Eliminating Energy-Related Tax Expenditures

With domestic oil production soaring, and petroleum and coal sector profits rising at a rapid clip, now seems the right time to cut back on tax expenditures related to oil extraction and processing.



oilsubsidies1.gif

Figure 1: US oil field production in thousands of barrels/day (blue, left axis), and profits in the petroleum and coal sector according to NIPA, in billions SAAR (red, right axis). Source: Energy Information Administration, BEA.

The Administration has proposed elimination of several tax expenditures. According to OMB, this would yield ten year savings equal to $41.4 billion.


oilsubsidies2.gif

Table 5-1 from Aldy (2013).

In the recent debate over the sequester, other provisions were suggested, including an end to an exemption for the tar sands industry that excludes it from paying an 8-cent-per-barrel fee that supports an oil spill fund. [1] The Congressional Research Service has discussed the elimination of the provisions in the table above.

On the one hand, the tax changes proposed … would increase tax collections from the oil and natural gas industries and may have the effect of decreasing exploration, development, and production, while increasing consumer prices and possibly increasing the nation’s dependence on foreign oil. These same proposals, from an alternate point of view, might be considered to be the elimination of tax preferences that have favored the oil and natural gas industries over other energy sources and made oil and natural gas products artificially inexpensive, with consumer cost held below the true cost of consumption when external costs associated with environmental costs and energy dependence, among others, are included.

I believe the negative impact on output is highly overstated. From Aldy (2013):

Proponents of fossil fuel subsidies claim that these subsidies support American energy independence. This argument does not appear to be applicable to coal, as the United States has been largely self-sufficient in coal over its history, with modest imports and exports in recent years. Moreover, it is quite unlikely that the current oil and gas subsidies explain this bullish outlook for domestic oil and gas production, since most of the prominent subsidies—such as intangible drilling costs expensing and percentage depletion—have been in the tax code over the 1970–2009 period that was characterized by a nearly 50 percent decline in U.S. oil production.


More important, the economic analyses of the impact of oil and gas subsidies show very little response in domestic production to these tax preferences. In one analysis of subsidy elimination, the estimated reduction in U.S. oil production would amount to about 26,000 barrels per day (Allaire and Brown 2009). This is quite modest considering the rapid growth in domestic oil production, which has grown, on average, each month by more than 30,000 barrels per day since January 2009. Thus, these tax subsidies do not meaningfully increase production, and as a result they do not stimulate job creation or lower U.S. oil, petroleum product, and natural gas prices. As largely inframarginal subsidies, they convey billions of dollars of benefits to the firms claiming them without an identifiable benefit for consumers or for the nation’s energy security.

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30 thoughts on “Eliminating Energy-Related Tax Expenditures

  1. Gene

    Reducing oil industry subsidies (to get the subsidy they actually have to be doing something) in an amount similar to a reduction in planned (have not done anything yet) govt spending with the sequestration, will not harm employment in the private sector but will devastate employment in the public sector?
    Is this correct? Am willing to learn.

  2. Pierre Charles

    On what basis can you assert that the “Coal sector” profits have been increasing at a rapid pace? Any look at Peabody, Arch, Alpha Natural resources,etc, would show this to be incorrect. Net income is negative.

  3. Menzie Chinn

    Gene: I didn’t mention the BCA. The reduction of tax expenditures should be assessed on its own merits, separate from the issue of the sequester.

    Pierre Charles: The data pertain to the aggregate “petroleum and coal” sector.

  4. Steven Kopits

    So, let’s take them one by one:
    Intangible Drilling Costs
    When energy companies drill, they incur costs for things like site preparation and labor. No physical asset is received for these costs, and over time they have been termed as intangible costs. Typically, they represent 60 to 80 percent of the cost of the well – the remainder being the physical steel, pumps and casing that become part of the well. Companies have long had the option of deducting these costs in the year they are spent – similar to deductions enjoyed by other industries.
    As a matter of matching, capital costs should be deducted as incurred against revenues. In the case of dry holes, revenues are effectively zero, and costs should be expensed, as is the case presently. For a producing well, drilling costs should, in principle, be amortized over the life of the well.
    To make this rule neutral, dry holes should be expensed, and producing wells should amortize against a type curve. For shale oil and gas wells, decline rates can be 80% in the first two years, so expensing should occur pro rata over the same period.
    However, in either case, costs will reduce tax liability equally. The only issue is the time frame. Proposed revisions to rules would decrease intangible expenses in Year 1 for a given well, and increase them every year thereafter.
    This measure is hoped to yield $13.9 bn over ten years. I have my sincerest doubts, since essentially by Year 2 in the new regime the expense level will exceed Year 2 over the previous regime. So you get pretty much all the bang for the buck in Year 1. After that, increased revenues have to depend on either increased drilling activity or increased drilling costs.
    As I have noted elsewhere, rig counts appear to have peaked for the cycle. For oil wells, any effect is likely to be on activity (but I think small); for natural gas, it will both reduce activity and increase selling prices.
    If the proposal envisions better matching in time, counter-proposals would call for both dry hole expensing and amortization over type curves for the shales. And if the company’s drilling multiple laterals off a single pad, some of which may be dry, and some not…well, good luck with legislative negotiations. It’s not hard to see why the O&G industry has expensed intangibles since 1913.

  5. Ricardo

    “Eliminating Energy-Related Tax Expenditures”
    George Orwell’s Newspeak is alive and well. “Tax deductions” become “tax expenditures.”
    1. Reducing taxes for expensing drilling costs become a government expenditure.
    2. Deduction for expense of oil and gas become a government expenditure.
    3. Depletion allowances become a government expenditure.
    4. See 3.
    5. Research expenses become a government expenditure.
    6. Expensing exploration and development become a government expenditure.
    7. Inflation costs become a government expenditure.
    8. Tax expense becomes a government expenditure.
    9. Cost of injectants become a government expenditure.
    10. Losses become a government expenditure.
    11. Expenses of recovery efforts become a government expenditure.
    12. Expense of production from marginal wells become a government expenditure.
    Deducting the expense of doing business is a government expenditure as if the government made the payment, but actual government expenditures for unemployement insurance payments, foreign aid, crony capitalist subsidies to failed “green” companies, and on and on – all of these are not government expenditures.
    Welcome to 1984.

  6. john jansen

    Ricardo stole my thunder. As soon as I read the blog post I thought Orwell. Nice work Ricardo.
    The term tax expenditure presupposes that 100 percent of a business’ revenue belongs to the government and that is the largesse of the government that leaves little kernels for the owners.
    What a sad state we are in!

  7. Steven Kopits

    Domestic Manufacturing Deduction
    This a deduction for creating “manufacturing” jobs in the US. It includes things like software and films, but excludes, for example, housing construction.
    I am not wedded to the law, but see no reason why oil–of which we are critically short–should be discriminated against compared to, say, film production.
    A better solution would be to do away with the law entirely and lower corporate tax rates to make them more competitive interationally.

  8. Menzie Chinn

    Ricardo and john jansen: Well, the term “tax expenditure” is well established in the public finance literature. However, if you wish, you can retreat to your own respective little cubbyholes, where such terms never disturb your sensibilities. While you are at it, please also quarantine “marginal utility”, “externalities”, “entitlements”, “discretionary”, etc.

  9. Steven Kopits

    Percentage Depletion
    There are two ways to calculate the reduction in tax basis in an asset, say, land, from depletion of its resource endowment through extraction.
    The first of these is cost-based depletion, in which the reduction in basis is calculated based on the share of production over the tax year divided by the resource endowment at the beginning of that tax year. So, if your tax basis was $1 million, and you extracted 5000 barrels of oil from a resource endowment of 50,000 barrels at the beginning of the year, then you would be able to claim a cost-based depletion allowance of $100,000 ($1 m * 5k/50k). All the big oil companies have to use this method.
    Alternatively, one could take a percentage depletion allowance, a statutory allowance of 15% of net revenues (for oil), irrespective of cost basis. This applies only to independent oil and gas producers who have no connection to refining or retailing, for amounts of up to 365,000 barrels (1000 barrels/day). This method does, in principle, allow recovery of more than 100% of the tax basis, however, doing so triggers certain treatment under the AMT.
    Of the 363,500 oil wells in the country, in terms of volume thresholds (but not ownership), percentage depletion applies to all but 1000 of them. In fact, about 300,000 of US oil wells produce less than 12 barrels per day, the so-called stripper wells, which account for about 16% of US oil production. Many of these will be quite sensitive to tax regime changes, since the wells themselves are pretty marginal.
    A further complication arises from landowners who did not purchase their land for extractive purposes. Take, for example, a farmer in Pennsylvania who finds gas under his land, and from which he receives royalties from a gas producer. Now, with that extraction, the farmer’s land is progressively decreasing in value, but he has no tax basis for depletion purposes. A 15% allowance against income can act as a proxy for a theoretical taxable basis in the land. So the 15% rule acknowledges some depletion when a cost basis in inapplicable.
    Again, the proposed modifications here do not apply to Big Oil. They are entirely targetted towards independent producers and private land owners with limited production.

  10. Jeffrey J. Brown

    Re: More competitive corporate tax rates
    I have always been in favor of the flat tax. The business tax would be levied on net cash flow, with 100% of business costs expenses in the year incurred. Business large and small could basically prepare their tax returns based on their checking account records.
    The only change I would make would be to add, at the retail level, an energy consumption tax, offset by abolishing the highly regressive Payroll Tax. The energy consumption tax would be used to fund Social Security and Medicare expenses.
    Incidentally, following is a link to a great (2007) essay by Kurt Cobb, which has a graph showing the rest of the US economy resting on the small percentage of the economy that is represented by the food & energy producers:
    http://resourceinsights.blogspot.com/2007/07/upside-down-economics.html
    The suggestion of this inverted pyramid is that it is inherently unstable. While the food and energy producers (at least the oil producers anyway) are doing quite well, the food and energy producers can’t support the entire economy.
    And going forward, I think that we are looking at some serious math problems regarding government revenue versus government “overhead.”
    Let’s think of local and state, and for that matter, national governments as being similar to oil exporting countries, in that they consume a percentage of tax revenues and net debt infusions, in order to pay current benefits and operating expenses and to pay current and future retirement/health benefits. Governments then export net tax revenues to citizens.
    And let’s just really focus on current and future retirement benefits.
    As Michael Lewis noted in his recent book, “Boomerang,” a lot of local governments, especially in California, are on track to consist of little more than a small staff that collects taxes and forwards virtually all tax revenue to retirees. And of course, most public pension systems are assuming a (highly unrealistic) estimate of 7% to 8% on future annual returns. Of course, the lower the actual investment return, the larger the unfunded pension obligation.
    In any case, if we assume flat to declining tax revenue, combined with rising retirement obligations (especially as investment returns continue to dissapoint), it seems to me that the net result would be an accelerating rate of decline in services provided to the taxpayers, perhaps even as governments try (probably) unsuccessfully to raise tax revenue, by raising tax rates.
    From an Amazon review of “Boomerang”
    Quoting UCLA neuroscientist Peter Whybrow in the book’s last chapter (on California’s financial problems, not European countries), Lewis writes, “‘Human beings are wandering around with brains that are fabulously limited. We’ve got the core of the average lizard.’ Wrapped around this reptilian core is a mammalian layer (associated with maternal concern and social interaction), and around that is wrapped a third layer, which enables feats of memory and the capacity for abstract thought. ‘The only problem is our passions are still driven by the lizard core.’ Even a person on a diet who sensibly avoids coming face-to-face with a piece of chocolate cake will find it hard to control himself if the chocolate cake somehow finds him. Every pastry chef in America understands this, and now nueroscience does, too. ‘In that moment the value of eating the chocolate cake exceeds the value of the diet. We cannot think down the road when we are faced with the chocolate cake.’ … Everywhere you turn you see Americans sacrifice their long-term interests for a short-term reward.”

  11. Steven Kopits

    Finally, a note on Government Take
    Government take is the share of production (in dollars) taken by the government in any form, including revenue sharing, royalties, or taxes.
    For 2013, capex will actually decline at Shell, Total and BP (substantially at the latter two), be flat at Shell, and up a bit at Chevron.
    You’ll recall that I noted that costs are increasing at 10-13% pace. Thus, the productivity of oil major capex may be expected to fall in 2013, and indeed, absolute spend may also fall.
    How then to support production? Well, the biggest single expense of these oil companies is government take, and it’s the only controllable expense (you can’t make geology cheaper). This leads us to believe that government take will fall over the next several years as governments realize that current regimes are suppressing production. Russia, for example, has already reduced certain taxes.
    In any event, those expecting government take to rise as a share of revenues are likely to find themselves increasingly disappointed.
    http://www.shell.com/global/aboutshell/investor/news-and-library/presentations—2013/fourth-quarter-and-full-year-2012-results-presentations.html#textwithimage_1
    See slide 19.

  12. CoRev

    Menzie, you — a liberal, do not understand nor probably relate to the distrust this administration engenders in many conservatives. Careful with that list of sensibilities. Your own liberal list of PC concerns is quite extensive.

  13. Ricardo

    Menzie,
    You forgot to mention Minitrue, Minipax, Miniplenty, Miniluv, Blackwhite, Crimethink (in Progressive-speak thoughtcrime) and others. Menzie you certainly bellyfeel newspeak Ingsoc.

  14. Bruce Carman

    Gentlemen, take a look at what is happening to the costs, cash flow, and stock prices of the precious metals miners in the past 12-18 months. This is coming to the energy patch just in time for their subsidies to be taken away during a global recession or worse.
    All that new capacity and extraction at $110 Brent is going to be very costly and unprofitable during a global recession with falling demand.
    Speaking of same, ECRI’s Achuthan still sees recessionary yo-yo years conditions:
    http://ecri-prod.s3.amazonaws.com/downloads/ECRI_1303_US_Business_Cycle.pdf

  15. Steven Kopits

    What new capacity, Bruce?
    We’ve spent $1.2 trillion in upstream spend in the last two years, and the only net increase in supply is US shale oil, and that’s up 1.5 mbpd on a base of about 89 mbpd, that is, the oil supply is increasing by a meager 0.8% per annum–and that’s after the application of $1.2 trillion.
    But you’re right. If oil prices fall, so will capex, and that $1.2 trillion ain’t buying us much even now. Imagine what we could buy for, say, $1 trillion dollars. Even less, and keep in mind that production costs are rising at 10-13%. On these trends, the oil supply will peak out in not more than the next few years.
    And Menzie’s talking about whether certain costs should be expensed or amortized. The issues are a bit bigger here.

  16. Joseph

    “Well, the term “tax expenditure” is well established in the public finance literature.”
    Not only is it well established in the literature, it is codified in federal law by the Congressional Budget and Impoundment Act of 1974. Tax expenditures are, by law, defined as “those revenue losses attributable to provisions of the Federal tax laws which allow a special credit, a preferential rate of tax, or a deferral of tax liability.” The law also requires that tax expenditures be computed and published each year as part of the budget process.
    By definition, expensing of intangible costs, percentage depletion, and foreign tax credit for royalties are special preferences and deviations from the tax code that are given only to the oil and coal industries that are not given to other industries. It is pure and simple corporate welfare on the backs of taxpayers that serves no general social purpose.

  17. Anonymous

    What’s special about energy production? Businesses deduct expenses, both incurred and accrued, in all sorts of ways prior to reaching taxable income. Is there some principle involved here? Or should we just skip to the end of the government tax grab and tax the top line? And why not do it for every business?
    All of this is just more reason to ditch corporate tax altogether. Tax income at the individual level. Businesses could then dispense with the costly work involved with tax optimization and avoidance. Government can dispense with the costs of fighting back. And politicians, economists, and pundits can go find something better to do than twist one of thousands of dials on the corporate tax scheme.

  18. Ricardo

    Joseph,
    Do you really not understand that Orwell in writing 1984 was not claiming that Newspeak was not codified into law, just the opposite. Orwell was telling us that it was not only codified into law but it was intentionally included to minipulate thinking, to flip “oldspeak” on its head to build a new world. Of course Newspeak is codified into law!

  19. Jeffrey J. Brown

    Re: New oil production capacity
    I’ve been looking at some preliminary 2012 data, and I am pretty sure that 2012 will be the seventh straight year that Global Net Exports of oil (GNE*) will be below the 2005 rate of 46 mbpd (million barrels per day, total petroleum liquids). There was probably a year over year decline in GNE, with developing countries, led by China, continuing to consume an increasing share of a declining volume of GNE.
    In any case, since 1998 we have seen a pattern of higher annual highs and higher annual lows in oil prices. Here are the past three year over year declines in annual Brent crude oil prices:
    1998: $13
    2001: $25
    2009: $62
    Price data: http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RBRTE&f=A
    *Top 33 net exporters in 2005

  20. tj

    I tend to aggree with Menzie in the cases where a special carve-out has been created for the fossil fuel sector. However, in the case of expenses that are a normal part of doing business, then I agree with Steven and Anonymous above. There is no reason to penalize the fossil fuel industry by taking away expenses on the income statement, while allowing other industries to keep them.
    $41 billion over a 10 year period is not a great cost to the fossil fuel industry. However, it comes as a time when the EPA is trying to put coal out of business. In the next 3 years, the EPA will use any means necessary to raise the cost of fossil fuel production and reduce it’s supply.
    If you want to treat energy as a public good, then remember that half the population of the earth lives in energy poverty. Raising the cost of energy production and energy prices creates some painful tradeoffs for the poor. As the price of energy goes up, the poor and anyone living paycheck to paycheck are forced to spend more on home heating and gasoline, leaving less to spend on food, clothing, medicine, etc.

  21. Anonymous

    tj: “I tend to aggree with Menzie in the cases where a special carve-out has been created for the fossil fuel sector. However, in the case of expenses that are a normal part of doing business, then I agree with Steven and Anonymous above. There is no reason to penalize the fossil fuel industry by taking away expenses on the income statement, while allowing other industries to keep them.”
    You misunderstand. All of these tax expenditures are special carve-outs that are not available to other industries. Eliminating these special preferences does not disadvantage them to other industries. It makes them equal to other industries. For example, the expensing of intangibles allows an oil company to deduct the expense in one year instead of amortizing the expense. Eliminating the special preference doesn’t eliminate expensing. It just requires them to spread the expense over a number of years, just like any other industry.
    The percentage depletion is a pure subsidy. It allows oil companies to deduct more expenses than they actually spend. That is not available to other industries.
    The foreign tax credit for royalties is another pure subsidy. It allows an oil company convert a normal tax deduction into a tax credit that is much more valuable. Again, this is a subsidy not available to other industries.
    So we aren’t talking about penalizing oil companies. We are talking about taxing them exactly like every other company in the U.S — nothing more, nothing less.
    It’s amusing to hear Steven Kopits say out of one side of his mouth that these subsidies are trivial, while out of the other side of his mouth he says that the oil industry can’t survive without them.
    There is a reason the oil industry spends millions of dollars a year on lobbyists to defend these special corporate welfare handouts. If they can spend $40 million a year on lobbyists and congressional bribes to keep $40 billion in corporate welfare, it is their most profitable investment by far. Much more lucrative than actually drilling for oil.

  22. Steven Kopits

    So we aren’t talking about penalizing oil companies. We are talking about taxing them exactly like every other company in the U.S — nothing more, nothing less.
    So, let’s be clear, Anon:
    Re Intangibles: I stated no objection to matching expenses to revenues. But that means expensing dry holes, and accelerated amortization for shale wells, which have high decline rates. However, when you get into this morass of trying to determine which holes were dry and matching to type curves, you’ll get a lot of gaming of the system and the need for a lot of auditing work. Expensing intangibles might just prove more convenient, as it has for the last century. I most certainly did not say the industry would not survive if longer amortization were the rule.
    Domestic Manufacturing Deduction: I agree. Oil should be treated as other manufacturing, including film. And it is, now. But better to just get rid of the law, and lower the tax rate for every corporation, not just those deemed to be “manufacturing”.
    Percentage depletion: First, this does not apply to large oil companies. Second, 170,000 wells–about half of all wells in the US–produce less than 2 barrels per day. These wells are likely to be quite price and cost sensitive. Now, they account for 2% of US production. If you take them off line, they won’t come back, because they’re just not that interesting. So I think taxation matters here, and I would not want to shut in those wells to little apparent gain.
    Third, in some cases, landowners do not have a tax basis for depletion purposes, and a flat 15% income exemption can serve as a proxy for that value. Alternatively, the owner could sell the land, buy it back for extractive purposes, and have a tax basis. But I don’t think we want to encourage people to flip their properties just for tax deductions.
    I personally do not see much room for real legislative change on intangibles expensing–I think it will be more pain and suffering than meaningful gain. Can you imagine an IRS auditor arguing with well operators about which type curve to use, well by well? What a nightmare.
    As for percentage depletion, I could conceive tightening the rules for thresholds. So, 1000 bpd = about $40 million / year. That’s a pretty sophisticated company and could afford some cost depletion estimates and accounting services.
    As a result, I could conceive tigthening the cost depletion threshold to, say, 200 barrels per day, or about $8 million per year. If I were a Republican legislator, that might be a chit for negotiation.
    I would caution, however, against the expectation that this would somehow generate much higher tax revenues. The 15% rule was intended to act as a proxy for cost depletion, so there might not be much in switching from one system to another.

  23. djt

    Tax something companies brag about – gross receipts. Get greed working for us! They can deduct child care expenses and home mortgage interest.

  24. 2slugbaits

    Steven Kopits What’s the economic rationale for oil depletion allowances? I can understand the rationale for depreciation of the capital equipment, but shouldn’t the lost productivity of a well due to extraction have been factored into the price of the exhaustible resource? In other words, the problem with oil depletion allowances is that they encourage extraction at a rate greater than optimal control theory would suggest.
    I also don’t follow your arguments about an oil constrained economy. If an economy is operating at capacity aren’t all inputs constraints? I suspect that what you really mean is that the short-run price and substitution elasticities are inelastic, and therefore the economy is vulnerable to oil supply shocks. But unless you’re a diehard Marxist and you believe in rectangular isoquants, all inputs are elastic over the long-run. Oil is no different.
    tj As the price of energy goes up, the poor and anyone living paycheck to paycheck are forced to spend more on home heating and gasoline, leaving less to spend on food, clothing, medicine, etc.
    Your concern for the poor is touching. If your concern is sincere, then it’s a pretty simple matter to tax carbon and redistribute the revenues to the poor. But why do I suspect your concern for the less fortunate is only a matter of tactical convenience? In any event whether higher energy prices increase or decrease the demand for low skill labor depends upon the asymmetric Morishima elasticities of substitution (i.e., complements or substitutes), and here the empirical evidence is inconclusive.

  25. Steven Kopits

    Slugs -
    Re: Depletion Allowances
    Suppose you purchased 1000 acres of scrub in the Texas for a million dollars with no other value than its reserves of oil equalling one million dollars.
    Now suppose you produced the million dollars of oil (with no other costs) and the property was left with no commercial value.
    Without a depletion allowance, you would have a taxable gain equal of $1 million, with a tax liability of, say, 35% of your revenues. But that tax liability would be pure loss!
    On the other hand, with a depletion allowance, you would have broken even: you paid a million dollars for the property, sold the oil for a million dollars, and owed no taxes, as you had no gain.
    So that’s the purpose of a depletion allowance.
    Re: Growth Constraints
    You pose an interesting question: At equilibrium, should all inputs be equally constrained. In principle, the answer is ‘yes’, but we can think of some examples where that’s not true.
    For example, air is free and plentiful. It’s not a binding constraint on economic activity, although it would be if you took it away. The whole climate debate is about whether air (low CO2 air) has become sufficiently scarce to warrant a price at all. In any event, air is a critical economic input, but with no price.
    Other resources have relatively low prices but will increase their price as they are increasingly exploited over time. Fisheries come to mind as an example.
    To take this example a bit further, supply or demand shocks can, at a certain tipping point, dramatically increase the price of a resource. Again, collapsing fisheries are an example.
    We also see collapsing productivity of oil extraction, coupled with a strong Chinese positive demand shock. Since late 2004, the oil supply has been unable to keep up with demand, and this has raised the price of oil.
    As a consequence, incumbent users will be under pressure to reduce consumption to bring marginal utilities back into equilibrium–just as you suggest. This path can, in fact, be calculated. When I write that US oil consumption will fall at a 1.5% pace, this is what I am referring to.
    During the period of adjustment, resources will not be in equilibrium, because of a need to adjust to one particular resource constraint. Thus, if the rains don’t come in Colorado, then you’ll need less fertilizer, because water will be the binding constraint on agricultural production.
    In the case of an on-going oil shock, you will have excess labor, because more oil-intensive activities will no longer be viable. So there is a period of re-invention while we figure out what to do with excess labor. This is exactly to your point.
    Importantly, the reduction in oil consumption is not an event, it’s a process, so pressure on the labor supply is chronic, not acute. The economy faces an on-going need for dynamic adjustment–there is no equilibrium achieved.
    The outcome of this process depends intrinsically on the pace at which the economy can adjust, hence my repeated comments on the rate of oil efficiency gains in GDP.
    If efficiency gains are able to outpace required oil consumption declines, then oil is not a binding constraint, GDP growth is not constrained, and marginal costs will determine prices. This is the view presented by either the IEA or the BP Outlook (just released). BP, for example, suggests that the oil supply will grow at 1.5% and demand at 0.7%, thus oil prices should fall. (This is prevented by OPEC taking 3 mbpd of capacity offline between 2013/2014 and 2020, of which (do the math) about 1.5 mbpd must come from Saudi Arabia alone.)
    On the other hand, if the economy is unable to adjust quickly enough, then labor re-absorption will remain sluggish and GDP growth will be below par (sound familiar?). Further, such re-employment as occurs may be at lower productivity levels than previous employment, because new employees are subject to less mobility–because they cannot use as much oil as they did before the recession. Put another way, if you could only choose from jobs within walking or bus distance from your house, you would likely face a lower wage than if you could drive 15 miles to work. So productivity is a function of distance. If the feasible distance to work falls, so may productivity.
    Does that answer your question?

  26. tj

    2slugs
    Your concern for the poor is touching. If your concern is sincere, then it’s a pretty simple matter to tax carbon and redistribute the revenues to the poor.
    Why is your answer to every social problem to raise taxes?
    Why not provide incentives for investment in the electrification of vast swaths of the earth without reliable electricity?

  27. anontoo

    re: Steven Kopits: depletion allowance
    1. The $1M does not have to be allocated to land. It can be allocated to the oil and then amortized as the oil is extracted. Is this not true?
    2. In the current legal set-up can oil companies using the depletion allowance to write off more than the cost of the oil they extract? If this is true, then why is this not a special tax concession at least in these cases?

  28. Steven Kopits

    1. The $1M does not have to be allocated to land. It can be allocated to the oil and then amortized as the oil is extracted. Is this not true?
    Yes, what you’re describing is the cost depletion method. See my related comment above.
    2. In the current legal set-up can oil companies using the depletion allowance to write off more than the cost of the oil they extract? If this is true, then why is this not a special tax concession at least in these cases?
    Oil companies are not allowed to use the percentage depletion method.
    The percent depletion allowance (but not the cost depletion method) theoretically allows recovery of more than 100% of the cost basis, as the percentage method is a straight 15% of oil or gas related revenues, not a share of cost basis.
    So, let’s suppose you paid $1 million for the property with oil on it, and produced $1 million worth of oil annually for 10 years (eg, each barrel in the ground was purchased for $10). By the percentage depletion method, you could claim 15% as a depletion deduction every year, totaling $150,000 per year, for a total of $1.5 million for the ten year period. This is clearly greater than the cost basis, and therefore a “subsidy” or preferential treatment for an oil investment in this case.
    On the other hand, the percentage depletion allowance is subject to a 65% share of income. So, in this case, the allowed percentage depletion would be about $1 million, about the same as the cost of the property.
    I’m not entirely clear on how realistic this example is, but you can see that the value of the 15% allowance depends on great deal on the cost of the property, the price the oil fetches on the market, and how much oil is ultimately produced.
    Now, let’s consider the half of US wells producing 2 bpd or less. Two barrels per day translates into about $80,000 of gross annual revenues. If, to use the cost depletion method, we have to add a resource estimate, cost accounting services, and additional expenses to argue with the IRS, then this well producing $80,000 of revenue might have to carry an additional, say, $5,000 in administrative costs (beyond other operating costs), which might make the well uneconomical and frankly, not produce much residual value to the IRS either.
    The 15% percentage depletion rule, in these cases, is just simpler and cheaper for everyone involved.
    I cannot comment on whether 15% is the right number or not. Different types of resources have different percentages assigned to them. (For uranium, the number is 22%.) One would have to run a detailed examination of data over the last five or six years to make such a determination.

  29. Macrol

    Excellent article. Repubs like to whine about tax breaks for renewables, but, refuse to consider tax breaks enjoyed by the richest, most subsidized industries in history. Yes, most subsidized !
    See the Persian Gulf war and the Iraq war for some examples. An industry subsidized with human lives.

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