Three Democratic senators have introduced a bill that would end tax subsidies for the five largest oil companies.

The bill, known as the Close Big Oil Tax Loopholes Act, was introduced Tuesday by Senators Robert Menendez, D-N.J., Sherrod Brown, D-Ohio, and Claire McCaskill, D-Mo. The bill would redirect the billions of dollars in savings from ending the tax breaks toward closing the budget deficit.

“At a time when families are feeling the pain at the pump and our deficit keeps growing at an alarming rate, we simply can’t afford to keep giving away billions in taxpayer handouts to oil companies that are doing nothing to help lower prices,” Menendez said in a statement. “The Close Big Oil Tax Loopholes Act is based on a simple premise: we need everyone to do their share to lower the deficit, not just working families and the elderly.”

The bill would modify the foreign tax credit rules applicable to major integrated oil companies. U.S. taxpayers are taxed on their income worldwide, but are entitled to a dollar-for-dollar tax credit for any income taxes paid to a foreign government. U.S. oil and gas companies have been accused of disguising royalty payments to foreign governments as foreign taxes, allowing them to lower their taxes in the U.S.  The bill would close this loophole for foreign oil production for the Big Five.

The bill would also limit the Section 199 domestic manufacturing tax deduction for income attributable to the production of oil, natural gas or their primary products. Congress enacted Section 199 in 2004, but in 2008 it froze the Section 199 deduction at 6 percent for all oil and gas activity. The bill would eliminate the Section 199 deduction for the Big Five.

The bill would also limit the deduction for intangible drilling and development costs by denying the Big Five oil companies the option of expensing Intangible Drilling Costs and require the costs to be capitalized. IDCs are expenditures such as wages, fuel, repairs, hauling and supplies necessary for the drilling of oil wells. Currently, integrated oil companies can expense 70 percent of the cost of IDCs. The bill would require the Big Five to capitalize all of their IDC costs.

In addition, the bill would limit the percentage depletion allowance for oil and gas wells. Firms that extract oil and gas are permitted a deduction to recover their capital investment under one of two methods. Cost depletion allows for the recovery of the actual capital investment—the costs of discovering, purchasing, and developing the well—over the period that the well produces income. Under this method, the taxpayer’s total deductions cannot exceed its original investment. Percentage depletion allows the cost recovery to be computed using a percentage of the revenue from the sale of the oil or gas. Under this method, total deductions could (and often do) exceed the taxpayer’s capital investment. The bill repeals percentage depletion for the Big  Five.

The bill would also provide a limitation on the deduction for tertiary injectants. Tertiary injectants are used in enhanced oil recovery to drive more oil from an existing well. Currently, oil companies are allowed to deduct the cost of tertiary injectants rather than capitalizing their costs and recovering them over time. The bill would require the Big Five to capitalize the cost of tertiary injectants they use during the year and recover those costs over time.

In addition, the bill would repeal Outer Continental Shelf deep water and deep gas royalty relief by repealing Sections 344 and 345 of the Energy Policy Act of 2005. Section 344 extended existing deep gas incentives, while Section 345 provided additional mandatory royalty relief for certain deepwater oil and gas production.

All of the savings realized as the result of the bill’s elimination of the tax breaks and other subsidies would be devoted to deficit reduction.

A similar bill that is being developed by Senate Finance Committee Chairman Max Baucus, D-Mont., would use the money to promote the development of clean, domestically produced fuel and provide incentives for building fuel-efficient vehicles and the infrastructure for clean energy, such as alternative energy fueling stations (see Baucus Plans to Draft Legislation to End Oil Tax Subsidies). Baucus’s committee plans to hold a hearing Thursday at which executives from the Big Five oil companies are scheduled to testify and defend their tax breaks. Similar legislation has been introduced in the House by Rep. Tim Bishop, D-N.Y. (see Congressman Introduces Bills to Repeal Tax Breaks for Oil Producers).

President Obama has urged Congress to repeal tax breaks for the largest oil companies as part of a deficit reduction effort. However, Republican congressional leaders have argued that the oil companies would only increase the cost of gasoline to make up for the loss of tax breaks.

“Yesterday, Democrats unveiled yet another attempt to slow American energy production, this time through a tax hike on American energy,” said Senate Minority Leader Mitch McConnell, D-Ken., on the Senate floor Wednesday. “They acknowledged, however, that this will not lower the price of gas, and they’re right. The Congressional Research Service tells us that raising taxes on American energy will do two things: increase the price of gas and increase our dependence on foreign competitors. By taxing American energy production, they’re also outsourcing American jobs. So let me get this straight: Higher gas prices, fewer American jobs, and more dependence on our foreign competitors at the expense of American energy? That’s their plan? No thanks.”

The oil industry has been lobbying fiercely to protect the tax breaks. "More taxes would do nothing to lower prices,” said Brian Johnson, a senior tax advisor with the American Petroleum Institute, during a press briefing Monday. “They would not affect the global economics underpinning oil supply and demand, which explain today's gas prices. They would, however, hurt the economy by reducing energy investment and the new jobs that would flow from that investment. Proponents of tax increases need to get serious about American jobs and American investment. Oil and natural gas companies can do much more to help, but the right policies are needed to facilitate this. Increasing taxes is not the answer.”

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