Posted by: bmeverett | February 17, 2012

The oil subsidy myth


Last Wednesday, I had my annual climate change debate with my friend and colleague Prof. Bill Moomaw at the Fletcher School. This is the ninth time we have held this debate, and it’s always fun.

Prof. Moomaw offered a new argument this year, which surprised me a bit. Unfortunately, I did not have the data at hand during the debate to refute the argument, so could only offer a general objection. A few minutes of web surfing, however, rips this argument to pieces.

The argument was that automobiles were too expensive for ordinary consumers in their early days, and were able to compete in the market place only because the government offered massive subsidies in the form of the oil percentage depletion allowance. In other words, government support was essential to the success of the automobile in America.

Here are the facts. The percentage depletion allowance was authorized by Congress in 1913. In that year, Ford sold 168,000 cars with a Model T runabout priced at $525 ($11,500 in today’s dollars). The United States already had over a million registered automobiles at that time.

Second, the US government was a completely different institution in the early 20th century than it is today. Before World War I, the federal government accounted for only 2-3% of GDP, compared to about 22% today. The federal government received most of its revenue from tariffs and excise taxes. There was no personal income tax, and the government had nothing like today’s massive economic management and regulatory structure. There was no government policy to promote one form of energy or transportation over another.

Third, the corporate income tax was not introduced until 1909 and then at a rate of 1% of earnings. When the percentage depletion allowance, excoriated by Prof. Moomaw, was introduced in 1913, the corporate income tax had been raised to 2% of a company’s earnings. In 1913, the price of gasoline in the US was about $0.08 per gallon, equivalent to about $1.75 per gallon in today’s dollars. Corporate earnings were not nearly as transparent then as they are today, but the refining, distribution and retailing system in 1913 was inefficient and expensive. Let’s assume for the sake of argument that oil companies earned $0.25 per gallon in profit ($2012) compared to $0.10 today. The corporate tax would have been 2% of that amount or $0.005 per gallon. Even if the percentage depletion allowance reduced corporate tax liability by half, its impact would have been one-quarter of one cent per gallon or about 0.1% of the price of gasoline.

People drove fewer miles in the early days of the industry, since both roads and leisure time were limited. Let’s say the average car traveled 3,000 miles in 1913 (compared to about 12,000 miles today). A Model T got about 25 miles per gallon of gasoline, so the driver would have needed about 120 gallons of gasoline per year costing $210. By our rough estimate, the percentage depletion allowance would have “subsidized” automobiles to the tune of about 30¢ per YEAR in today’s dollars.

The idea that government subsidies supported the introduction of automobiles has no factual support. Why bother with this argument then? The purpose seems to be to counter the conservative assertion that the market rather than government should choose winners. If all technologies required government support in their early stages to overcome economic hurdles, then renewable energy subsidies just mirror those given to other energy sources.

President Obama and congressional democrats also push the argument that the oil companies have always been heavily subsidized because it supports the narrative that their profits are illegitimate and therefore should be taxed away. For a more complete discussion of this issue, please see my post “Taxing the Oil Industry” from July 8, 2010.

We are seeing a troubling pattern in our public discourse – the creation of politically convenient myths that are persuasive but patently false. Here’s the most recent list:
1. The “Buffett Rule” myth: The rich pay lower tax rates than the middle class.
2. The “banker’s greed” myth: The 2008 financial crisis was caused by the deregulation of the banking system.
3. The Elizabeth Warren myth: If a business uses public roads, then its profits are a public asset.
These new myths are recent additions to the Depression myth, which states that after the stock market crash in 1929, Herbert Hoover and the Republicans left the problem to markets which caused the economy to sink into depression. FDR, on the other hand, recognized the need for massive government intervention and thus saved us.
All of these myths are factually incorrect, and easily disproved by even a cursory reading of history or a basic understanding of economics. They are nonetheless useful to those who support continued growth in government power. The propagators of these myths rely on their plausibility and the expectation that the public has neither the time nor the inclination to check the facts. Very worrying.

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Responses

  1. Petroleum engineer – sixty years in the oil industry has hardened me to all of the false info fed the public about the oil industry. However, the depletion allowance allowed the explorers for oil and gas a chance to write off a lot of very expensive exploration and drilling expense and in many cases the 22.5% allowance saved some explorers who were drilling too many dry holes, or getting low volume producers. Somehow the general public thinks all you have to do is drill a hole – there is no risk!
    It always amazes me how many sidewalk experts in Congress think they understand the oil business. Wrong – most could not run a one-chair barbershop successfully. Of course, Al Gore could teach them – coouldn’t he?
    See my BLOG – http://www.energycrisis12.blogspot.com

  2. Great read!
    I agree its scary that Americas have become lazy and wont take the time to ck facts!!


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