SHUGHART: Crushing oil companies and their workers

Democrats want to double down on oil-firm income taxes

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Shortly after the U.S. Energy Information Administration released a report estimating that President Obama’s six-month moratorium on offshore drilling in waters deeper than 500 feet will cut domestic production by 30 million barrels during the coming year, Sen. Robert Menendez, New Jersey Democrat, announced legislation that promises to reduce oil and gas output even further, possibly delaying economic recovery.

Titled the Close Big Oil Tax Loopholes Act, the bill aims, among other provisions, to undo for one and only one industry, a U.S. Treasury rule, in place for more than a quarter-century, that allows American companies operating overseas to claim credits on their U.S. corporate income tax returns for income taxes paid to foreign governments.

The purpose of the rule applying to so-called dual-capacity taxpayers is to avoid taxing corporate income twice. The U.S. government taxes the income of its multinational corporations on a worldwide basis. Without a credit for income taxes paid into foreign treasuries, income earned outside the United States would be subject to double-taxation in the same way that the incomes of individuals would be if state personal income taxes could not be deducted in computing their federal tax liabilities.

Besides selectively raising taxes on a critical sector of the economy - the U.S. oil and gas industry employs about 9.2 million workers and accounts for about 7.2 percent of gross domestic product (GDP) - the idiosyncratic tax treatment of American companies engaged in the extraction of natural resources overseas suggests that, if passed, Mr. Menendez’s bill will place domestic energy producers at a considerable competitive disadvantage relative to their foreign rivals.

Current rules allow dual-capacity taxpayers to claim U.S. income tax credits only for income taxes paid to foreign governments. They are not permitted to deduct royalties or other fees paid for production rights. Moreover, the U.S. Treasury places the burden on domestic oil and gas companies to prove that any credit claimed is in fact limited to payments of foreign taxes on income.

Mr. Menendez and his legislation’s co-sponsors, Democratic Sens. Bill Nelson of Florida and Jeff Merkley of Oregon, want to reclassify as nondeductible royalties or expenses any income taxes paid by oil and gas companies in excess of the income taxes foreign governments impose on manufacturers and other non-energy firms. But many foreign nations levy much higher income-tax rates on U.S. energy producers than they do on other U.S. corporations.

If, for example, the foreign tax rate on the incomes of U.S. manufacturers is 10 percent, while the income tax rate on U.S. energy producers is 35 percent, the income tax credits of domestic oil and gas companies will shrink dramatically, and the difference will be taxed twice.

The Menendez bill also proposes to repeal a host of other ostensible “loopholes” in the federal income tax code as it applies to American energy producers with an eye on “recouping” $20 billion in tax revenue over the next decade. It implements part of President Obama’s 2011 budget message in which, pursuing his “green” agenda, he outlined a policy of stopping subsidies to “polluting industries.”

It is clear, however, that the Close Big Oil Tax Loopholes Act is meant to punish America’s oil and gas industry, perhaps in reprisal for the Deepwater Horizon disaster, largely the fault of a British company, and more likely to expropriate additional tax revenue from a politically vulnerable sector that is perceived popularly as being extraordinarily profitable.

It is not. Average oil- and gas-industry earnings run about 7.7 cents per dollar of sales, a figure that is less than that of many other sectors of the economy: Earnings per dollar of sales are about 7.9 cents for U.S. industry as a whole.

A recession is exactly the wrong time to raise taxes on anyone, especially an industry that “creates” so many jobs and already contributes billions to treasuries here and abroad. If anything, American taxpayers should be grateful that, unlike GM, Chrysler and Wall Street, U.S. energy companies are not (yet) wards of the state.

William F. Shughart II, a senior fellow of the Independent Institute, is an economics professor at the University of Mississippi and editor of “Taxing Choice: The Predatory Politics of Fiscal Discrimination” (Transaction Publishers, 1997).

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