Tuesday, February 19, 2008

Using the tax code to solve energy problems won’t work

We have a problem of depending upon foreign sources for energy supplies but the government is not helping to improve our situation; and neither Senator Hillary Clinton nor Senator Barack Obama will provide a solution.

Hillary Clinton, Speaker Pelosi et al want to tax oil companies seemingly out of revenge for operating successfully; something the government has never, and will never, be able to do. Taxing successful energy sources and subsidizing unsuccessful ones is the essence of what passes as an energy policy. This was tried in the 1970s and early 1980s and is about to be repeated in the Renewable Energy and Energy Conservation Tax Act of 2008 (‘REECTA’), recently introduced in the House. This bill would effectively raise taxes on the oil and natural gas sector and use the revenue (at least as much as won’t be diverted for other social programs) on alternative energy sources like wind, solar, and biofuels. The only sure thing about this approach is that it will raise prices for consumers while not improving energy security.

Nowhere in the Constitution is there any authority for the government to use our tax code to force a social result desired by socialists, their friends and other sycophants; but that is exactly what the government has done time and time again. In this case the aim is to punish oil companies for being profitable enterprises; which industry will be next, perhaps manufacturers of incandescent light bulbs.

Provisions of REECTA requires taxes paid by oil companies be increased by eliminating or reducing some existing deductions against income from energy production, including the manufacturer's deduction under the American Jobs Creation Act of 2004. Presently this deduction against income applies to all domestic industries but the proposed bill would exclude major oil companies producing oil and gas in the United States. The tax increase is estimated by the Joint Committee on Taxation to be $13.5 billion but other tax increases in the bill would bring the total to $18 billion.

Of course proposals to increase taxes on oil companies is prompted by consumers’ anger at higher gasoline prices and the belief by congress that oil companies are under taxed. However, oil companies have 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 actually higher then the average rate of 32.3 percent for the market as a whole, according to the Tax Foundation. Moreover, oil company’s profits produced record tax bills. According to the Energy Information Administration, gross revenues from the 27 biggest energy companies was a record high $220 billion in 2006, which is above the $188 billion in 2005 and $129 billion in 2004. Income taxes paid also rose to a record high of $81 billion in 2006, compared to $67 billion in 2005 and $45 billion in 2004. This effective tax rate of 37 percent in 2006 is in line with (and actually a bit higher) than large corporations in general.

REECTA provisions are also contrary to the energy security rationale behind the bill. The tax increase on domestic oil producers gives an advantage to OPEC and other non-U.S. suppliers who are not subject to most of these provisions. The new tax measures would reduce domestic supplies of oil and gas with the result that oil imports would increase. There is also no doubt that as demand continues to grow prices for consumers will increase. Additional taxes on the producers of oil filters down to drivers and results in higher gas prices.

In 1980 the Carter administration imposed a windfall profit tax (WPT) on oil firms. After it proved to have disastrous results, it was repealed under the Reagan Administration in 1988. The impetus for WPT was also anger at "big oil" over high prices. 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." Punitive tax hikes in the proposed bill, though not labeled an excess profit tax, will have the same result.

Supporters of REECTA say the extra income to government from higher taxes on the oil industry will be used to subsidize politically correct alternative energy sources such as wind and solar power. However, the history of using the tax code to encourage changed behavior shows this approach is a failure, and federal attempts to encourage alternative energy sources will be another failure. Many of the recipients of tax breaks and incentives in the bill have been subsidized for decades; for example, ethanol has been subsidized since 1978 with the expectation that ethanol would become viable within a few years and then go off the dole and compete in the marketplace. But this has never happened and instead Congress recently passed a huge expansion of the ethanol mandate to force Americans to use more ethanol even as it continues to be heavily subsidized. Wind and solar power have done no better.

After decades of special tax breaks, alternative energy still provides only a small fraction of the country’s energy needs. Wind and solar energy account for less than 3 percent of our electricity because of their high costs and unreliability and the percentage of electricity from renewable sources is not expected to increase soon, according to the Energy Information Administration.

After all these years the government fails to understand shortcomings of programs which require subsidies to continue is the wrong approach. Efforts by politicians to pick winners and losers among energy sources and giving subsidies to some has a record of failure as compared to allowing market forces to determine the direction of energy innovation.

The Renewable Energy and Energy Conservation Tax Act of 2008 increases taxes on the energy sources the United States relies upon (oil and natural gas), in order to subsidize unproven alternatives. Increasing taxes on what works and giving subsidies to what doesn't work has failed in the past and would not succeed now. Congress should have a policy that trusts in the free market.

Since the tax code has nothing to do with increases in energy prices, changing tax laws would not benefit consumers. In fact, we will actually be hurt over the long term. Tax increases will reduce supplies and increase prices by discouraging investment in new domestic drilling for oil and natural gas, and in development of alternative supplies of oil. If we want our economy to grow, more domestic oil and natural gas supplies will be needed in the years ahead. Raising taxes on energy would move our country in the opposite direction because it would raise the cost of capital for exploration and production and make development of new energy projects less likely.

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