Source: Staff of the Joint Committee on Taxation.
Note: This option would take effect in January 2014.
When calculating their taxable income, firms in most industrial sectors in the United States are generally allowed to deduct a portion of the investment costs they incurred that year and in previous years. The portion of those costs that is deductible depends on prescribed rates of depreciation or, for certain natural resources, depletion. Costs are deducted over a number of years to reflect an asset’s rate of depreciation or depletion.
In contrast, the U.S. tax code treats extractive industries that produce oil, natural gas, coal, and hard minerals more favorably. Two tax preferences in particular give extractive industries an advantage over other industries:
This option includes two different approaches to limiting tax preferences for extractive industries. The first approach would replace the expensing of exploration and development costs for oil, gas, coal, and hard minerals with the rules for deducting costs that apply in other industries. That approach would increase revenues by $18 billion over the 2014–2023 period, according to estimates by the staff of the Joint Committee on Taxation (JCT). The second approach would eliminate the percentage depletion allowance. That approach would raise $16 billion over that 10-year period, according to JCT. If the two approaches were combined, revenues would increase by $34 billion over the 2014–2023 period.
The principal argument in favor of this option is that the two tax preferences for extractive industries distort the allocation of society’s resources in several ways. First, for the economy as a whole, the preferences influence the allocation of resources between the extractive industries and other industries in an inefficient manner. Those incentives encourage some investments in drilling and mining that produce a smaller market value of output than the investments would produce elsewhere because, when making investment decisions, companies take into account not only the market value of the output but also the tax advantage that expensing and percentage depletion provide. Second, for the same reason, the preferences also lead to an inefficient allocation of resources within the extractive industries. Third, the preferences encourage producers to extract more resources in a shorter time. In the case of oil, for example, that additional drilling makes the United States less dependent on imported oil in the short run, but it accelerates the depletion of the nation’s store of oil and causes greater reliance on foreign producers in the long run.
An argument against this option is that it treats expenses that might be viewed as similar in different ways. In particular, exploration and development costs for extractive industries can be seen as analogous to research and development costs, which can be expensed by all businesses. Another argument against this option is that encouraging producers to continue exploring and developing domestic energy resources may enhance the ability of U.S. households and businesses to accommodate disruptions in the supply of energy from other countries.