Energy Tomorrow Radio: Episode - 116 The Problem with New Taxes
Jane Van Ryan
Posted August 31, 2010
In today's episode, I interview Stephen Comstock, API's tax policy manager, about proposals from Congress and the administration that could raise taxes on the oil and natural gas industry. If enacted, these taxes would have a negative impact on the U.S. economy and the industry.
Use the audio player below to listen to information about the article and follow along with the show notes. I hope you find the podcast informative.
00:17 Congress and the Obama administration are proposing some Tax Code changes that could have a very negative impact on America's oil and natural gas industry. It appears that they are using the recent Gulf oil spill as an excuse to single out the industry and force it to pay more in taxes than any other industries. Stephen Comstock, API's tax policy manager, is in the studio with us today to explain.
00:45 Now, before we get into the Tax Code changes that are being considered, let's provide a little background information to our listeners. Just how much does the industry pay in taxes now?
00:53 Mr. Comstock: The latest information we have is from 2008. The Energy Information Administration collects the data from the top 25 energy companies in the United States. It collects all sorts of financial information, one of which is taxes. What they found is that in 2008, these companies on a worldwide basis paid more than $98 billion in taxes.
01:19 What does that mean in terms of their effective tax rate?
01:23 Mr. Comstock: They have an effective tax rate of a little bit over 48 percent. The statutory rate in the United States is 35 percent so they are actually paying more tax on a worldwide basis than the U.S. rate. Generally though, most manufacturing companies, the Standard and Poor companies, have an effective rate of around 28 percent. So you can see there is quite a disparity between the amount of tax that the oil and natural gas companies pay versus other industries.
01:51 One of the Tax Code changes being discussed is the deduction called 199. Can you describe what that is exactly and when and why it was enacted?
02:02 Mr. Comstock: In 2004, Congress decided that they needed to do something to encourage job creation and job retention amongst manufacturing in the United States. They set up a deduction that is calculated by taking your U.S. domestic production activities--and those production activities can be manufacturing, growing, extraction, other types of production activities--and they take a percentage of that amount and that becomes your deduction. What that effectively does is generate a tax rate cut in your overall activities. Instead of paying 35 percent on your U.S. manufacturing activities, you actually pay a little bit less. It was phased in over time so now most industries pay an effective rate of around 32 percent. This is a little bit different for oil and natural gas. Oil and natural gas entities do qualify for this deduction. However, in 2007, Congress limited the deduction for only oil and natural gas industry so now the industry actually pays a 33 percent rate.
03:28 But Congress is talking about making another change, right?
03:30 Mr. Comstock: What they want to do now is just eliminate it outright for oil and natural gas entities. Of course this is a deduction that is clearly tied to jobs and job retention activities here in the United States. Oil and natural gas jobs, which are high- paying good jobs which help all sorts of localities, and we employ people all across the United States, are somehow not as good as other jobs in the mind of Congress.
04:07 Another interesting tax issue that has come up is that large oil companies that have global operations and also pay taxes to foreign countries are looking at a situation in which the government is considering changing the foreign tax credit. Is that right?
04:27 Mr. Comstock: Yes, the foreign tax credit is very different than other tax credits that you think of. The U.S. taxes its residents on a worldwide basis. For example, if you earn income in France, you pay tax on that income in France and the U.S. will still tax that French income. However, in order for U.S. companies to be treated fairly with all other companies operating in France, they allow you to offset the U.S. taxes that you would otherwise pay on that income with the taxes that you pay in France. But in order to make sure the companies are kept whole with other French companies or Chinese companies, or Italian companies, it will allow you to use the French tax to offset the U.S. tax that you would otherwise pay on that income.
05:17 So it avoids double taxation.
05:19 Mr. Comstock: It avoids double taxation and it also should be said that it is not used to reduce U.S. tax on U.S. income. It is only an offset for U.S. tax on foreign income. For example, if you are earning income in Massachusetts, you can't use the foreign tax credit to offset U.S. tax on that income.
05:40 What does Congress want to do?
05:42 Mr. Comstock: The way that it is set up is that every taxpayer has to prove that the tax they are getting a credit for is in fact a tax. In fact, oil and natural gas companies have multiple levels of restrictions and regulations and rules that they have to go through. But what the administration says is that regardless of all that, we think that your tax that you pay should be X and anything over that is not creditable. The amount of tax that we are able to use to offset the U.S. tax will be much more limited. As a result the companies will face double taxation on their foreign operations.
06:20 And the oil and natural gas industry will end up paying out more money in taxes every year.
06:23 Mr. Comstock: They will be paying out more money in taxes, but more importantly they will lose the ability to compete abroad. Not only will it become more expensive for them to engage in future operations to win new bids for new resources, but it will also be more expensive for existing operations because companies thought they understood the economics and tax costs. All of the sudden, they are all thrown up in the air. There may be a situation where an operation in the U.K. or an operation in Nigeria or an operation in the Far East suddenly becomes more economical to somebody else other than a U.S. oil and natural gas company.
07:00 Let's move on to yet another challenge. This one involves the new financial regulations law which apparently contains some language that could again be very problematic for global oil and natural gas companies and their investors. Can you explain what that's about?
07:14 Mr. Comstock: As part of the banking bill that passed, there was a requirement that if you're engaged in extractive industries as part of your SEC filings, you now have to report specific information on amounts that you pay to foreign governments. This includes information on royalty amounts, tax amounts and other payments that you might make to foreign governments. It would only apply to extractive industries. The idea here is to collect the information so that people in those foreign countries can understand how much money is flowing to the governments. The SEC is not collecting information for people in the United States, or people looking to invest in U.S. companies, they are collecting information in order to make it more transparent for people located in foreign countries to understand what's going to their government. The SEC, whose job it is to protect U.S. investors, is actually going beyond its purview because of this new law and is actually collecting this information for foreign nationals.
08:30 But would it have the effect of raising taxes?
08:35 Mr. Comstock: It wouldn't raise taxes. However, it could put U.S. companies at a competitive disadvantage. For example, if a company is competing against a company from China that doesn't have to file SEC reporting and is operating in a country that doesn't necessarily want this information brought forward. Now, when that company looks at who they should engage with to produce their hydrocarbons or produce their resources, they now realize they can engage with a U.S. company that has to report all of this information to make it public or a Chinese company or some other company that does not have to do the same. It just makes it harder to compete. Now people would say it's a good thing to make this transparency available. But there are already international processes in place to do this, which works with the governments rather than forces the governments. There is a process where the companies operating in these countries work with the host government and work with other organizations in order to understand how to make this information transparent and available.
09:45 Stephen, there is a sentiment in the United States that is pretty anti-oil. I don't think that is a surprise to anybody, and there are a lot of critics out there that say major oil and natural gas companies are large and they can afford a higher tax burden or afford more paperwork. How do you respond to that?
10:04 Mr. Comstock: It's getting back to the effective tax rate. People say that somehow these companies don't pay their fair share and my response to them is maybe they are right, it's because we pay more than our fair share. There are substantial amounts of money being paid in taxes and substantial amounts of money flowing to governments, not only in the form of taxes but also in the form of royalties and other funds that come in such as severance taxes, property taxes, substantial tax burden that is incurred on these companies which flows to governments. Taxes are paid not only to the U.S. government, but also to state and local governments.
10:42 I've also heard economists say that if you want less of something, tax it. Does that hold true for oil and natural gas supplies?
10:49 Mr. Comstock: I think it does. One of the items we haven't talked about is a good example of that. Congress is considering repealing a deduction that's associated with drilling costs. You incur costs associated with the labor of drilling activities. These are the drillers, the engineers, people that are involved in the activity of going out and finding the oil and natural gas. The deduction has been around since the inception of the Code. The idea here is that the government understands that there is risk, that you don't necessarily know it's there until you actually drill. So in many ways, it's like our research and development. In fact, research and development companies get the same type of deduction to the extent that if you are a scientist and you go out and you find a new drug, you are able to deduct that cost. It also generates capital that allows you to engage in the next well and allows you to find the next prospect. Taking that away will essentially shut off that capital. As a result, it will mean less drilling, less jobs and less activity into domestic drilling space.
12:00 You have given us a lot of food for thought here today, Stephen. And I will be watching to see what happens when Congress comes back into session.
12:09 Mr. Comstock: They come back into session in September and it's going to be very exciting I think.
12:13 Thank you very much, Stephen, for joining us today on Energy Tomorrow Radio.
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