pump to $5 per gallon by 2016.
Subsidizing Unsuccessful Energy
Much of the extra revenue generated from these taxes would go
toward subsidizing politically correct alternative energy sources,
such as ethanol and wind power. The bill includes both tax
incentives to build plants that generate alternative energy and tax
credits on the energy sold. However, the 30-plus-year history of
federal attempts to encourage alternatives contains numerous
failures and few, if any, successes. Indeed, many of the recipients
of tax breaks and incentives in the Senate bill have been
subsidized for decades, originally with the promise that they would
become viable within a few years and then go off the dole and
compete in the marketplace. But this has never happened. For
example, ethanol, which gets special breaks in the Senate bill, has
enjoyed preferential treatment since 1978.
Even after decades of tax code assistance, alternative energy
still provides only a small fraction of America's energy needs. For
example, wind and solar energy account for only a few percent of
America's electricity, due to their high costs and unreliability.
In the end, Washington learns, the hard way, that these
alternatives have serious economic and technological shortcomings,
which is why they needed all these special tax breaks in the first
If the past is any guide, it is likely that the energy sources
favored in the Senate bill will again disappoint.
In addition to the tax breaks, other portions of the bill
mandate a five-fold increase in the amount of renewable fuels that
must be used. Thus, their producers will enjoy both favorable tax
treatment and a guaranteed market--all at consumer expense.
The pending energy bill would increase taxes on the energy
sources America relies upon, namely oil and natural gas, in order
to subsidize alternatives with a spotty track record. Raising taxes
on what works and heaping subsidies on what doesn't was not good
energy tax policy when tried in the past and won't fare any better
this time around. For the sake of consumers, these provisions
should be scrapped.
Ben Lieberman is Senior
Policy Analyst for Energy and the Environment in the Thomas A. Roe
Institute for Economic Policy Studies at The Heritage
Scott A. Hodge and Jonathan Williams, "Large
Oil Industry Tax Payments Undercut Case for Windfall Profits Tax,"
Tax Foundation, January 31, 2006.