US Oil Warns Against Tax Hike

by Mike Godfrey, Tax-News.com, Washington

18 August 2010

Raising taxes on the US oil and natural gas industry could significantly reduce domestic oil and gas production next year and cut it by as much as 10% in 2017, a new study concludes.

The study, by Wood Mackenzie, evaluates the merits of eliminating two tax incentives for the oil and gas industry: the intangible drilling cost expensing; and the domestic production activities deduction, known as the 'section 199' deduction.

A substitute amendment to the small business lending bill pending in the Senate, submitted earlier this month by Sen. Max Baucus, would repeal section 199 of the US tax code, which currently allows the largest US oil firms to deduct 6% of their income from oil and gas production from their tax liability, effective December 31, 2010. This repeal would only apply to the five largest corporations with more than USD1bn of before-tax income.

Baucus argues that the incentive is no longer needed because the top-five oil producing firms in the US have been highly profitable in recent years, and because average oil production has fallen slightly from 5.5 million barrels per day in 2005 when the tax break was introduced, to 5.48 million barrels per day currently.

However, Jack Gerard, CEO of the American Petroleum Institute, warns that production will inevitably fall if section 199 is repealed.

“The study illustrates a fundamental rule of economics: tax something more, get less of it,” he said. “But more important than the lost production is the loss of thousands of jobs that would follow. Advocates of higher taxes should understand who would really be hurt.”

“The incentives have increased US energy production and jobs, and other industries enjoy the same or similar incentives,” Gerard continued. “Proposals to eliminate them for oil and gas alone would discriminate against an industry that already pays federal income tax at an effective rate more than 70% higher than the other S&P Industrials.”

The study estimates that, ironically, the natural gas industry, considered a clean-burning fuel, will be worst affected by the proposed measure. “Almost half of the gas plays we consider to have future development potential are at risk under the proposed tax changes," said Gerard. "The gas plays that become sub-economic are not only great in number, but represent more than 10% of the gas that will be produced over the next ten years.”

The Baucus amendment has been drawn up to offer an alternative way to pay for the Small Business Lending Fund proposed in the Small Business Jobs Act. The amendment also raises the threshold for reporting purchases of goods and property from USD600 to USD5,000 for companies with more than 25 employees. Firms with fewer than 25 employees would be exempted altogether from the information reporting requirement, enacted as part of the health care reforms earlier this year.

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