ON the MARGIN (C) Tax Analysts 2012

ON THE MARGIN (C) Tax Analysts 2012. All rights reserved. does not claim copyright in any public domain or third party content. tax notes® Big Oil, Targeted Taxes, and the profitable and unpopular taxpayers for disparate treatment. Perhaps the most notable example is the Rule of Law war against Big Oil. Congressional Democrats have By Kevin A. Hassett and Alan D. Viard repeatedly tried to impose on five companies — BP, Exxon Mobil, Shell, Chevron, and ConocoPhillips — unfavorable tax rules that do not apply to other Kevin A. Hassett is a senior companies. These efforts have succeeded in one fellow and director of eco- instance, because section 167(h)(5) now prescribes a nomic policy studies at the longer amortization period for some expenditures American Enterprise Institute, by the five oil producers. On May 17, 2011, the where Alan D. Viard is a resi- Senate rejected a bill that would have imposed dent scholar. The views ex- several additional penalties on them. The Senate pressed in this article are solely also rejected a similar bill on March 29, as this the authors’ and do not reflect article went to press. the views of any other person Kevin A. Hassett or institution. The authors Throughout the debate, no coherent tax policy thank Veronika Polakova for argument has been offered for singling out these excellent research assistance. five companies for tax rules different from those In this article, Hassett and that apply to other corporate taxpayers. Instead, the Viard argue that proposals to proposed tax increases appear to be the result of single out the five largest oil political hostility driven by indignation at the oil producers for disparate tax producers’ high profits and by distress at high treatment based on political gasoline prices. Supporters of the tax increases hostility toward those compa- complain that the companies have ‘‘too much’’ Alan D. Viard nies threatens the rule of law. money and that the government is entitled to seize Copyright 2012 Kevin A. Hassett and money from them if it believes it can spend the Alan D. Viard. funds more wisely. In a free society, however, gov- All rights reserved. ernment collects revenue from companies and individuals under neutral tax rules, not based on an ad hoc determination that politically disfavored com- Commerce and manufactures can seldom panies or individuals have too much money. flourish long in any state which does not enjoy The debate on these targeted tax increases has a regular administration of justice, in which been marked by several fallacies. One misconcep- the people do not feel themselves secure in the tion is that oil producers can freely claim the foreign possession of their property, in which the faith tax credit for royalties paid to foreign governments. of contracts is not supported by law, and in Another fallacy is that the five large companies reap which the authority of the state is not sup- tax savings from percentage depletion, a tax break posed to be regularly employed in enforcing for which they have actually been ineligible since the payment of debts from all those who are 1975. The most prevalent misconception, however, able to pay. Commerce and manufactures, in is that targeted tax increases on these companies short, can seldom flourish in any state in would move the tax system toward neutrality. In which there is not a certain degree of confi- reality, the proposals would move the tax system dence in the justice of government. away from neutrality by imposing on five unpopular companies restrictions that do not apply to other — Adam Smith, Wealth of Nations, Book V, companies. Chapter 3 It may be tempting to dismiss objections to these In recent years, politicians have frequently di- proposals. After all, the proposed tax increases are rected harsh rhetoric toward particular corporate clearly not going to drive anyone into destitution. taxpayers that earn high profits. At times, this The five oil producers are indeed earning large rhetoric has been accompanied by substantive profits, and the proposed tax increases would be a policy proposals that single out a narrow set of tiny fraction of those profits. TAX NOTES, April 9, 2012 217 COMMENTARY / ON THE MARGIN Yet, these targeted tax increases threaten the rule production volume greater than 500,000 barrels and of law and pose significant risks to the economy at gross receipts greater than $1 billion during the tax (C) Tax Analysts 2012. All rights reserved. does not claim copyright in any public domain or third party content. large. Societies governed by the rule of law can, year. Each affected company using the last-in, first- should, and do tax those who are well off to support out inventory method would have been required to those who are in need. But they must not single out revalue its crude oil inventory by $18.75 per barrel specific companies or individuals for additional and its inventory of natural gas and petroleum taxes because of political or public hostility. Free products by $18.75 per barrel-of-oil equivalent at societies can base taxes on income, consumption, the close of its tax year ending in 2005. The com- wealth, or many other economic variables and can pany would have been required to reduce its cost of set either high or low tax rates. But they cannot base goods sold and thereby increase its gross income for taxes on political unpopularity. There are strong the tax year by the amount of the revaluation. empirical and theoretical reasons to expect that Section 6655 penalties for any failure to pay esti- those violations of the rule of law can have harmful, mated taxes arising from the unexpected tax in- indirect effects on economic growth that are dispro- crease would have been waived. No similar tax portionately large relative to their direct impact. would have applied to other oil producers or to In this article, we closely examine the oil issue to other companies using the LIFO method. provide a history of the phenomenon of targeted tax One sponsor of the provision, Senate Finance increases. We begin by describing the barrage of Committee member Charles E. Schumer, D-N.Y., proposals and laws in 2005 through 2010 that justified the provision as a base-broadening meas- targeted the five large producers, and then discuss ure that would prevent the affected companies from in greater detail S. 940, the bill that the Senate reporting ‘‘artificially low’’ profits generated by considered in May 2011. We conclude by discussing LIFO when product prices had risen.3 He did not the implications of targeted taxes for the rule of law explain, however, why this logic applied to only the and economic growth. targeted companies or why the bill offered no relief Early Efforts to Target Big Oil for the artificially high profits that LIFO generates The large oil producers have repeatedly been during periods of falling oil prices. targeted for adverse treatment in recent legislative S. 2020 would also have eliminated amortization proposals. We discuss only measures that were deductions for geological and geophysical (G&G) brought to the floor of at least one chamber of expenditures by integrated oil companies with pro- Congress and set aside the many bills that never duction volumes greater than 500,000 barrels per reached the floor.1 day, effective for amounts paid or incurred after On November 18, 2005, the Senate passed S. 2020, August 8, 2005. G&G expenditures are the costs of the proposed Tax Relief Act of 2005. The bill in- seismic shooting to determine whether to acquire cluded two provisions targeting the large oil pro- acreage for oil production. Rather than amortizing ducers: a one-time inventory tax and a longer those expenditures over a 24-month period, which amortization period for some expenditures. Al- other oil producers would have been allowed to though the inventory tax never became law, a continue doing, the affected companies would have modified version of the amortization provision was been required to recover those costs through depre- later enacted, as discussed below. ciation of any equipment involved or through cost S. 2020 would have imposed a one-time inven- depletion. tory tax on integrated oil companies2 with daily A modified version of that amortization provision became law on May 17, 2006, when Congress added section 167(h)(5) to the tax code.4 Section 1One proposal that did not reach the floor merits a brief 167(h)(5)(A) provided that ‘‘major integrated oil mention because it would have assigned the large oil producers producers’’ must amortize G&G expenditures over an inferior constitutional status. On June 3, 2011, the House a five-year period, effective for amounts paid or Judiciary Committee was marking up a proposed amendment to the U.S. Constitution that would have required a two-thirds incurred after May 17, 2006. Section 167(h)(5)(B) vote of both chambers of Congress to raise taxes. Rep. Jerrold Nadler, D-N.Y., offered an amendment that would have waived the two-thirds rule for any measure that ‘‘repeals or reduces any exemption, deduction, or credit with respect to any producer of volume greater than 75,000 barrels per day. As explained below, crude oil or natural gas with annual gross receipts in excess of integrated companies are ineligible for percentage depletion ten billion dollars.’’ The Nadler amendment was rejected on a and may expense only 70 percent of intangible drilling costs. 12-7 vote. The proposed constitutional amendment has not been 3Charles E. Schumer, ‘‘Big Oil’s Reported Profits Are Kept adopted. Artificially Low,’’ letter to the editor, The Wall Street Journal, Dec.

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