Revisiting Energy and Taxes

Mark Green
Posted August 6, 2014

America’s oil and natural gas industry sends an average of $85 million a day to the federal government in the form of taxes, rents, royalties and bonus payments. Averaged over 2007-2012, the industry’s effective tax rate – income taxes paid to governments, divided by pretax income – was 44.6 percent. That’s well above the averages for other industries over the same time period:

We say all that to say this: Attacks that claim the oil and natural gas industry isn’t paying its fair share and/or that it gets special treatment are ridiculous. Industry is paying its fair share and then some – even as it supports 9.8 million jobs and 8 percent of the U.S. economy. Even if you’re discussing just U.S. taxes (as one recent report did), Tax Foundation Chief Economist William McBride points out that the average 24 percent rate paid by oil and natural gas companies is more than the 22 percent average for all corporations, as reported by the IRS.

That’s apparently not enough for some, who don’t like the fact the oil and natural gas industry creates earnings for its shareholders – millions of Americans, the real owners of “Big Oil” who benefit from having mutual funds, IRAs or from belonging to a public or private pension plan, including 401(k)s – or others who just don’t like oil and natural gas.

We’ve rebutted the claims about subsidies and special tax treatments in the past. The simple fact is, like every business in America, oil and natural gas companies are allowed under the tax code to deduct operating costs when calculating their federal income tax. But a deduction or a deferral doesn’t impact a project’s lifetime tax liability.

For example, the deduction for intangible drilling costs (IDC) is a mechanism that allows accelerated deduction of drilling costs, such as labor costs, associated with exploration activities (accounting for about 60 to 80 percent of the cost of the well). Exploration and production companies can claim a deduction equal to 100 percent of these costs in the year spent. Integrated companies – “Big Oil” – can only deduct 70 percent with the remainder recovered over five years. It’s a deduction, not a credit or a government spending outlay, and the mechanism is no different than the policy behind and treatments of R&D costs, such as those available for other industries.

The Tax Foundation’s McBride writes:

(IDC)  … merely allows companies to immediately deduct, i.e. expense, the costs of drilling. That is not a subsidy, it is the proper treatment of a real and legitimate business cost. The corporate tax is a profit tax, and profit equals revenue minus costs. Labor costs are fully and immediately deductible, so why not other costs?

The overarching point is to remember that tax treatments like IDC were created to spur investment, energy activity, job creation and economic growth. Cost-recovery in the oil and natural gas industry helps facilitate new investment, new energy development, new job creation and additional economic stimulus.

Conversely, doing away with cost recovery and other provisions under the tax code effectively would increase industry taxes and reduce resources for investment and job creation. Americans get this, 69 percent of registered voters agreeing in a recent poll that increasing energy taxes hurts everyone because they ultimately could drive up energy costs for consumers.

The American energy revolution has been one of the few bright spots in our economy – boosting a manufacturing renaissance while significantly enhancing our energy security. An oil and natural gas industry that is robust and that is able to make the investments in new development is the key driver of that revolution. We need tax policies that are fair and that allow our energy revolution to continue and grow.