September 16, 2014

The Honorable Ron Wyden, Chairman
Senate Committee on Finance
221 Dirksen Senate Office Building
Washington, DC 20510-3703

 

Dear Chairman Wyden:

Taxpayers for Common Sense is a national non-partisan budget watchdog that has been working on behalf of the nation’s taxpayers since 1995. We applaud the Committee for holding this important hearing, “Reforming America’s Outdated Energy Tax Code.”

Everyone believes federal tax policy should improve economic growth. This will reduce the rate of growth of our debt – and should ultimately decrease the overall size of our debt. We also believe that tax policy, like federal spending, must help maximize the benefits of economic growth for all taxpayers. It has been more than a quarter-century since the last overhaul of the tax code, and in that time it has become littered with increased complexity, parochial tax treatments, and revenue giveaways.

Former Senate Finance Committee Chairman Max Baucus (D-MT) and House Ways and Means Committee Chairman Dave Camp (R-MI) recently put forth comprehensive tax reform proposals including valuable energy-related provisions that would begin to remove unnecessary favoritism and distortions in the tax code. We believe many of these changes are positive steps toward making the tax code more efficient.

Even as comprehensive tax reform has stalled, Congress should not hesitate to immediately repeal and reform wasteful energy tax provisions. Please find below our more detailed comments on these proposals, as well as the two attached reports Taxpayers for Common Sense recently released, which analyze existing oil and gas tax provisions and their impact on effective tax rates.

Cost Recovery

  • Congress should repeal the Intangible Drilling Cost deduction, Percentage Depletion Allowance, the Last-in, First-out accounting method, and similar provisions.

Current Law: The intangible drilling costs (IDC) deduction currently allows qualified natural resource developers to immediately deduct “wages, fuel, repairs, hauling, and supplies related to drilling wells and preparing them for production,” as well as similar costs incurred in designing and fabricating drilling platforms. Eligible independent oil and gas producers and royalty owners currently can claim “percentage depletion,” which allows independent producers a flat deduction of a percentage of gross income from each well and allow them deductions in excess of their investment in the property.  Taxpayers can choose different methods to account for inventory, including the Last-in, First-out LIFO method, which assumes the items in ending inventory are those earliest acquired by the taxpayer.

Reform Proposals: Both the Baucus and Camp proposals repeal percentage depletion allowance. The Baucus draft reforms the tax subsidies that allow for immediate write-off of intangible drilling costs (IDC), tertiary injectants, and mining exploration and development expenditures, as well as the rapid amortization of geological and geophysical expenditures. Natural resources developers would now be allowed a 5-year amortization of these expenditures. Both the Camp and Baucus proposals repeal the Last-in, First-out (LIFO) accounting method.

Discussion: Under the Baucus draft, the effective date for the repeal of percentage depletion (properties placed in production after 2014) allows owners of existing mines and wells to continue to deduct amounts in excess of their actual costs. This is poor tax policy and it contrasts with the changes the Baucus draft proposes for depreciation and amortization of intangibles, which that would slow down the recovery of such costs incurred before the bill’s effective date. Congress should repeal percentage depletion for all properties and allow any remaining basis in existing wells or mines to be recovered through cost depletion.

While the Baucus draft is an improvement to existing law, a 5-year recovery period for oil and gas well investments only lessens the existing tax subsidy. The 5-year amortization also contrasts with the bill’s treatment of other forms of capital cost recovery, as it reduces depreciation benefits and lengthens the period for amortization of intangibles to 20 years. Economically, the useful lives of wells and mines on various formations can extend as long as 40 years. Amortization periods should be tied to economic data.

LIFO has allowed oil refiners to maintain very favorable treatment of their costs. LIFO allows companies to defer payment on increases in the value of their goods even if those increases have nothing to do with general inflation – the avowed purpose of LIFO.

Carbon Capture and Sequestration

  • The credit for carbon capture and sequestration is not in the long-term interests of taxpayers.

Current Law: A 20 percent investment tax credit is currently available for qualified advanced coal projects that use integrated gasification combined cycle technology (IGCC), and a 15 percent investment tax credit is available for qualified advanced coal projects that use “clean coal” technology. A 20 percent investment tax credit is also available for certified industrial gasification projects. A credit of $10-$20 is available for each ton of carbon dioxide captured and disposed of in secure geological storage or used as a tertiary injectant in an oil or natural gas project. The program is limited to 75 million metric tons of qualified carbon dioxide captured.

Reform Proposals: The Camp proposal includes the repeal of the carbon dioxide sequestration credit, effective for credits determined for tax years beginning after 2014. The Baucus draft proposes the option of claiming a 20 percent investment tax credit after 2016 for existing facilities that undertake a carbon capture and sequestration (CCS) retrofit that captures at least 50 percent of carbon dioxide emissions.

Discussion: Carbon capture and storage technology is largely untested and unproven. Current carbon capture technology would need to be scaled-up as much as 100 times in order to be workable in commercial power plants. If Washington wants to invest in foundational research and development to support CCS, it should be done with a spending program rather than a first-come, first-served tax credit program with no real accountability. 

Biofuels and Alternative Fuels

  • Biofuel, biomass, and alternative fuel tax preferences – including the cellulosic, biodiesel, open-loop biomass, alternative fuel, and alternative fuel property tax credits – should be allowed to expire permanently, and they should not be replaced with other tax credits.

Current Law: There are a variety of tax credits for production and distribution of biofuels. Cellulosic ethanol, a form of biofuel made from cellulosic matter in plants, is subsidized by the federal government at a rate of $1.01 for each gallon produced.[1] Biodiesel or renewable diesel is also subsidized at a rate of $1.00 for each gallon produced or utilized in the blending process.[2] An alternative fuel credit is currently available to companies that produce unconventional fuels at a rate of 50 cents per gallon. An alternative fuels mixture credit is available at the same rate to companies that blend traditional fossil fuels with small amounts of high carbon fuels. The Alternative Fuel Vehicle Refueling Property Credit provides a 30 percent tax credit for facilities dispensing certain alternative fuels.[3] Open loop biomass facilities are eligible for a production tax credit of 1.1 cents for every kilowatt-hour of electricity produced and sold.[4]

Reform Proposals: The Baucus energy discussion draft simplifies current energy tax incentives by consolidating over 40 separate provisions into two production tax credits and two alternative investment tax credits (ITC),[5] including a “new tax credit for clean transportation fuel that is technology-neutral and performance-based.” The Camp proposal repeals tax credits for biofuels and electricity produced from certain renewable resources, including closed-loop biomass, open-loop biomass, and municipal solid waste.

Discussion: Production tax credits and ITCs by their nature and design distort investment decisions and subsidize otherwise non-economic investment.  The new transportation fuel credit proposed in the Baucus plan would allow corn ethanol facilities powered by biomass sources to once again become eligible for federal tax breaks, even though the Volumetric Ethanol Excise Tax Credit (VEETC) was so unpopular that it was ended in 2011. For the first time, corn butanol, another corn-based biofuel, would become eligible for the new tax credit even though the use of corn-based biofuels has failed to reduce greenhouse gas emissions.[6] The proposed credit also fails to take into account full life-cycle carbon emissions since it would exclude carbon emitted during the production of feedstocks used in ethanol or biodiesel production, such as corn or soybeans. It would also create unintended consequences as a result of increased biomass and biofuel production, such as higher food prices and indirect land use changes which cause deforestation and production on previously uncultivated land.

A Better Alternative: An Upstream Carbon Tax

In general, a better policy choice than production and investment tax credits is an upstream carbon tax. It would encourage through prices the adoption of energy efficiency measures by consumers and businesses. Imposition of an upstream carbon tax would not require the creation of a large new bureaucracy to measure actual emissions and collect the tax, and the number of firms required to file tax returns for an upstream tax would be limited. It would apply to the principal sources of CO2 emissions: coal, natural gas and petroleum products, and it could impose differing rates on each taxable substance so that each is taxed equivalently in terms of tons of potential CO2 emissions. The CO2 equivalence rate could be set and adjusted to achieve any desired combination of revenue collections and CO2 emissions reductions.

There must be more regular review of the business income tax provisions to ensure that the special provisions for some taxpayers are providing adequate return on the forgone revenue investment of us all. We urge the Finance Committee to continue its efforts to move forward with tax reform, especially the repeal and reform of outdated, costly energy provisions – even in the absence of comprehensive tax reform.

 

Sincerely,

 

Ryan Alexander President, Taxpayers for Common Sense



[1] Cellulosic ethanol is also eligible for numerous grants, loan guarantees, and other subsidies through the farm bill energy title and various energy bill provisions. The federal Renewable Fuel Standard (RFS) also mandates production of 16 billion gallons of cellulosic ethanol by 2022. Biomass-based diesel qualifies as an “advanced biofuel” toward the RFS mandate.

[2] Types of biodiesel eligible for the tax credit include those derived from the following feedstocks: “virgin oils, esters derived from corn, soybeans, sunflower seeds, cottonseeds, canola, crambe, rapeseeds, safflowers, flaxseeds, rice bran, mustard seeds, and camelina, and from animal fats.” http://www.propetroleum.com/PDFS/certificate_bio-diesel.pdf

[3] Eligible facilities include gasoline stations, those installing biodiesel or 85% ethanol (E85) blender pumps, or repowering sites for electric vehicles. Stations dispensing natural gas, liquefied natural gas (LNG), and liquefied petroleum gas (LPG) are also eligible for the credit.

[4] Including facilities use agricultural livestock waste nutrients, nonhazardous cellulosic waste material, or other agricultural waste materials to produce electricity.

[5] The amount of the credit varies across fuel types with level of greenhouse gas emission per unit of energy produced – energy sources that produce no CO2 equivalent emissions receive the maximum credit. The draft phases out the new credits and ITCs when the Treasury Department (with EPA and Energy Department) determines that average CO2 equivalents per BTU have fallen below specified targets.

 

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