Senate tax plan spares big oil industry deduction

WASHINGTON — When Sen. Max Baucus launched his opening volley against oil and gas industry tax breaks, he proposed eliminating a host of their long-cherished deductions.

The Montana Democrat offered a plan to bar companies from immediately writing off intangible drilling costs, block taxpayers from claiming a percentage depletion for oil and natural gas wells, and force U.S. firms to abandon using the “last in first out” accounting technique to value stockpiles.

But Baucus left one big deduction out of the mix. Spared from the Finance Committee chairman’s plans is the Sec. 199 domestic manufacturing deduction, which is broadly claimed by a range of industries, from automakers and movie producers to newspaper publishers and, yes, oil companies. It was created in 2004 to encourage domestic job creation.

Most manufacturers can claim a deduction of up to 9 percent, applied to net income from domestic manufacturing activities. The oil and gas industry, which is categorized as a manufacturing industry for tax purposes, is limited to 6 percent.

But President Barack Obama has repeatedly called on Congress to do away with the deduction altogether for oil and gas firms. And a Sec. 199 repeal has been included in some Democrats’ plans to axe tax breaks for the biggest U.S. oil companies.

It is unclear why Baucus decided not to target the deduction — at least for oil and gas firms — even as he proposed doing away with so many others.

Singled out?

The National Taxpayers Union has run print advertisements warning against “singling out America’s energy companies” by denying them the Sec. 199 deduction. Such a move “would penalize a major industry that is contributing strongly to America’s economic recovery and creating thousands of new jobs,” the NTU says.

The oil industry’s leading trade group, the American Petroleum Institute, says eliminating the manufacturing deduction for the oil and natural gas industry “will have the harmful effect of hurting American energy workers and their contributions to our economic recovery” and make it more difficult for companies to finance expensive domestic products.

But critics say the provision is rightly limited to companies who could easily move their manufacturing facilities outside U.S. borders, since the goal is fostering U.S. jobs.

Daniel Weiss, with the Center for American Progress, has argued that unlike other manufacturers, oil and gas companies working in the United States are fairly tethered to the hydrocarbons under American soil. “This provision was designed to encourage domestic manufacturers to keep their facilities and jobs in the United States,” he says, but “it is impossible to move U.S. oil fields to other nations.”

In a report to lawmakers, the non-partisan Congressional Research Service notes that the oil and gas industry differs from traditional factory manufacturing in a number of ways:

The production of petroleum products at a refinery is only indirectly related to the level of employment. This implies that if wage costs go down due to the tax deduction, there is less chance that the result will be increased output due to higher employment. Even if employment did increase, it would have little effect on national employment levels due to the capital-intensive nature of the industry. The Bureau of Labor Statistics reports that oil and natural gas extraction industries employed approximately 185,500 workers in December 2011, of which about 105,700 were classified as production workers.

More deductions

Weiss said that while Baucus’ proposal would axe $46 billion in oil industry tax breaks, he also should have taken aim at the domestic manufacturing deduction, as well as dual-capacity taxpayer rules that allow companies to deduct what they pay foreign governments in royalties for oil produced overseas. Another possible target left out of Baucus’ plans: an accelerated two-year time period for writing off the costs of geological and geophysical expenses tied with hunting for oil and gas.

Although lawmakers are looking to rewrite the U.S. tax code as early as this year, President Barack Obama’s decision to nominate Baucus as his next ambassador to China may change the timeline.

A coalition of more than a dozen oil and gas industry groups sent a letter to Baucus last month arguing that his plan for extending depreciation of drilling and other expenses would especially affect the capital-intensive oil business and divert cash away from “future domestic investment.”