One well-publicized element of President Obama’s proposed budget is the elimination of “subsidies” for fossil fuels. But, in large part, these are not subsidies at all. One proposal relates to the tax treatment of oil-company incomes. According to the New York Times, Obama proposes to eliminate the expensing of what are called intangible drilling costs. These represent about 70 percent of all drilling costs and are made up of labor, supplies, contractors, and fuel. Under current law, oil companies can write off the expenses against other income in the year that those expenses are incurred, rather than depreciating them over time. In reality, to allow expensing of these payments is not a subsidy. It avoids the imposition of a tax penalty on oil drilling and is an example of how all production costs should be treated by the tax code.
Expensing guarantees that companies can reclaim the full cost of their investments against taxes and that they are not penalized for investing in what are called “long lived” investments projects. These are investments, like drilling for oil, that will yield income over an extended period of time. Investment costs to a company five, ten, or twenty years into the future are worth less than they are today. If a company is not allowed to write off an investment in the year that it is incurred, it is being denied the right to write off the full cost of that investment.
The longer the time period over which investment costs have to be depreciated, the less the tax deduction is worth. If a deduction on costs that are incurred today cannot be taken for 15 or 20 years, the company is penalized by the tax code for incurring those costs and for making that investment over other investments that might have a shorter write-off period. The immediate expensing of costs puts all investment spending on an equal footing and ensures that the tax treatment of investments is consistent with sound economic principles of taxation.
So Obama, in proposing to eliminate expensing of these drilling costs, is not abolishing a tax subsidy, but is imposing a tax penalty. And, given his often-articulated disdain for fossil fuels, he is probably quite aware of this fact.
– Roy Cordato is vice president for research at the John Locke Foundation.