Playing Politics with Energy Profits

As sure as the sun rises in the east and sets in the west, no doubt existed as to what the reaction would be in certain political circles to recent reports on oil industry profits.

Near-record quarterly profits - such as $10.7 billion for Exxon Mobil - led to cries for higher taxes on oil companies.

For example, in his weekly address on April 30, President Barack Obama declared: "Of course, while rising gas prices mean real pain for our families at the pump, they also mean bigger profits for oil companies. This week, the largest oil companies announced that they'd made more than $25 billion in the first few months of 2011 - up about 30 percent from last year. Now, I don't have a problem with any company or industry being rewarded for their success. The incentive of healthy profits is what fuels entrepreneurialism and helps drives our economy forward. But I do have a problem with the unwarranted taxpayer subsidies we've been handing out to oil and gas companies - to the tune of $4 billion a year. When oil companies are making huge profits and you're struggling at the pump, and we're scouring the federal budget for spending we can afford to do without, these tax giveaways aren't right. They aren't smart. And we need to end them."

Two points need to be addressed. First, what are these "subsidies" that the President references, and second, what role do profits play in the energy business?

As for "subsidies," what we're really talking about are tax deductions, not subsidies. A subsidy is a government handout. These deductions are no different from what's available to other industries. They include:

• accelerated deductions for "intangible drilling costs," i.e., exploration-related costs, which equate to research and development costs in other industries;

• the foreign tax credit that ensures firms do not wind up getting hit by double taxation;

• the Section 199 domestic manufacturer's deduction that applies to production in the U.S. (and the oil and gas industry only gets a 6% deduction compared to 9% for other industries);

• and the last-in-first-out (LIFO) accounting method, which has been a standard accounting method available since the 1930s, and is of particular importance to firms during inflationary periods in order to more accurately reflect costs.

Clearly, these do not fall under any kind of legitimate definition of "subsidies."

For good measure, it is worth noting how much the oil industry actually provides the government in revenue. API noted in a brief released last month that the effective income tax rate on the oil and gas industry was 70 percent higher than the effective rate for S&P Industrial firms; "U.S. oil and gas companies pay on average almost $100 million every single day to the federal treasury in rents, royalties, and lease payments," not including excise tax payments; and from 2004 to 2008, major oil and gas producers paid $300 billion in income taxes, $60 billion in production, sales, use, property and other non-income taxes, and $350 billion in excise levies on petroleum products.

That's an enormous amount of resources being drained away from firms producing the energy on which our economy runs, only to be spent unwisely by politicians. It seems to make the case for tax cuts, not higher taxes on domestic energy providers, as the President is proposing.

As for the role of profits, it's interesting that the President said he has no problem with "any company or industry being rewarded for their success," and that he endorsed "the incentive of healthy profits." But one has to question such assertions when the President clearly is engaged in trying to stir up populist passions against such profits, and use these earnings reports to raise taxes on the industry.

Beyond the rhetoric, the reality of profits in the market process cannot be ignored. Profits send signals to investors and producers to boost exploration, development and production. Profits are central to how the market allocates resources. Policies - such as these tax increases proposed by the President, along with the Obama EPA advancing with regulations on carbon-dioxide emissions - send the opposite signal. After all, the resulting increased costs and diminished profits would channel resources away from domestic energy production.

Clearly, politicians attacking oil and gas companies due to profits earned are trying to score political points at the expense of sound economics and policy. In the end, everyone - including individuals to small businesses - wind up paying the price for governmental policies that raise the costs of and reduce domestic energy production.

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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council