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Friday, May 13, 2011

About Those Oil Company Tax Breaks

Discretion is dangerous.

Whether or not one has a warm cozy feeling about big oil companies, one should be troubled by the government’s power to issue selective “tax breaks” and to rescind them whenever politicians need the money. You won’t catch me saying anything nice about any tax, but I reserve a special animus for any system that gives politicians the power to treat different productive activities differently. Let’s take equality before the law seriously.

In his attempt to shrink the budget deficit President Obama hopes to pick up $44 billion over ten years by ending certain tax preferences for the oil industry; the big five companies’ $35 billion in first-quarter profits make them a juicy target for politicians unexpectedly seized with a sense of fiscal responsibility. Of course the oil companies are no strangers to power, having enjoyed a mostly cooperative relationship with national and state officials for generations. Live by the lobbyist, die by the lobbyist, they ought to say.

Not that this should bear on the question, but for the record, even with oil and gasoline prices rising of late, industry profitability is hardly extraordinary. In the first quarter of the year the industry ranked 114th out of 215, with an average profit on sales of 6.2 cents per dollar. The pundits who rail about this aren’t likely to mention that the broadcasting industry average is 10.5 percent and the periodicals industry average is 51 percent.

Discretionary Power

But let’s leave the oil industry aside (today) and concentrate on the arbitrary and discretionary power implicit in the tax controversy. In 2004 the Domestic Manufacturing Deduction (DMD) was enacted, which the Associated Press says “allows companies of almost any type to deduct from their taxable income up to 9 percent of profits from domestic manufacturing. Under the rule, oil and gas companies were classified as manufacturers, but their deduction was capped at 6 percent.” As indicated, the purpose of the deduction was to encourage domestic manufacturing. The money the oil industry saves from this deduction is 42 percent of the total Obama is trying to get his hands on. (The rest of the $44 billion would come from ending specific oil industry allowances regarding intangible costs, well depreciation, and payment of royalties to foreign governments.)

If we judge government actions by the liberty standard, one might well conclude that the DMD was a mistake for two reasons. First it’s an inferior way to reduce the taxes. The burden on economic activity should be lifted not by ad hoc deductions granted by politicians trying to look as though they are “doing something,” but rather by slashing tax rates across the board — if not outright repealing taxes. (The latter is always preferred, given the traits that taxation has in common with robbery – as a previous Freeman editor, Frank Chodorov, was fond of pointing out.) Second the deduction is manipulative: It doesn’t apply to any and all economic activity but only for domestic manufacturing, thus introducing a differential that favors some over others and distorts the marketplace. (At the margin, some will do what is necessary to get the deduction rather than what makes true economic sense.)

Politicians of course love the power to reward and punish that a complex tax code accords them, but the rest of us should be concerned by such discretion. Considering the muddled media coverage, it would be useful to distinguish subsidies from tax “breaks,” “loopholes,” and the like. A subsidy is cash from the government treasury compliments of the taxpayers. The other things are exemptions from a tax: say, a deduction from taxable income or a credit against taxes “owed.”

Moral Distinctions

The moral distinction between a subsidy and a tax break should be obvious. With the former the beneficiary gets someone else’s money by force; with the latter the beneficiary keeps what otherwise would have been taken.

I would offer distinction among varieties of tax breaks. There’s a world of difference between an across-the-board tax cut or repeal and a targeted cut, deduction, or credit. Advocates of liberty should always applaud the first while being dubious of the second. Why? For the reason already noted: Discretion is dangerous. Politicians don’t need the traditional power of a central planner to impose economic schemes. All they need is the power to write differential tax policy. Virtually anything that can be done by regulatory decree can be also done by selective tax preferences. In the 1980s, when Japanese carmakers were running rings about the American Big Three, some protectionist congressmen proposed a tax deduction for buyers of domestic vehicles only. (It wasn’t enacted.) When government can shape economic behavior through the tax code, there surely is no free market. Tax neutrality is a chimera, but we should still object whenever the tax writers try to manipulate the economic process.

What Now?

This of course does not tell us what should happen with the tax preferences already in effect, specifically the oil-industry breaks. I have a few reasons for advising that they be left untouched (pending  drastic reduction or repeal of taxes.) First, removing them would now amount to a tax increase, that is, the additional forced, therefore immoral, transfer of resources to the government. Second, selective elimination would be another exercise in economic planning through the tax code. And third, ending the deductions would give the politicians the means commit further mischief.

Cutting the deficit should be a step toward cutting the budget, which in turn should be a step toward shrinking the government. The State doesn’t need more revenues. It needs to stop doing things.

  • Sheldon Richman is the former editor of The Freeman and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families and thousands of articles.