Among President Obama’s recommendations for fixing the budget is the elimination of $4 billion per year in “subsidies” for oil companies. This will be the third time the president has made a push for ending oil subsidies and the third time that economists have scratched their heads and asked, “What subsidies?”
Firstly, the oil industry is one of the most heavily taxed sectors in the entire nation. While the average company in the Standard and Poor’s index pays an effective tax rate of 28.1 percent, oil companies pay a whopping 48.8 percent. There are plenty of reasons to hate industrial policy, but under-taxation of petroleum is not one of them.
Secondly, taxes, for obvious reasons, are levied on a business’s net income after costs, not its gross revenue. This creates a bit of an issue: how does one treat purchases of equipment and other resources that last longer than one year? The normal, non-distortionary treatment is to deduct capital costs according to the depreciation rate of that capital. The oil industry is no exception.
The word “subsidy” implies that the government is writing checks to Exxon Mobil when in actuality, Obama is proposing the elimination of oil companies’ ability to take standard deductions available to all businesses. Specifically, instead of being able to deduct the capital and labor that goes into the exploration and development of new oil wells, Obama would prefer that U.S. tax policy ignore these costs altogether and pretend that oil companies are more profitable than they actually are. This is not a plan to replace favorable treatment of oil companies with a level playing field, but a plan to take a field that is already heavily tilted against oil and skew it even further.
“Ending oil subsidies” polls well — that’s why Obama keeps reviving the notion. But if the public knew what Obama really wanted to do — raise taxes on the development of new oil resources, that support would quickly (and rightly) evaporate.