The Senate Finance Committee held a hearing Tuesday to examine the impact of tax reform on U.S. energy policy.

“Thankfully, we’re already making progress diversifying our energy portfolio,” said committee chairman Max Baucus, D-Mont. “We have an opportunity, through tax reform, to drive that progress even further.”

He noted that tax incentives provide 85 percent of the energy sector’s federal support and cover different forms of energy, including nuclear, oil, gas, coal, wind, solar and geothermal. The tax provisions also cover a wide variety of energy uses, from powering common home appliances to running massive factories, but the type and level of tax incentives varies for different technologies. “Some incentives are temporary,” Baucus noted. “Others are permanent. In some cases, there are multiple incentives for the same technology. The result is inefficiency.”

Sen. Orrin Hatch, R-Utah, the ranking Republican member of the committee, noted that the number of energy-related tax provisions has been growing in the tax code and he referred to a speech that Baucus gave on Monday about the increasing complexity of the code (see Baucus Plans Tax Code Overhaul).

“Energy policy has been creeping into the tax code at an exponential rate,” said Hatch. “Yesterday, I heard the chairman compare the tax code to the Hydra—the hundred-headed creature of Greek mythology. Each time you cut off one head, two more grow back. I believe this analogy is particularly apt with respect to energy tax provisions.”

“I could keep talking, but there is no tax incentive for producing a lot of hot air yet, so I’ll just let the witnesses get to it,” Hatch concluded.

One of those witnesses was a former member of the Senate, Don Nickles, who is now chairman and CEO of the Nickles Group, a lobbying firm in Washington, D.C., that represents a number of large oil companies, including ExxonMobil, Anadarko Petroleum and National Oilwell Varco. He is also on the boards of Chesapeake Energy and Valero Energy.

“Mr. Chairman, if you do tax reform correctly, there will never be a need to hold an ‘energy’ tax hearing ever again, because tax reform should seek to treat energy companies and the products they produce just like everybody else. No subsidies, and no penalties," said Nickles. "If the tax system you devise encourages investment (as it should), energy companies will benefit just like other companies. If a lower corporate rate and simplified territorial system make U.S. companies more competitive (which it will), energy companies will benefit just like other companies.”

Nickles argued that while the tax code should not subsidize energy companies, it also should not penalize them. He criticized President Obama’s efforts to close down tax breaks for the major oil companies.

“The President loves to talk about tax ‘subsidies’ received by oil and gas companies,” said Nickles. “By doing so, I suppose he hopes to create the impression with voters that our energy companies are receiving checks from the government. In fact, the President has it exactly backwards. U.S. oil and gas companies pay more than $86 million every day to the federal government in income taxes, rents, royalties, and lease payments. Last year, the income tax expenses for those companies averaged 40.6 percent, compared to 25.1 percent for other S&P industrial companies. Who is subsidizing whom? The hostility toward domestic oil and gas companies from this administration has no foundation in tax or economic policy.”

Philip R. Sharp, president of the research institution Resources for the Future, discussed energy policy and changing technologies and the implications for tax reform. “To achieve significant reform that focuses on economic progress and efficiency, the committee may want to consider some version of a carbon tax with revenues dedicated to cutting other taxes that impede economic growth,” he said. "I need to repeat that RFF does not take a position on this or other issues, and I am not here to say that this is the only choice we have for addressing greenhouse gas emissions. But it is a choice that many economists believe is the most cost-effective way for the United States to address the carbon problem.”

He noted that a carbon tax has several features that make it attractive from an economic perspective and perhaps as an avenue to enable the transformation of the tax code. It could generate revenue that, if recycled into the economy by cutting so called “distortionary taxes,” has the potential for contributing to economic growth rather than being a depressant, Sharp pointed out. It could begin modestly and rise over time, permitting adjustment. A carbon tax could also reduce the need for more extensive subsidies and regulations to address the climate problem.

“However, I think it is obvious that a carbon tax proposal is not ready for prime time,” Sharp added. “Indeed, there is a clear need for greater analysis, more consideration of design options, and extensive vetting with various sectors of the economy.”

Harold Hamm, chairman and CEO of Continental Resources, a petroleum liquids producer, argued for preserving tax breaks for intangible drilling costs and percentage depletion.

“Independent oil and natural gas producers are in the exploration and production segment of the industry, with no marketing operations and very limited refining operations,” he said. “We have no opinion on the viability of tax provisions for multinational integrated oil and gas companies like Section 199 and Foreign Tax credits. These are not the tax provisions providing the capital that is fueling America’s march to energy independence.  In order to achieve American energy independence, we must maintain tax provisions critical to independent oil and gas producers, including intangible drilling costs and percentage depletion. IDCs permit companies to deduct the entire cost of drilling a well during the first year rather than spreading it out over a period of years. This is only available on wells drilled in the United States. It is not available to major integrated oil and gas companies on any wells drilled outside the United States.”

He pointed out that IDCs have been available since 1913 and are consistent with how other businesses are allowed to treat similar costs to help manage risk, such as R&D for the technology industry and development costs for the coal mining industry. Percentage depletion is a 15 percent deduction used by independent producers and royalty owners, and is limited to the first 1,000 barrels a day of production. Congress eliminated percentage depletion for major integrated companies more than 30 years ago, Hamm pointed out. He argued that the negative economic impact of a repeal of IDCs would place thousands of jobs at risk, including 58,000 direct, indirect and induced U.S. jobs this year and 165,000 direct, indirect and induced U.S. jobs by 2020.

Harvard professor Dale Jorgenson told the committee that comprehensive tax reform is overdue, and that tax expenditures on energy are among the possible sources needed.

"A system of environmental taxes would be very effective in dealing with the hidden costs of energy," Jorgenson added. "We now have four decades of experience with the energy conservation that results from higher energy prices. In addition, energy taxes would be cost-effective. They would put renewable energy sources not subject to energy taxes onto a level playing field with the nonrenewable sources that will continue to provide a major part of our energy. Moreover, energy taxes would reflect the highly important differences in the hidden costs of energy associated with the combustion of coal, oil and natural gas. In the stringent budgetary environment we will be facing for some time, we need to make cost-effective use of every one of the taxpayer’s hard-earned dollars."

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