Congressional Research Service (CRS) Memo, "Tax Policy and Gasoline Prices"
A Congressional Research Service (CRS) Memo, "Tax Policy and Gasoline Prices," concludes that the elimination of tax benefits for big oil companies under recent proposed legislation would likely have little impact on consumers' gas prices. Although this bill has recently stalled in the Senate, it appears that the proposal, which has strong Administration support, may resurface in later budget negotiations.
Background on proposed legislation. On May 10, 2011, Senators Robert Menendez (D-NJ), Sherrod Brown (D-OH), Claire McCaskill (D-MO), and Jon Tester (D-MT) introduced S. 940, the "Close Big Oil Tax Loopholes Act," in the Senate. The bill, which would repeal tax breaks for the five largest oil companies, was introduced as a means to reduce the deficit by raising approximately $1.2 billion in 2012.
Although Senate Democrats failed to gain the 60 votes necessary to move to consideration of the bill on May 17, 2011—the motion to proceed failed by a vote of 52 to 48—it appears that the proposed legislation may resurface in later budget negotiations. Senate Majority Leader Harry Reid (D-NV) has said, "I am confident before we finish budget negotiations here in anticipation of raising the debt ceiling that [this bill] will be part of it." The Obama Administration has also released a statement showing its strong support for the bill.
The bill would affect major integrated oil companies (as defined in section Code Sec. 167(h)(5)(B)) by:
... eliminating the Code Sec. 199 domestic production activity deduction for gross receipts from the production, transportation, or distribution of oil, natural gas, or any primary product thereof, effective for tax years beginning after Dec. 31, 2011.
... eliminating the Code Sec. 263(c) option to expense intangible drilling and development costs (IDCs), effective for amounts paid or incurred in tax years beginning after Dec. 31, 2011.
... modifying the Code Sec. 901 foreign tax credit rules for major integrated oil companies which are "dual capacity taxpayers." This provision would prevent U.S. oil and gas companies from disguising royalty payments to foreign governments as foreign taxes, thereby allowing them to lower their taxes in the U.S. The bill would close this loophole, effective for taxes paid or accrued in tax years beginning after the enactment date.
... repealing the Code Sec. 613A percentage depletion allowance for oil and gas wells, effective for tax years beginning after Dec. 31, 2011.
... amending Code Sec. 193 to require the cost of tertiary injectants to be capitalized, rather than treated as deductible expenses, effective for amounts paid or incurred in tax years beginning after Dec. 31, 2011.
Background on price of gasoline. The CRS Memo indicates that the price of gasoline is a combination of four components: (1) the price of crude oil (67%); (2) federal, state, and local excise and sales taxes on gasoline sales (13%); (3) refining expenses (11%); and (4) distribution and marketing expenses (9%). An increase in the price of gasoline as a result of the proposed legislation would generally come about through an increase in the price of oil. However, the CRS Memo notes that the price of oil is determined on world markets and tends not to be sensitive to small cost variations experienced in regional production areas. In the recent market environment—with the price of oil averaging approximately $90 per barrel over the period December 2010 through February 2011 and the current price of over $100 per barrel—CRS concludes that prices are well in excess of costs, and a small increase in taxes would be unlikely to reduce oil output or increase petroleum product (gasoline) prices.
Analysis and conclusion. The CRS Memo concludes that the proposed legislation would likely have little impact on gas prices. It evaluated the major changes under the proposed legislation to determine their effect.
Code Sec. 199 deduction. The CRS Memo reasoned that the repeal of the deduction was equivalent to an increase in the tax on corporate profit, and that it's widely accepted that a proportional change in taxes on profit affects neither the firm's incremental costs nor its revenues. Accordingly, such a tax doesn't change a firm's behavior with respect to output. Since output doesn't change, there is little reason to believe that the price of oil, or gasoline, will increase. Further, the CRS Memo concludes that it is unlikely in the short run that the proposed repeal would result in greater dependence on foreign-sourced oil and natural gas. Once a well is in the producing phase, production tends to be maximized (within the limits of sound oil field management techniques). With current oil prices at or near $100 per barrel in the U.S., it's unlikely that firms will slow production or close wells as the result of the loss of the Code Sec. 199 deduction.
IDC expensing. The CRS Memo concludes that repealing IDC expensing and replacing it with cost amortization more consistent with more common depreciation methods would likely have no effect on current U.S. oil production, and thus no effect on current gasoline prices. Since IDC expensing has little effect on wells already in production, available output and prices should be unaffected if the expensing provision is repealed and replaced with less favorable amortization procedures.
Dual capacity rules. The CRS Memo concludes that this provision, effectively a tax on profit, shouldn't have any effect on the firms' output or pricing decisions, and so shouldn't have any effect on the price of gasoline. Further, the change in the dual capacity taxpayer rules might make overseas investment that leads to foreign profits less attractive to the companies than investment in the U.S., which could lead the firms to enhance domestic capital spending leading to increased domestic production and reduced oil dependency.
Percentage depletion. The percentage depletion allowance was repealed for the major oil companies by the Tax Reduction Act of'75 (P.L. 94-12), and generally remains in effect only for the independent oil companies. Accordingly, the CRS Memo concluded that the percentage depletion allowance should no longer be a factor in investment, output and pricing decisions by the five major oil companies.
Tertiary injectants deduction. While the repeal of this expensing provision could have a larger impact on smaller, independent exploration and development firms, the CRS Memo concludes that it was likely that the repeal, with a change to capitalization, or amortization, would have only a small effect on the five major oil companies' oil production or pricing—especially in a market where oil commands over $100 per barrel. In periods of low oil prices, the repeal of the deduction could have a larger effect. Thus, the effect on domestic gasoline prices would likely be small.
Other considerations. The CRS Memo concludes that even if the proposed tax changes did impact domestic or overseas exploration and development activity, that doesn't necessarily imply that less oil would be available in the U.S. market. It reasoned that more might be imported, with little or no effect on gasoline prices. However, the CRS Memo cautions that the effect of tax changes might be hard to separate from the effect of other factors that have contributed to fluctuations in the price of oil and gasoline—e.g., political unrest, expectations' effects on financial markets, macroeconomic growth trends, and the value of the dollar.