The Facts

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What Is the Section 199 Deduction and Who Qualifies for It?

The Section 199 domestic production activities deduction was enacted as a provision of the American Jobs Creation Act of 2004, conceived as an incentive for American manufacturers to grow their companies and create jobs here in America. Although it helps to take the edge off the worst marginal corporate tax rate in the developed world, it can’t serve as a substitute for a fairer, simpler tax system that would help us compete abroad.

Although it was conceived as a tax incentive aimed at a narrow part of American manufacturing, Congress has tinkered so extensively with Section 199 over the past eight years, that it’s now estimated that 1/3 of all U.S. business activityand virtually every company in the Dow Jones Industrial Average – qualifies for the 199 “manufacturing” tax credit.

What Is the Dual Capacity Credit?

The term “dual capacity” refers to the U.S. tax rules that apply to American companies earning income abroad as well as here at home.  While most countries tax their residents only on the business income earned within their own countries (a method known as “territorial” taxation), our government taxes the worldwide income of its residents.   To help prevent double taxation on foreign income, our government currently does allow a credit against U.S. tax liability on such foreign business income for foreign income taxes paid.

Qualifying for the “dual capacity” provisions is expensive and time-consuming, but for 25 years this process has worked to give American enterprise a fighting chance in the international marketplace.  As a result, it has also delivered an enormous and steady flow of tax revenue to the U.S. Treasury from firms that have been able to compete abroad.

What Are Some Politicians Seeking from the Oil and Gas Industry?

Rather than pursuing fundamental tax reform that makes the system fairer for all businesses, the Obama Administration as well as some politicians in Congress seek to repeal Section 199 and dual capacity status just for our traditional energy companies. They’ve even taken to calling this credit and deduction “subsidies,” though only when they’re taking aim at oil and gas.

There’s a Big Difference between a Subsidy and a Deduction

In order to have a fully informed debate about the future of energy tax policy, it’s important to accurately portray the tax treatments in question. The provisions targeted are not, in fact, subsidies. They are policies created in the hopes of making American companies more competitive and effective.

A subsidy is characterized by a direct payment from the government to a company in hopes of propping it up or otherwise boosting its prospects … think of federal “stimulus” grants to the solar energy industry.  A deduction, however, is in place to assure that an American firm is taxed only on its real income. Such provisions enable businesses to write off legitimate expenses and calculate tax liability based on net income, as opposed to gross revenue. This is standard practice – for both businesses and individuals. That’s why elected officials need to recognize the damage that can be done by misusing the term “subsidy.” To paint provisions like dual capacity or Section 199 as “subsidies” is factually inaccurate and misleading.

Oil and Gas Is Critical to the American Economy

Policymakers must avoid any tax changes that disadvantage a single industry – especially one so vital to American workers. The oil and gas industry supports more than 9.2 million American jobs and counting. In 2011, the industry accounted for 148,000 new jobs, which represents nine percent of the total number of new jobs created in the U.S. – across all sectors – for the year.

Oil and gas is investing heavily in the future of the American economy – and is doing so at a rate far beyond that of most other industries. According to the Progressive Policy Institute, oil and gas companies invested more than $36 billion in the American economy in 2011 alone – enough to be labeled one of the group’s “Investment Heroes.”

The Economic Consequences of Increased Taxes on Oil and Gas Are Severe

Increasing taxes on the oil and gas industry would trigger significant problems for the American economy. According to Professor Joseph Mason of LSU, the repeal of Section 199 and dual capacity provisions would result in 155,000 lost jobs and $341 billion in lost economic output. Repealing these provisions will increase energy costs for American consumers already struggling with lingering high gas prices.

Policymakers need to recognize the counter-productive nature of efforts to increase taxes on the oil and gas industry.  For example, a tax proposal in circulation would impact only American companies while leaving state-run foreign competitors – like China’s CNOOC – unscathed. Such a policy would serve as a  huge disadvantage for the U.S. in the race to develop international energy markets and the jobs associated with them. Repealing provisions for the oil and gas industry would reduce the industry’s ability to compete and invest domestically, ultimately resulting in less incoming revenue for the Treasury. The tax hikes would result in an $83.5 billion reduction in long-term incoming revenue – far beyond the approximately $30 billion that the proposals seek to generate.

Tax Fairness: How Does the Oil and Gas Industry Compare?

Calls to hike taxes on oil and gas are based on  the assumption that the companies in question aren’t carrying their “fair share” of the tax burden.

In reality, the oil and gas industry pays its share – and a great deal more. The facts are:

  • In 2011 the reported tax burdens of the five major oil and gas companies added up to $95 billion for the year, or $261 million per day.
  • ExxonMobil has paid three dollars in taxes for every one dollar in profits since 1999 – more than $1 trillion versus $352 billion in profits.
  • The oil and gas industry pays an average tax rate of more than 41 percent. The rest of the S&P industrial average pays 26.5 percent.

Efforts to tax oil and gas based on assertions of fairness, then, are either ill-informed or disingenuous.

By the Numbers

  • 35% – Federal corporate tax rate that the United States requires American businesses to pay no matter where income is earned – domestically or abroad.
  • 70% – Amount of corporate earnings that would be claimed by the combination of U.S. and foreign corporate taxes, if dual capacity provisions were repealed.
  • $44.8 Billion – Amount that the eight major energy companies contributed to the U.S. economy in 2011. The repeal of dual capacity would threaten the industry’s future ability to invest significantly in America’s economy.

Sources: Peterson Institute for International Economics, October 2011, “US Tax Discrimination Against Large Corporations Should Be Discarded,” by Dr. Gary Hufbauer and Martin Vieiro, page 11; Progressive Policy Institute,
July 2012, “Investment Heroes: Who is betting on America’s future?” by Diana Carew and Michael Mandel, page 3.