Posted by: bmeverett | July 8, 2010

Taxing the oil industry


Another really poor article in The New York Times – this time a July 3 offering by the Time’s David Kocieniewski entitled “As Oil Industry Fights a Tax, It Reaps Subsidies.” Tax analysis is complicated, but journalists endeavoring to write about taxes should make the effort to get it right. Mr. Kocieniewski’s argument is that the oil industry is guilty of bad behavior for accepting tax breaks while opposing new taxes. In my June 8 post entitled “The I Hate Congress Act” I noted that Congress deliberately makes the tax code complicated to disguise the process of selling tax breaks to favored constituents. The oil industry gets its share, but the question is does it get more? It’s painfully obvious that taxpayers take advantage of all the tax breaks they can. Every single one of us does so. It’s equally obvious that enjoying tax breaks does not obligate us to support whatever new tax proposals Congress dreams up. Mr. Kocieniewski’s point may be valid, but he certainly hasn’t made his case. Let me offer for future reference some guidelines on how reporters should address corporate tax issues.

First and foremost, make sure that what you are saying is clear and accurate. For example, Mr. Kocieniewski says, “According to the most recent study by the Congressional Budget Office, released in 2005, capital investments like oil field leases and drilling equipment are taxed at an effective rate of 9 percent, significantly lower than the overall rate of 25 percent for businesses in general and lower than virtually any other industry.” Companies pay taxes on income, not investments. Furthermore, the thrust of the CBO study (there’s a link in the article on the NYT website) is to address the complete elimination of taxes on capital income, not to complain that the oil industry pays less than the average.

Second, understanding taxes requires an analysis of the total picture, not just a few scattered anecdotes. I’ve done a rough assessment of the global oil market for 2008, a year of unusually high oil prices and profits. (The numbers for 2009 are not yet available.) The total retail value of all the petroleum products sold in the world in 2008 was about $4.5 trillion dollars. The cash cost of actually producing, transporting, refining, distributing and retailing these products was about $2.1 trillion, so $2.4 trillion was what economists call “economic rent” – the surplus available to be shared among market participants. Did the oil companies capture most of that surplus? Hardly. Oil-producing governments, including Saudi Arabia, Russia, Canada, Mexico, the UK and others, took about $1.3 trillion or about 55%. Oil-consuming governments, including Europe, Japan and (yes) the United States, took $0.9 trillion or about 38% in the form of excise taxes. That leaves $200 billion (7%) for the oil industry, which did much of the work and took much of the risk. If you’re worried about who’s really benefitting from all your fuel bills, the answer is governments.

Third, much of the confusion in tax analysis involves double taxation. It would seem to be a simple principle that income should only be taxed once. For most people earning a paycheck, that’s true, but it’s not true for investors. Let’s take a simple example. Suppose 100 people get together, invest $10,000 each and form a US corporation with assets of $1,000,000. If the corporation earns $100,000 in taxable income in its first year of operation, it would be required to pay a 25% US corporate income tax or $25,000. That doesn’t sound too bad to people who have to pay even higher rates on their salaries. If the corporation dividends out the remaining $75,000 to its shareholders, however, they are required to pay personal income tax on that money – essentially a second level of tax on the same income. Before the Bush administration reformed the tax system in 2003, dividends were taxed at the same rate as other income. Wealthy shareholders could end up paying 39.6% on the $75,000 dividends. That meant that the effective tax rate could be as high as 54.7% – enough to discourage many otherwise attractive investments. The Bush tax reforms reduced the dividend rate to 15% for upper-income taxpayers, resulting in an overall maximum tax rate of 36.25% – roughly the same as taxes on salaries and wages for high-income earners. The Obama administration is planning to eliminate that reform, allowing dividend taxes to rise to their previous levels. Not a good formula for economic growth and not at all fair. If individuals are going to pay full tax rates on dividends, there should be no corporate income tax at all.

We encounter a similar problem with foreign tax credits – often portrayed as some kind of loophole. Let’s suppose that ExxonMobil produces oil in some African country, which has an income tax of 50% on oil earnings. If the company makes $1,000,000 in pre-tax income, and pays $500,000 to the local government, how much should it pay to the US? If ExxonMobil has to pay 25% of $1,000,000, and its shareholders have to pay 39.6% tax on dividends, the effective tax rate is 85%. Does that make any sense? Would we really be better off if we made US oil companies uncompetitive, allowing non-US companies, like the Russians and the Chinese, to produce that oil and earn a nice return out of the reach of the IRS? What we do in fact is to treat the $500,000 local income tax as a credit against US corporate income taxes. Perfectly sensible and not a subsidy.

We have a similar problem among states. When I teach at the Fletcher School at Tufts in Massachusetts, I am required to pay Massachusetts income tax of 5.3% on my salary. I live in Washington, DC, however, and am also required to pay income taxes there at a rate of 8.5%. Would it be fair for me to pay 13.8% (5.3% + 8.5%) in state taxes? I don’t think so. In fact, I pay 5.3% to Massachusetts and 3.2% (8.5% – 5.3%) to DC.

Mr. Kocieniewski also says, “Other tax breaks were born of international politics. In an attempt to deter Soviet influence in the Middle East in the 1950s, the State Department backed a Saudi Arabian accounting maneuver that reclassified the royalties charged by foreign governments to American oil drillers. Saudi Arabia and others began to treat some of the royalties as taxes, which entitled the companies to subtract those payments from their American tax bills. Despite repeated attempts to forbid this accounting practice, companies continue to deduct the payments.” Sounds sinister, but two quick points. There’s no real difference between royalties and income taxes. Both come out of the company’s earnings and into the host government’s treasury. They ought to be treated the same. Moreover, does Mr. Kocieniewski really mean to argue that the companies should increase their payments when Congress TRIES to raise their taxes rather than when Congress actually DOES raise the tax? Who would do that?

Fourth, Mr. Kocieniewski picks up the familiar theme of US companies moving some or all operations overseas to avoid US income taxes and quotes some numbers on how much money this strategy costs the US government. In reality, if the US makes it difficult and expensive for US companies to operate overseas, one of two things will happen. Either US companies will move some operations out of US jurisdiction or foreign companies not burdened by such taxes will take business away from their US competitors. Which would you prefer?

Fifth, you need to be careful how you interpret politics. Addressing the efforts by Senator Robert Menendez (D-NJ) to eliminate oil industry “tax breaks,” Mr. Kocieniewski says, “But one notable omission in his bill shows the vast economic reach of the industry. While the legislation would cut many incentives over the next decade, it would not touch the tax breaks for oil refineries, many of which have operations and employees in his home state, New Jersey.” Senator Menendez’ position does not show the sinister power of the oil companies so much as the natural tendency of all elected officials to protect their own constituents, while they try to raise taxes on everyone else.

As a final point, reporters should not treat the industry as a monolithic block. The tax that Mr. Kocieniewski seems to think the oil industry should support is a tax on petroleum production to pay for the Gulf cleanup. Why is that fair? If an oil truck runs off the road and spills oil on the highway, should all truck drivers be forced to pay for the cleanup? Whatever happened to individual responsibility?

I guess it’s my fault for expecting quality reporting from the New York Times. Hope springs eternal.

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Responses

  1. […] the rest of this great post here Comments (0)    Posted in Oil Spill   […]

  2. […] really poor article in The New York Times this time a July 3 offering by the Times David Kocieniewski entitled As Oil Industry Fights a […]

  3. Maximum Influence Advantage…

    I found your entry interesting do I’ve added a Trackback to it on my weblog :)…

  4. Excellent article – if only the mainstream media (Fox included) presented concrete #’s like these, the general public might actually know what’s going on instead of “Bush’s evil wealthy tax cuts are finally ending!”


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