How Should the US Tax Petroleum Profits?


Profits from Ballooning Oil Company have produced a volley of “unforeseen profit tax” proposals. How well will their various provisions to increase tax revenue from oil profits meet near-term US policy targets without disrupting domestic production or raising consumer prices?

The US currently taxes petroleum production in two main ways: an income tax and an ad valorem royalty of 18.5 percent for oil pumped on federal land. Effective income tax rates for both corporate and pass-through oil producers are lower than in most other industries Sector-specific tax breaks,

Tax revenue from domestic oil production gains less in the US than in other major oil producing countries. In addition, that part falls When oil prices rise because of a heavy reliance on US royalties, because oil companies’ gross receipts are far less from profits than increases in prices.

The US could address this by increasing profit taxation relative to royalties. An obvious first step would be to repeal the current profit tax break for the oil and gas industry, which would raise about $3.5 billion annually. The second step would be to either raise the existing profit tax rates on petroleum or levy an additional profit tax.

To avoid reducing domestic production, the petroleum profits tax base should be limited to excess returns, or “rents”. Unlike an income tax, a rent tax doesn’t burden marginal investments — those that break even after taxes. The main difference between rent tax and income tax is that rent tax allows full expenditure of investments and excludes financial flows such as interest expense.

Ideally, the petroleum rental tax should only apply to “upstream” extraction activities, not “downstream” refining or distribution. Natural resource rent arises from the exploitation of a certain natural resource, while downstream profits depend on reversible capital and labor inputs. Limiting the petroleum profit tax base to rents requires separate tax accounting for upstream activity, or “ring-fencing”.

there are in a variety of ways To levy tax on oil rent. The easiest way out for the US would be to increase the income tax rates on petroleum extraction. Because 100 percent”bonus depreciation“Allows most equipment to be spent, the US income tax now emulates a rent tax, although it also includes financial inflows.

With the return of the corporate tax rate on petroleum extraction to 35 percent restore tax parity For any depreciation investment made prior to 2018. Since many US oil companies are organized as pass-throughs, a corresponding additional tax would need to be imposed on their profits.

Representatives Pete DeFazio (D-OR), the Center for American Progress, and (reportedly) Senator Ron Wyden (D-OR) propose an additional tax on petroleum profits. These proposals would increase the government’s share of oil profits but less efficiently than a permanent rent tax.

The Center for American Progress (CAP) proposes to levy a tax on book income, which deducts capital expenditure commensurate with economic depreciationOrdinary returns are likely to be taxed. In contrast, the DeFazio and Wyden proposals will start with taxable income, which currently allows for full spending.

The DeFazio proposal will adjust taxable income for financial flows, while the Wyden proposal will reportedly provide an additional deduction for current year’s investments. These features move the income tax base in the direction of rent tax.

The CAP and Wyden proposals call for temporary windfall taxes. Temporary tax increases, especially for long-term investment industries such as the oil industry, distort the life-cycle tax burden and increase investor risk.

The excise tax on domestic production proposed by Senator Sheldon Whitehouse (D-RI) is effectively a royalty. Royalties impose a heavy burden on the normal return on investment as they do not allow for deduction of production costs.

The Whitehouse proposal eases this effect by tying a tax on price increases above a benchmark and limiting it to major oil companies only. Progressive royalties generate more revenue as oil prices rise than flat-rate royalties, although not as effectively as a rent tax. Imposing excise taxes only on Big Oil, whose U.S. production is concentrated in low-cost conventional wells, focuses taxation on excess returns.

All four windfall tax proposals will target only large oil companies for both economic and political reasons. Giving discounts to smaller producers, who engage in high-cost drilling, which are more sensitive to price changes, could avoid disappointing domestic supplies. And, politically, lawmakers may prefer to focus on the growing profits of large, publicly owned oil corporations.

However, raising tax rates on a subset of companies within an industry distorts investment incentives and reduces production efficiency. Since a properly designed rent tax would only impose a sufficiently high profit burden on producers, there should be no need to exempt marginal producers.

The US could tax a large portion of petroleum profits without discouraging production by raising taxes on petroleum rents. And the way to do this is by eliminating the existing tax breaks and levying a permanent petroleum rent tax.


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