Are Big Oil's Tax Breaks Really as Generous as They Seem?

People love to hate on Big Oil. Along with the financial services industry, Big Oil companies -- a group that generally refers to integrated majors like ExxonMobil, Chevron, BP, Shell and others -- are some of the most universally loathed companies.

Well, a recent report by Taxpayers for Common Sense, a Washington, D.C.-based nonpartisan federal budget watchdog organization, is sure to add more fuel to the fire.

Photo credit: Flickr/Nestor Galina

More money, less taxes?
According to the report, America's 20 largest oil and gas companies paid just 11.7% in corporate taxes -- about a third of the 35% tax rate typically imposed on large corporations. Some smaller firms even managed to get away with paying Uncle Sam a measly 3.7% rate, the report found.

How do they do it? Mainly tax breaks and special provisions. The report explains:

"If an independent oil and gas company constructs an asset like an oil rig, for example, it can claim a tax deduction for all of its intangible drilling costs (IDC), which include the costs of designing and fabricating drilling platforms."

This provision seems especially unfair because it allows oil companies to deduct expenses related to building an asset from their taxable income and defer payment to a later date. By contrast, other parties who construct an asset would have to expense the costs related to building that asset over a long period of time, typically based on the asset's useful life.

As the report explains, the ability to defer payments year after year can result in a company's total deferred liabilities reaching gargantuan amounts. ExxonMobil, for instance, deferred $54.5 billion of tax liabilities in the latest fiscal year. While Exxon will eventually pay this money back to the government, it won't have to pay any interest on it, even if it takes two decades to repay.

If that doesn't worsen public disapproval of oil companies, perhaps the fact that some smaller companies actually got money from the government while deferring most or all of their taxes will. For instance, Pioneer Natural Resources, a Houston-based independent exploration and production company, deferred all of its taxes from 2009 to 2013 while reporting negative current income taxes over the period, meaning it effectively received $6 million from the government.

Is the tax code really all that generous?
While an 11.7% effective tax rate seems way too low and the various deductions, tax breaks, and other loopholes appear unfair, it's important to note a few points before lambasting the entire industry.

Firstly, despite paying a below-average corporate income tax rate, oil companies are among the biggest contributors to government tax revenues. According to an analysis by Standard & Poor's Capital IQ, three of the nation's largest oil companies -- Exxon, Chevron, and ConocoPhillips -- paid the biggest portion of corporate income taxes in absolute terms from 2007 to 2012.

The three companies added $146 billion, $85.5 billion, and $58.2 billion, respectively, to Uncle Sam's coffers over the period. And that's just a fraction of all the taxes and duties they're required to pay. For instance, Exxon alone paid a whopping $67 billion in sales-based taxes ($30.6 billion) and other taxes ($36.4 billion) last year, nearly three times the $24.3 billion it paid in income taxes.

Secondly, there are good reasons for allowing companies to make deductions for exploration drilling. Despite radical advances in technology, infrastructure, and safety over the past several years, the oil and gas exploration business remains fraught with risk, and dry holes occur more frequently than you might think. That's why it makes sense to compensate these companies for taking on that risk.

Lastly, it seems rational for the smaller independent oil and gas producers to pay less in taxes than their Big Oil counterparts. Many of these companies are heavily leveraged when they start out, and it typically takes at least a few years before they can cover their drilling expenses through cash flow. Considering it was the smaller independent companies that gave us the shale energy boom, it seems logical to provide them with the right incentives to keep supplying us with cheap energy.

The bottom line
All in all, while certain provisions of the tax code related to taxation of oil & gas companies appear unfair, it's important to remember that the industry pays a lot more than just corporate income taxes and is one of the biggest contributors to U.S. government tax revenues. In that light, the industry's tax breaks and special provisions look less unreasonable.

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