Don't Balance the Budget On the Energy Industry
Fast approaching its debt limit, the U.S. has few choices: it can default or lawmakers can raise the debt ceiling. Signifying he will not support the latter option without first finalizing a debt reduction plan, President Obama has indicated a deficit deal must include "spending reductions in the tax code." Hidden in that jargon, however, are old revenue-reducing tax hikes on politically unfavorable industries like oil and natural gas.
Tearing a page from last year's federal budget proposal (and similar proposals dating back to 2008), the Administration's debt reduction plan would levy some $37 billion in new taxes on the industry through the repeal of critical tax deductions and credits. These include the manufacturer's tax deduction known as Section 199-a tax incentive enacted by President Bush in 2004 to put American manufacturers on equal footing with overseas competitors-and ‘dual capacity'-a credit to reduce the U.S. tax burden levied on foreign income taxed abroad.
Although the changes are touted as a deficit reduction measure, their cancelation would perversely lead to a net loss of $54 billion in tax revenue over the next 10 years.
Economists have understood for decades that the relationship between tax levels and government revenue is a backward-bending curve, not a straight line. After a certain tax rate threshold, higher taxes have a negative effect on production.
In layman's terms, tax people too much, and they no longer have the inventive to work. In a perverse feedback loop, decreased production lowers the tax base and federal revenues so that increased taxes result in lower federal revenues.
My 2010 analysis showed that revoking key corporate tax measure such as dual capacity and Section 199 could be expected to reduce tax revenues by $83.5 billion over 10 years. Compared with projected revenue gains of less than $30 billion for those programs, the tax policy change can therefore be expected to result in a net $50 billion+ loss, enlarging-not reducing-the federal deficit gap.
If we put aside for a moment the politics of oil and gas, Congress can at least consider policies that stimulate production and increase tax revenues. One area to explore is getting the Obama administration back to their earlier commitment to open the outer continental shelf (OCS), long viewed as a windfall revenue opportunity.
Prior to the Deepwater Horizon disaster, President Obama favored this policy. My own 2009 study suggested that America stands to gain $8 trillion in additional economic output in the next 40 years (in current dollars), resulting in $2.2 trillion in tax and royalty revenues and 1.2 million new jobs by opening access to our offshore oil and gas resources.
Moreover, evidence from 2008, the last time the administration opened new lands to leasing, suggests that such a move would also result in a substantial immediate bonus bid income from leasing. In 2008, alone, the Treasury took in more than $10 billion in such bids before languishing at $1-2 billion in 2009 and 2010.
In the spirit of true tax reform, the President and his allies in Congress can still consider making the system more efficient and enhancing economic performance. But real tax reform that can be justified by deficit reduction has to embrace deductions that affect the majority of Americans, rather than target selective industries.
An overhaul could address some of the problems of dual capacity by also looking at territorial reforms that would reduce incentives for foreign tax shelters. But it seems that sensible alternatives that could drive substantial improvements in U.S. economic efficiency and growth are being foregone at this crucial juncture in the name of pork-barrel politics and logrolling.
Solving America's financial problems in a "responsible" way is no small task and requires meaningful institutional reform at all levels of government. If the true subject of the debt debate is fiscal revenue, policymakers should compare the economic damage that would occur from raising taxes on oil and gas companies with the benefit that would accrue from opening up new production before finalizing a deficit deal.