In the most recent budget proposal from the Obama administration, there are several mentions about increasing revenue from oil and gas companies to fund efforts in the Department of Energy to spur clean-energy initiatives. The oil and gas industry is vehemently opposed to the idea, claiming that the government is using the industry as a piggy bank for its new energy endeavors. At the same time, many advocates claim that major oil companies don't pay their fair share of income taxes.
Can both sides be right? In a way, yes. Let's look at both sides of the argument and see how the case can be made for both.
What happened to 35%?
Based on federal regulations, the corporate federal tax rate is roughly 35% for any company that makes over $18 million a year in income. But just like individuals filling out their tax forms, the amount that is paid is rarely the same as that individual's effective tax bracket. There are always plenty of deductions and additions that are used to adjust income. With all of these tax benefits, the amount that ultimately goes to the IRS might not even approach that number. Just look at ExxonMobil's (NYSE:XOM) and Chevron's (NYSE:CVX) income tax levels for 2012.
|Company||Earnings Before Taxes (USD Millions)||US Income Taxes (USD Millions)||Percent of Income|
Tax rates like that are more than enough to enrage individuals who see a much larger part of their paycheck get taken away, and it certainly gives plenty of firepower for someone who wants to argue that oil companies don't pay enough.
There are a couple things to consider when looking at these numbers. First, these are global oil companies, and not all of the taxes they pay are in the United States. Also, there are several taxes that are specific to the oil and gas industry that are not normally accounted for in income taxes. For example, oil companies need to pay $0.08 per barrel of oil for a trust fund that's used to pay for oil spills, and they need to pay royalties for any oil that produced on federal lands. When you figure in these additional taxes to Exxon's tax bill, you get a figure in the U.S. of $12.1 billion.
That brings the tax rate up to about 14%, which still seems pretty paltry for the world's largest company. What you also need to consider, though, is the word "world." With operations in more than 43 countries, each country wants a piece of that pie through its own taxes, royalties, and so on. When all of these things are tallied up worldwide, Exxon dolled out $102 billion to governments in 2012.
Sticker price versus what you pay
Looking purely at U.S. income tax expenditures clearly doesn't give a full picture of what these major oil companies are paying in tax. To get a better look, let's examine their effective tax rates. This is a simple ratio for the income tax expense divided by the company's total earnings before taxes from the past 12 months.
According to S&P's Capital IQ, some the largest oil companies in the U.S. have the biggest tax rates around.
|Company||Effective Tax Rate|
|Royal Dutch Shell||46.6%|
So when all is said and done, the tax rate can be much higher than the 35% that goes to the IRS. What's probably even more surprising about those tax rates, though, is they're even much higher than for the major players in other parts of American industry.
|Company||Effective Tax Rate|
What a Fool believes
The thing about numbers is that they can be easily presented in a way that gives credence to any argument, and any fact or truth can be produced to back up a claim. Do big oil companies like Exxon pay considerably lower U.S. income taxes than individuals? Yes. But do they pay a high tax rate that would seem unfair to other sectors? Yes. So if the Obama administration thinks the oil industry should pay its fair share, they can find a way to frame that argument, and the opposition can give its own side just as well.
While these types of arguments make for good cocktail party fodder, very rarely should taxes sway your investment decisions. To paraphrase Warren Buffett, when someone pitches a sound investment idea to you, the first thought in your mind is never "what will my tax rate be on the gain?" Rather, focus on solid companies that will perform no matter what business environment is out there.
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