Dissecting the Energy Tax Breaks Debate

I really dislike the tax code.  If I had my druthers, the entire code would be scrapped, and we'd start all over with a much flatter, simpler system devoid of all the incentives and disincentives that warp business decisions and restrain the growth and expansion that would otherwise occur in a true free-market economy.   That's why I was a co-sponsor of The Fair Tax, a consumption based plan, when I was a member of Congress.   Unfortunately, complete reform of the tax code seems a distant dream as Congress deals with the more immediately obvious issues at hand.

So, we are left with an endless tug-and-pull of what is penalized (taxed) and what gets rewarded (subsidized) in the tax code.  As public opinion and political winds shift from time to time, the assignment of "winner" or "loser" status within the tax code often changes, too.  Yesterday's favored son can become tomorrow's pariah. 

Regarding the current hot topic of the tax treatment of the energy industry, it is important to first distinguish between tax credits and direct subsidies.  Credits and deductions are used to incentivize a whole host of actions that the government deems desirable.  For example, home ownership is perceived as a good thing, so interest paid on a mortgage enjoys favored status as deductible within the code.  The fossil fuel industry is heavily front-end loaded with expenses.  As a result, and because domestic energy production is desirable, Congress has provided various credits and deductions for certain capital investments.  However, public perception aside, the oil and gas industry receives no direct subsidy payments from the federal government.  None.

While the tax code encourages investment in oil and gas, it also collects plenty in taxes.  Contrary to popular mythology, the oil and gas industry pays a much heftier percentage of net income in taxes (41.1%) than the average of all other S&P Industrials (26.5%).   Yes, the energy companies are profitable, but their profit margins are right in line with manufacturing, aerospace, and food industries, while computer, pharmaceutical, and the beverage companies have triple the net income margins of traditional energy.  

Juxtaposed to oil and gas, green energy has benefited from layers of direct subsidies of hundreds of millions of dollars in federal and state government grants.  Further, a host of generous consumer tax code incentives encourage consumers to purchase products utilizing technologies like hybrid vehicles, solar panels, wind turbines, and government approved "energy efficient" windows and appliances.  These are basically government subsidized transfer payments to make the favored green industry more cost competitive.  For example, a 45 cent per gallon direct subsidy is paid to blenders for adding ethanol to fuel mixes. 

In addition, a plethora of government mandates require minimum percentages of renewable sources – irrespective of cost – for the generation of electricity as well as the composition of blended fuels at the pump in states and regions throughout the nation.  

The current spike in energy prices is at least partially a result of the consequences of mistaken past public policy decisions.  In times like these, politicians have an obsession to "do something" as evidence to the voters that they care.   I hope they think before they double-down with more bad policy decisions. 

I don't like subsidies and I don't like Congress or the IRS deciding what is good behavior and what is bad.   But, I do understand that you get more of what gets incentivized, and less of what is penalized.  And, there is a huge difference in "redistributing the wealth" through direct subsidy payments, and a tax credit that encourages investment in much needed production that creates jobs and taxable income. 

If congress is serious about creating jobs and jump starting the economy, they should lower the corporate tax rate, which is the highest among the 34 OECD nations, rather than increase the tax burden on energy or any industry.

Whether we like it or not, about 85% of the energy America relies upon comes from fossil fuels.  It's been that way for a long time, and it isn't likely to change anytime real soon.  Further, economies expand and create jobs when there is access to plentiful, affordable supplies of energy.

Capital is fungible, and energy production is the prototypical global industry. Plenty of nations around the world are providing a far more welcoming business environment for energy production that the U.S. already with a less onerous tax code and far less regulatory burden. 

If increasing our domestic supply is really a national objective, then this might not be the best time to send exactly the opposite message to the people that provide the capital to drill the wells. 

Posted by National Journal, Energy & Environment Blog, May 4, 2011