The President vs. Big Oil

Posted by Dan Karney on Feb 4, 2011

Filed Under (Environmental Policy, U.S. Fiscal Policy)

In last week’s State of the Union (SOTU) Address, President Obama was less than crystal clear about the future of America’s energy policy (see the previous CBPP post “The State of the Union may be strong…”).  However, the President did seem determined to pick a fight with Big Oil by declaring, “We need to get behind [clean energy] innovation.  And to help pay for it, I’m asking Congress to eliminate the billions in taxpayer dollars we currently give to oil companies… So instead of subsidizing yesterday’s energy, let’s invest in tomorrow’s.” (Read the full SOTU Address here.)

Backing up his promise, on Monday the Obama administration asked Congress to eliminate $36.5 billion over 10 years in subsidies for oil and gas companies starting on October 1st, according to Reuters (source).  At issue are industry-specific tax breaks on drilling and extraction costs.  The administration estimates that the $36.5 billion subsidy represents only 1% of expected industry revenues over the coming decade.

In response, the American Petroleum Institute (API), the oil and gas industry’s main lobbying body, declared, “If the president were serious about job creation, he would be working with us to develop American oil and gas by American workers for American consumers.”  And went on to add, “The federal government by no stretch of the imagination subsidizes the oil industry. The oil industry subsidizes the federal government at a rate of $95 million a day.”

I am going to address two issues, one specific and the other general, regarding the Big Oil subsidy debate.

First, the claim the oil and gas industry is not subsidized by the federal government seems factually incorrect.  A 2005 Congressional Budget Office study (here), found the effective tax rate on capital income from petroleum and natural-gas structures to be 9.2%, the lowest rate among all the asset types studied.  The oil industry claims that since it pays $95 million a day in taxes and royalties to the federal government that it is not being subsidized; however, the relative tax rates that determine which industry is being favored by the tax code and thus subsidized.  Here, a relatively low tax rate on capital in oil industry encourages capital investment because the rate of return on capital to be profitable in the oil industry is lower than other sectors due to the lower tax rate.  The over-investment in the oil industry leads to more oil production, and likely total profits, than would be the case if all industries were taxed at the same rate.

Second, a subsidy can come in many forms.  For example, a payment can occur per unit of output, such as the Production Tax Credit (PTC) for renewable energy that provides a 2.1-cent per kilowatt-hour subsidy for electricity generated by generate wind, solar, geothermal, and “closed-loop” bioenergy (source).  Alternatively, paying a lower tax rate relative to other industries is also a type of subsidy as in the case of the oil industry (see above).  However, both types of subsidies affect the federal budget in similar, yet mirrored ways, where the former essentially pays out money, while the later forgoes revenue.  In the end, the fiscal deficit depends on the difference in spending and revenue, so either type of subsidy (payments or forgone taxes) impacts the deficit.

One Response to “The President vs. Big Oil”

  • Don Kentner says:

    Wondering how state severance taxes figure into this tax “subsidy”. Most states have a 7% tax on gross revenues at the wellhead. Was this considered by CBO?