To lead abroad on climate, repeal oil and gas tax breaks at home

Source: By Gilbert Metcalfe, The Hill • Posted: Friday, August 12, 2016

Politicians have been fighting over tax breaks for the oil and gas industry for decades.

Proponents of reform argue that eliminating tax preferences for producers of oil and gas would save $4 billion taxpayer dollars each year and strengthen American leadership on climate change.

However, defenders of the tax breaks respond that repealing them would decimate domestic oil and gas production and destroy jobs, imperiling America’s energy security and its economic strength.

For such a contentious issue, little research is available to predict how the industry would actually respond to tax reform.

In a recent study published by the Council on Foreign Relations, I calculate the effects of repealing the three largest tax breaks for the industry.

My results suggest that tax reform might reduce domestic production of oil and gas by less than 5 percent. As a consequence, gasoline prices might rise by at most two pennies per gallon at the pump. Higher natural gas prices might increase household electricity bills by up to seven dollars per month. These effects are tiny compared with the variation in prices in recent years.

My analysis shows that the alleged perils of tax reform—energy, insecurity and an economic downturn—are overstated.

First, tax reform would minimally affect energy security. A 5 percent drop in domestic oil production would not substantially increase U.S. imports of foreign oil.

The fact that oil is a globally traded commodity, how much oil a country imports matters less than the quantity it consumes overall, which is better measure of an economy’s vulnerability to global price volatility.

Since tax reform would barely alter domestic oil consumption—consumers will not reduce their use of gasoline when it is one or two pennies per gallon more expensive—it should not materially affect energy security when it comes to oil.  Similarly, tax reform would reduce domestic natural gas consumption by less than 4 percent, marginally reducing the U.S. economy’s exposure to gas price volatility.

Second, tax reform is more likely to help than to hurt the U.S. economy as a whole, though employment in the oil and gas sector in particular might decline. A 5 percent reduction in domestic oil and gas production in the long term might cause the sector to shed 10,000 jobs, but for each of those jobs, the federal government would spend $400,000 less in annual tax breaks to the industry.

Those fiscal savings could be used to more efficiently stimulate growth elsewhere in the economy and offset job losses in the oil and gas sector.

In contrast to the arguments against it, the case for tax reform is much more compelling. Tax reform would only have a modest direct effect on greenhouse gas emissions—global consumption of oil and gas would not change very much— it could also strengthen the U.S. hand in its global diplomacy on climate change.

The United States has backed the G20 initiative to phase out fossil fuel subsidies in the world’s largest economies. However, its own subsidies to fossil fuel producers undercut its ability to convince major developing economies to roll back their fossil fuel subsidies.

Because they encourage wasteful energy consumption, such subsidies substantially increase global emissions. If the United States were to repeal its oil and gas tax preferences, it would increase pressure on China and India and other major polluting countries to roll back their subsidies.

Finally, ending oil and gas tax breaks might clear a path to broader tax reform, which the U.S. economy badly needs.  Although the direct savings from ending these tax breaks would reduce the federal budget deficit by less than 1 percent, successful reform of these preferences—protected by formidable interest groups—may embolden policymakers to tackle other preferences in the tax code.

Ultimately, a simpler tax code can save taxpayers money and more efficiently allocate economic resources.

The irony is that for all the discord that has surrounded this issue for decades, repealing oil and gas tax preferences is a fundamentally bipartisan idea. Republicans want to fix the tax code; Democrats want stronger environmental policies.

This long overdue reform would bring benefits to both sides of the aisle, a rare opportunity for common ground in a bipartisan agenda.

Gilbert E. Metcalf is a Professor of Economics at Tufts University.