Snake Oil Hearings

Does an industry that keeps achieving record profits deserve extraordinary tax breaks?  That’s the question that is supposed to be at the heart of hearings on the Hill today.  Senate Majority Leader Harry Reid hopes to remove tax breaks from the five companies that basically form the de facto cartel known as the oil refining and distribution business. However, in a political environment, theatrics, pandering, and grandstanding are expected and delivered.  It’s turned into either a farm or zoo environment, or perhaps a fantasy menagerie with folks mentioning dogs, horses, unicorns, and rhinos.  Good thing they’re not in Florida or there might be charges of bestiality.

At its core, the hearing is pure political theater, a fact acknowledged by Republican Sen. Orrin Hatch, who called it a dog and pony show during his opening remarks.

“This hearing should not be used to score cheap political points, but I am afraid … that’s what we are going to see here today,” Hatch said.

Others disagreed, and also invoked wildlife — this time of the mythical variety.

“One of my colleagues suggested that this hearing is nothing more than a dog and pony show,” Schumer said. “Well you would have an easier time convincing the American people that a unicorn just flew into this hearing room than that these big oil companies need taxpayer subsidies. That’s the real fairy tale.”

My Senator Mary Landrieu–who is a fully owned subsidiary of oil interests–thinks her colleagues are singling out one industry because current oil prices have made the electorate cranky. Yes, yes, the poor oil industry is the victim of discrimination, my friends.

While Democrats can score political points by grilling corporate executives, actually holding a vote on a bill could expose rifts within their caucus and undermine the message that Obama and Senate Majority Leader Harry Reid, D-Nev., are hoping to send to the public: that it is the Democrats who are serious about rolling back costly benefits for flush oil and gas companies.

Regardless of what a final tax bill includes, Reid can count on at least a few defections from conservative Democrats and those representing oil-rich states. Alaska Democrat Mark Begich is almost a certain “no” vote, as are Ben Nelson of Nebraska and Mary L. Landrieu of Louisiana.

“I don’t think targeting the oil and gas industry and holding them up like the villains, even if it’s just Big Oil, is the right approach,” Landrieu said last week, expressing a long-held view.

Given the position of Landrieu and others, Reid faces the difficult task of converting more than a handful of Republicans to his cause if he has any hopes of reaching a filibuster-proof 60-vote majority.

Politico had a primer up on what to consider during the Big Oil exec testimony.  One of the things to remember is that what we have now is an industry with fixed refining capacities and a growing world demand.

Oil prices have jumped this year primarily because of Middle East unrest and market speculation.

“Gasoline prices are primarily a function of crude oil prices, which are set in the marketplace by global supply and demand — not by companies such as ours,” ExxonMobil’s Tillerson is expected to tell the panel.

Meanwhile, the world’s top 10 oil companies are state-owned by countries like Saudi Arabia, Iran, Iraq and Venezuela. They aren’t targets of the hearing or the bill, and Senate Democrats admit that going after the Big Oil profits won’t do anything in the short term or long term to lower gasoline prices or increase U.S. supplies.

The oil companies and the GOP say the incentives repeal is nothing but a tax increase to be passed on to consumers.

The ability to pass tax increases or cost increases to consumer has to do with the price elasticity or sensitivity of buyers to prices of gas at the pumps.  In the short run, gas consumption is fairly insensitive.  There is only so much people can scale back either driving habits or replace gas guzzlers with more fuel efficient vehicles. (Frankly, I always enjoy watching truck and SUV owners deal with higher prices.  I find it an entertaining form of instant karma for their wanting to be seen driving upscale, short buses.)  The industry’s argument is that much of the higher gas prices will be temporary and that within six months, the market will go the other direction. Then they will have to eat through retained earnings to live.   We’ve heard that line in testimony today.  Here’s what CEO John Watson of Chevron/Exxon said earlier.

Gasoline prices are driven by forces beyond their control, heads of major oil companies tell lawmakers in arguing against repeal of tax breaks for their firms. ‘Don’t punish our industry for doing its job well,’ one CEO says.

Here’s a similar explanation of market conditions by Shell CEO Marvin Odum.

The national average for a gallon of regular unleaded is close to $4, and at least 17 states have prices well above that benchmark, according to recent surveys. The oil executives argued that scaling back their tax breaks would unfairly single out their industry and hamper their ability to pursue new energy exploration, jeopardizing jobs and perhaps leading to even higher prices. They also contended their companies weren’t to blame for high gas prices.

“Stated simply, oil is a global commodity,” Shell Oil Co. President Marvin E. Odum said. “With worldwide economic recovery underway, demand is on the rise, sending prices upward.

“No one person, organization or industry can set the price for crude oil,” he said.

Conoco Phillips CEO James Mulva took Landrieu’s line which was basically that other industries get so many tax breaks, why shouldn’t they?  (But MOM, Wall Street’s daddy gives him a much bigger allowance than we get!)

ConocoPhillips CEO James Mulva said that companies should receive tax breaks available to other industries.

While Wyden brought his own video, Sen. Pat Roberts (R-Kan.) played a clip of President Obama, in a trip to Brazil earlier this year, cheering the discovery of oil off that country’s shores, something that Republicans have sought to use to criticize the administration for not doing more to promote domestic energy production.

Other Democrats questioned a recent press release from ConocoPhillips that assailed the tax repeals as “un-American.”

“Did you really mean to question my patriotism?” Sen. Robert Menendez (D-N.J.) asked Mulva. “Do you believe that President Obama is un-American because he has proposed cutting oil subsidies?”

Mulva replied that “nothing was intended to be personally directed to you.”

The real question is why are we giving special tax treatments to any corporation?  The reason for any tax break is to basically encourage certain behaviors or to basically reward a political donor these days.   The incredibly complex world of corporate tax breaks effectively takes our high base level of corporate tax rates and puts it squarely into the bottom tier of countries in terms of effective tax rates.

Companies–like the oil refining industry–that are plant and equipment intensive get a huge number of tax write offs for various kinds of investments. This distorts corporate investment behavior and causes them to seek ways to lower costs by chasing the tax breaks on individual products.   It’s basically a reverse sin-tax in terms of policy. The problem is that the more complex the tax breaks are and the longer they stay in place, the more irrelevant they may become to current economic standing.  Once placed, tax breaks become difficult to repeal.

Republicans have been going on about the statutory level of corporate tax rates during the last few election cycles.  The problem is that with these tax breaks, the effective rate of corporate taxes is no where close to the statutory level so the discussion is dishonest.  There are several other important things that are left out of this conversation.  First, most countries with low statutory rates have much smaller economies than the US.  The US is a large country with lots of infrastructure and huge military expenditures.  This means it has higher expenditures and requires higher revenues. You can’t compare the tax rate of a small economy to a large one.     The US rate is, however, comparable to other developed nations with similarly large economies and  commitments.  This gets left out of the conversation.

Another thing that’s been left out of the conversation is one particular argument we’ve heard today.  That is that you can’t single the oil industry out for “special treatment” and deprive them of tax breaks when you aren’t willing to do it to others.  This is really disingenuous on many levels. First,  dirty industries like the oil industry have incredible spillover costs.  Their businesses cost state and local governments as well as the federal government more money than say, WalMart because they pollute.  Cleaning up pollution is expensive.  Dealing with the health costs of pollution is expensive.  Dealing with the fall out from global warming is expensive.  It’s difficult to say that all corporations should be treated equally in terms of taxation when their contribution to gross social costs can be so variable.

Second,  differences in effective marginal corporate tax rates are driven by two basic factors. That is tax treatment of  the depreciation of plant and equipment and tax treatment of the various sources of financing.  (Oh, dear, you’ve discovered that I am also a corporate finance professor as well as an economist!)  So, the oil industry’s heavy reliance on plant and equipment gives them more access to special tax treatment than a WalMart.  This effectively increases the benefits of their economies of scale and it also encourages market concentration.  An oligopoly or near monopoly is never a good thing for its customers.  This is especially true when supply is limited and demand is up.

The deal is that the depreciation deductions are extremely generous in the US and have been since the 1980s. That was part and parcel of the Reagan supply side policy.   In the CBO study that I’m referencing, you can see just how generous our depreciation write offs are compared to other countries. Here’s a recent statistic for machinery.   If the Republicans were so correct with their tax dogma, nearly every company that relies on equipment should be relocated here in the U.S. by now.  Of course, we know that labor costs tend to be a bigger, driving variable and hence, we’ve lost manufacturing despite the depreciation benefits.  The oil industry however, has its major refineries here.  Those babies are difficult to replace.  They aren’t and can’t go any where unless they are willing to build refineries elsewhere.

For the 19 OECD countries in 2003, the present value of depreciation deductions for an investment in machinery, measured as a percentage of the initial cost of the investment, ranged from 66.4 percent to
87.1 percent (see Figure 2-7 on page 28). For the United States, the present value under the tax code in 2003 was 78.5 percent of the asset’s initial cost, which is higher than the present value of such deductions in more than 80 percent of the other OECD countries

So, were taxes the major decision variable, we would see a lot of investment in equipment here in comparison to countries like Germany that are in that OECD sample.  We don’t.  So, what’s the deal?  The deal is that taxes, again, are not the major decision variable for businesses they come more into play to determine break points for individual projects.  Tax rates impact the overall rate of return but are not as the cost of labor or financing.  Plus, if the oil industry was really driven by tax breaks, we’d see more refinaries.  The problem with that is that building a refinery would disadvantage one of the companies unless all of them built refineries because it’s an extremely expensive undertaking. There’s no reason to build a refinery because oil companies are at the most profitable when they can take advantage of restricted supply during high demand or high price periods like right now.  So, all this oil exec whining about taxes is even a side show for them as well as the politicians today. As long as they can continually recapitalize some of the existing structure, they can effectively decrease their tax obligations easily while still maintaining the happy position of restricted supply.

What we need to do as a country is have a huge, realistic discussion about revenues and taxation. Our current system is basically insane.  I read something else this morning that makes me think this morass will exist in perpetuity. Here’s something from The Atlantic and an ‘undisclosed’ Republican aide to put it all into perspective. This  Republican aide basically says that Republicans are not being intellectually honest on taxes.  The truth is that no one really is, but here’s a quote to think about.

“There are two worlds,” the source said. “One world is political, and the sole objective is to maintain party message. The other world is real, and in the real world, fixing the deficit is a matter of national survival. When you get down to the real world decisions, it’s not about whether to raise taxes. It’s about the ratio of spending to revenue increases. That’s the issue.”

I repeated the question: Are you saying that the GOP’s utter resistance to revenue increases is political? The aide responded: “Yeah.” The source indicated that spending cuts should vastly outweigh tax increases, but that the final solution will probably be a blend.

There’s nothing news-making about politicians being political and playing games of chicken with national policy. But I had never spoken to a GOP spokesperson, on or off the record, who had drawn such a clear distinction between the party’s position against tax increases and the real-world need to raise tax revenue, even if slightly. (The source was equally damning of Democrats, who, the source said, dissembled when they talked about fixing the budget on the back of tax hikes for the rich and cuts to defense.)

I’d say there’s no intellectual honesty present in these hearings either. CEO’s only care about the bottom line.  Politicians only care about getting huge campaign war chests and achieving reelection or comfortable retirement in lobbyland.  Given those constraints, my tax accountant brother-in-law should continue to live a very comfortable life for some time and the rest of us will continue to pay through the nose at the pump and elsewhere.