An Overview of Oil Industry and Subsidies

by Brian McGraw on May 2, 2011

in Blog, Features

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Here is an excellent overview (by Robert Rapier) of taxes and the oil industry. The basic takeaways are that a simpler tax code is much preferable to what we have now, that ending these deductions without reforming the tax code will be damaging, and the oil industry’s profit margins are actually lower than many other industries. The whole thing is worth reading, but below are a few excerpts.

The biggest ‘oil company subsidy’ — amounting to $1.7 billion per year for the oil industry — is a manufacturer’s tax deduction that is explained in Section 199 of the IRS code. This is a tax credit designed to keep manufacturing in the U.S., but it isn’t limited to oil companies. It is a tax credit enjoyed by ethanol companies (have you ever heard anyone call it an ethanol subsidy?), computer companies (we are subsidizing Microsoft and Google!) and foreign companies who operate factories in the U.S.

One never hears of proposals to entirely do away with Section 199. Apparently, since this tax credit was designed as an incentive to keep manufacturing in the U.S., many would feel that eliminating it for all companies would provide less incentive for them to keep their factories in the U.S. Some of the same people apparently don’t believe this reasoning will apply with the oil industry.

Another category of subsidies is a percentage depletion allowance. It is worth about $1 billion a year for U.S. oil companies. Again, it isn’t limited to oil companies; other extractive industries are able to take the percentage depletion allowance. It is similar to a depreciation allowance in other businesses.

Another category is the foreign tax credit. Again, you may be surprised to find out that this ‘oil subsidy’ isn’t limited to the oil industry. But it is worth $850 million to the oil industry, and is designed to make sure that profits that have been taxed by foreign countries aren’t taxed again when they are returned to the U.S. Eliminating the foreign tax credit will provide an incentive for oil companies to keep the profits out of the U.S. and reinvest them abroad, helping to accomplish the goal of shrinking the U.S. oil industry.

In a nutshell, a large chunk of Big Oil’s ’subsidies’ are the same as those of Big Ethanol (which also has direct per gallon subsidies), Big Computer (Microsoft, Google, etc.), Big Auto, Big Pharmaceutical, and all the other industries large and small. They are not like their subsidies, they are in most cases the exact same tax deductions from the same tax code. The oil industry already pays an estimated $36 billion per year in U.S. taxes, and they have a higher tax rate than that of Microsoft or Google — both companies with higher profit margins than those of the oil industry. But those who argue that we preferentially eliminate, for instance, Section 199 and the foreign tax credit for the oil companies are in effect saying they have no problems subsidizing industries that are more profitable than the oil industry.

From part of the conclusion:

I get that it doesn’t seem fair that ExxonMobil’s record profits are coming out of our pockets. But the current proposals won’t do anything to combat what is coming out of our pockets. It will ensure that more of that profit — and the jobs that those profits support — are shifted to foreign suppliers. As much as people hate ExxonMobil, would they rather those profits were being reaped by Saudi Aramco? That is the alternative.

I understand that some believe that singling out the U.S. oil industry for punishment would help level the playing field for alternative energy companies. I think the dream of many is that if we make U.S. oil companies uncompetitive, the alternative energy sector will flourish and make up for the lost production from the oil industry. The future can be cleaner and greener and the only losers will be the oil industry. This is an incredibly naive view. In fact, look at the situation in Europe. Gasoline costs $8 to $10 a gallon, and cars are still predominantly fueled by petroleum. And it will be the same in the U.S. if gasoline rises to $10 a gallon.

I do think he leaves out the fact that a history of higher gas prices have changed behavior in Europe, as they would in the United States as well. Europeans drive smaller cars, have a higher population density, and are more likely to use alternative means of transportation. However, it takes decades to make large changes like this, and these changes should be driven by consumer preference through the market, rather than those who want to force Americans into adopting their idyllic view of life.

The very simple picture of “oil industry subsidies” crafted by the media isn’t quite accurate. Lower corporate tax rates (or preferably, end the corporate income tax entirely) and simultaneously remove these deductions.

Finally, consider reading an article from CNN on the same topic, and note how differently these subsidies are portrayed.

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