Congress Has Narrow Window to Level Energy Tax Playing Field
For the first time in more than 30 years, Congress and the White House are moving in one direction toward major changes to the tax code. For months in the run-up to U.S. House leadership unveiling its proposed tax-reform plan, lobbyists have descended on Capitol Hill in mass, looking to concentrate benefits and divert costs for their private clients, often at the expense of the national interest.
Such rent-seeking by the lobbying class is an obvious (and constitutionally protected) consequence of a democratic society that allows the free expression and association of many diverse and narrow groups. The next several weeks will involve democratic "sausage making" at both its best and its worst on Capitol Hill.
It is true that such deal-making is not as aesthetically pleasing as idealists would like, but this is also a major opportunity to make the tax code clearer, simpler and less distortionary to energy markets. For devotees of limited government, pairing the elimination of a wide range of tax preferences with lower tax rates is the Holy Grail of policy goals. However, such goals remain difficult to execute.
A great example of positive deal-making in Washington took place in late 2015, when the Obama administration and the Republican-led 114th Congress agreed to extend expiring solar and wind tax credits for five more years in return for lifting the ban on U.S. oil exports. The total cost to taxpayers of extending the Production Tax Credit (PTC) and Investment Tax Credit (ITC) for renewable energy through 2020 was roughly $76 billion. Meanwhile, oil exports from the United States have grown over the past two years from near zero to almost 2 million barrels each day and may increase to 4 million barrels per day by 2022.
Such a win-win example for both taxpayers and the U.S. economy should motivate Congress to strip the tax code of provisions that were written to benefit specific energy technologies, regardless whether the activity is carbon-based or carbon-free.
The R Street Institute recently treated the subject of energy tax subsidies to an in-depth study, finding that energy-specific provisions in the tax code generally fall into one of five categories: tax-exempt bonding, the beneficial categorization of income, tax deductions, tax credits and faster cost recovery. The first four generally are tailor-made tax policies that ultimately worsen distortions in investment and behavior to a degree that undermines free-market principals. These policies include:
Tax-Advantaged Bonding: In a few instances, Congress has created tax advantages for activity and conservation bonds to be floated to finance energy or conservation projects like transmission lines and wind farms. The problem with tax advantages is they can lead to substantial "overinvestment" in certain projects that would not be built without the subsidy.
Advantageous Categorization of Income: In several instances, Congress has used specialized tax treatment of certain types of energy-related income in order to provide a tax advantage. One clear example is the creation of “master limited partnerships” or “MLPs.” Such partnerships involve investment in oil and coal production, but not renewable industries, creating an uneven tax treatment of competing technologies.
Tax Deductions: Congress has enacted numerous deductions specific to energy over the past several decades. Among them are a percentage depletion allowance for small oil and gas drillers, a domestic manufacturing deduction for coal mining and a tax deduction for mining and solid waste reclamation and closure. All these examples are industry- or technology-specific and give an unfair tax advantage to companies and industries.
Tax Credits: Unlike deductions, credits allow a dollar-for-dollar reduction in a taxpayer’s liability, and Congress has been very generous in using them to implement many pet projects in the energy sphere while distorting investment decisions. The most prominent examples are the above-mentioned PTC and ITC for wind and solar that are being phased out by the end of the decade.
All told, there are 28 separate incentives in the tax code that fall under the definition of industry- or technology-specific tax carve-outs. Congress should take the opportunity to eliminate these market-distorting and politically unfair energy provisions, which would save taxpayers billions of dollars a year.
Faster Cost Recovery: The one exception to the removal of unfair and distorting energy benefits in the tax code are provisions that encourage the goal of cost recovery. Genuine recovery of expenses is a core principle of pro-growth tax reform because it encourages investment and simplifies tax compliance. Oil producers have benefited from a so-called “intangible drilling costs” (IDC) provision for decades, allowing them to deduct expenses that have no salvage value. This provision substantially improves the industry’s ability to recover costs and thus reduce their tax liability. Instead of removing the ability to recover costs from the oil industry quickly, the tax benefit should be expanded to include other industries may that must recover costs from depreciating infrastructure.
U.S. political history suggests corporate tax reform happens just once a generation. It would be both wise and farsighted for policymakers to make adjustments to the tax code that expands cost recovery to other non-fossil fuel energy sources, leading to a level-playing field for domestic energy production.
In order to encourage businesses to invest, congressional leaders have been pushing tax plans that either feature full expensing or at least some significant compression of depreciation schedules. Any budget offsets needed to allow for increased cost recovery could target the more than two dozen other energy tax breaks that have been added to the tax code in recent decades, with little thought to the unintended economic and political consequences. Now is the time for Congress to act.
William Murray is federal energy policy manager with the R Street Institute.