By Lawrence J. McQuillan
After oil companies released their first-quarter earnings figures-showing exceptionally high profits-Democratic leaders predictably called for an end to “subsidies.”
Lawmakers promptly hauled some top energy CEOs to Washington, accused them of greed, and introduced legislation to impose new taxes on oil and natural gas companies.
That bill was defeated, but some lawmakers continue to gin up public support for huge new taxes. Don’t be fooled. Much of the rhetoric surrounding oil taxes and profits is misleading.
Despite public perception, the industry has a relatively low profit margin and pays a much larger share of its revenues in taxes than most other industries. And stiff tax hikes will actually harm the economy, destroy jobs, and hamper innovation.
Let’s start with those “subsidies.” The truth is oil and natural gas don’t get a dime in direct government grants, unlike wind and other much-hyped “green” sectors that can’t compete on a level playing field and can’t meet our country’s energy demands.
What lawmakers call subsidies are actually tax deductions that allow companies to retain more of what they earn and use those earnings for exploration.
These deductions aren’t special favors. They’re essentially the same kind of deductions available to every other industry that enable companies to recoup operation costs and only get taxed on net income.
Take the Intangible Drilling and Development Costs (IDC) deduction, which lets companies exempt the expenses associated with finding and developing new oil fields. The Obama administration estimates its elimination would raise more than $12 billion for federal coffers over the next 10 years.
Exploration costs account for 60 to 80 percent of the total cost of the average well. And oil companies typically employ the IDC deduction for things like wages for researchers developing new drilling techniques to access hard-to-reach reserves.
There’s also the Tertiary Injectants Deduction, which totals about $92 million a year. This provision allows companies to write-off some costs associated with reviving old wells and extending production.
Getting rid of these provisions would also hurt the economy. Today the oil industry supports 9.2 million American jobs. And while much of the economy was in a slump between 2007 and 2009, the oil industry grew.
Hitting oil companies with tax increases would leave them with less capital for new refineries and entice them to uproot domestic operations and relocate to more tax-friendly countries. This would reduce domestic energy production, cut jobs, and raise pump prices.
Indeed, Wood Mackenzie, a consultancy, shows that removing the standard slate of industry deductions would cause domestic oil production to drop 1 percent and cause a 5 percent drop in domestic natural gas production after just one year. Researchers also found that over the next decade, such a move would threaten 165,000 jobs.
Oil companies are currently paying their fair share of taxes. In 2009, according to the Compustat North American Database, oil and natural gas companies paid income taxes at an effective rate of 48.4 percent or 72 percent higher than the average effective rate of 28.1 percent paid by all other S&P industrial companies.
Oil companies earn large revenues in absolute terms, but their profit margins are actually quite low. From 2006 to 2010, the top oil and natural gas companies averaged an annual profit margin of 6.65 percent, below the U.S. manufacturing average.
In the first quarter of this year, ExxonMobil estimates that it made about 7 cents on every gallon of gasoline sold. Meanwhile, the government made 40-60 cents per gallon in state and federal taxes.
The relentless denunciations in Congress simply don’t square with the facts. If turned into policy, they’ll damage the still-fragile American economy, drive out jobs and investment, and increase gas prices.
Lawrence J. McQuillan, PhD, is director of Business and Economic Studies at the Pacific Research Institute. Contact him at LMcQuillan@pacificresearch.org.