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Wednesday, July 27, 2011

Energy Tax Hikes, the Budget and Economy

When it comes to kicking around energy companies, it seems that President Barack Obama simply cannot restrain himself. His default switch appears set in an anti-business, anti-market position.

He was at it again, for example, in a July 11 press conference on the federal debt. He reiterated his call for increased energy taxes, along with taking a potshot at entrepreneurs and employees in the general aviation industry. Obama claimed that “egregious loopholes that are benefiting corporate jet owners or oil companies at a time when they’re making billions of dollars of profits.”

In reality, the so-called “egregious loopholes” the president refers to are nothing more than rather standard tax deductions available to most businesses, allowing them to more ably compete in the global marketplace. His singling out of “oil companies” is a political tactic. It has nothing to do with sound economics or responsible government budgeting.

In fact, consider a new study by Louisiana State University Finance Professor Joseph Mason for the American Energy Alliance. In “Budget Impasse Hinges on Confusion among Deficit Reduction, Tax Increase, and Tax Reform: An Economic Analysis of Dual Capacity and Section 199 Proposals for the U.S. Oil and Gas Industry,” Mason points out, “Part of President Obama’s proposal for increasing the oil and gas industry’s tax-burden is the elimination of the Section 199 tax deduction for oil and gas companies and adding substantial additional restrictions to the foreign tax credit rules by changing the so-called ‘Dual Capacity’ taxpayer rules.”

Mason explains the basics on each of these tax measures. On Section 199, he notes:

“Section 199 of the Internal Revenue Code was created under the American Jobs Creation Act to ‘provide a permanent benefit ... to taxpayers in a wide variety of industries.’ It allows taxpayers that produce or manufacture in the United States to deduct from their taxable income a certain percentage of such domestic production activity each year. In 2005, the Congressional Budget Office estimated that the provision ‘effectively reduced the United States’ highest federal statutory corporate tax rate for income from domestic production from 35 percent to 31.85 percent.’ The adjusted rate for U.S. corporations brings the American rate closer to (though still not as low as) the average rate for nations of the Organization of Economic Cooperation and Development, helping U.S. corporations doing business domestically compete against lower-taxed foreign competitors.”

As for the foreign tax credit rules, Mason explains:

“All U.S. firms are entitled to a credit against their U.S. tax liability on foreign earned income for foreign income taxes already paid on that income. Specific, more restrictive rules apply to certain taxpayers, called Dual Capacity taxpayers, including oil and gas companies. Under Dual Capacity, a U.S. oil and gas company that does foreign business may only ‘credit the portion of [a foreign tax] levy in the amount of what the generally imposed [foreign] income tax would be’, unless it can show some higher amount is in fact an income tax, and no portion of that higher amount is a royalty or disguised royalty (or, in the words of the regulations, a payment for a “specific economic benefit”). If a taxpayer can meet this extraordinary burden of proof, then it is entitled to treat such additional amount paid as income taxes eligible as offsets against potential U.S. income tax on such foreign income. This provision is crucial for many U.S. energy firms competing with foreign state-run corporations from such countries as Russia, Venezuela, and China, or with companies based in countries outside the U.S., such as those headquartered in France, the U.K., the Netherlands, etc., which generally do not impose home country income tax on income earned outside of their borders (generally territorial taxation systems).”

In the end, these Obama tax increases would put domestic energy producers at a severe competitive disadvantage. That’s an odd choice at a time when great emphasis is placed on the need for enhanced domestic energy production, not to mention the jobs that go along with such additional production.

But perhaps it’s all about fighting the federal budget deficit and debt?

Well, Mason finds that the resulting negatives for the industry and economy resulting from these tax increases would translate into greater revenue losses for the government compared to the projected increased revenue from the actual tax hikes. As summed up in the report:

“The proposed revisions to Section 199 and Dual Capacity for the oil and gas industry are expected by the Treasury to raise approximately $30 billion in Federal tax revenue over the next ten years. But this comes at the expense of industry cutbacks that can reasonably be expected to cost the economy some $341 billion in economic output, 155,000 jobs, $68 billion in wages, and $83.5 billion in reduced tax revenues. The net fiscal effect, a loss of $53.5 billion in tax revenues, suggests that the policy proposals exacerbate, rather than alleviate, the Federal deficit.”

In the political view of the world advanced by those who support tax increases, they believe such actions will have no impact on economic activity. Increase taxes on energy firms, for example, and it is merely assumed that nothing in the market actually changes despite increased costs and altered incentives.

In the real world, however, costs and incentives very much matter. The economy is dynamic. Higher taxes diminish economic activity, and therefore, government fails to gain as much revenue as assumed, or when all the costs are factored into the equation, government can actually wind up losing revenue. That’s the reality illustrated by this study regarding two key energy tax hikes proposed by President Obama.

But given Mr. Obama’s bias against oil companies one has to wonder if he even thinks through, or cares about, such economic realities.


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

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