Tax Expenditures in the Energy Sector
The federal government heavily relies on the tax code to implement policy in the energy sector. In fiscal year 2009, the estimated revenue loss in the sector from tax expenditures totaled nearly $6.3 billion.1 Tax expenditures are government revenue losses resulting from provisions in the tax code that allow a taxpayer or business to reduce their tax burden by taking certain deductions, exemptions, exclusions, preferential rates, deferrals or credits. Tax expenditures have a similar effect on the federal deficit as government spending. They can also have effects on recipients that are similar to grants or other types of subsidies. For instance, if the government wants to encourage people to buy solar panels for their homes, it could send checks to those who bought panels or offer tax breaks after the panels have been purchased.2
Figure 1: Top Tax Expenditures by Revenue Loss FY 2009 ($ millions)
Source: Subsidyscope analysis of Analytical Perspectives. OMB. Budget of the U.S. Government, Fiscal Year 2011. p. 209.
*This program is not a typical tax expenditure but is estimated in a footnote of the Tax Expenditure Budget in Analytical Perspectives. See p. 213.
There are 24 specific tax expenditures identified by the U.S. Department of the Treasury (Treasury) as serving the energy sector, though only a few of these provisions account for most of the revenue lost to tax subsidies.3 The top six of these tax expenditures totaled $4.8 billion, or over 75 percent of all energy-related tax expenditures in fiscal year 2009.4 Some tax expenditures such as the allowance for accelerated depreciation and the foreign tax credit, that benefit businesses broadly across the economy, including the energy sector, are not included in these aggregate estimates.5
Subsidyscope divided the energy tax expenditures reported by Treasury into four categories: those that support fossil fuels, those that support renewable or alternative fuels (e.g., bio-diesel), those that support energy efficiency or conservation, and those that are 'multi-use,' in that they are used in the energy sector but are available across various industries, and cannot be placed in one of the first three categories. The federal government provided incentives through the tax code of $3.2 billion to support fossil fuels; $1.5 billion to support renewable and alternative fuels; $1.2 billion to encourage energy efficiency or conservation; and $430 million for multi-use tax expenditures, in fiscal year 2009 (see Table 1). All four categories combined resulted in an estimated $6.3 billion loss to government revenue in fiscal year 2009, a slight increase over the revenue loss in recent years. Note that estimates of the revenue lost to tax expenditures change each year and can vary dramatically depending on legislative actions and economic conditions. Energy sector tax expenditures averaged roughly $4 billion per year over fiscal years 2000 through 2008, and fossil fuels have been the largest beneficiary of tax subsidies in the time period for which Subsidyscope has data. (See Box 1 for historical tax expenditure trends by category.)
Listed below are the tax expenditures reported by the Treasury, and assigned to the energy sector in the fiscal year 2011 edition of the Analytical Perspectives supplement to the President's Budget; the categorization presented in the table has been added by Subsidyscope.
Table 1: Energy Related Tax Expenditures for Individuals and Corporations, FY 2009
|Support fossil fuels|
|Expensing of exploration and development costs, fuels||$1,640|
|Temporary 50% expensing for equipment used in the refining of liquid fuels||$770|
|Excess of percentage over cost depletion, fuels||$340|
|Credit for investment in clean coal facilities||$180|
|Natural gas distribution pipelines treated as 15-year property||$80|
|Capital gains treatment of royalties on coal||$70|
|Alternative fuel production credit1||$60|
|Amortize all geological and geophysical expenditures over 2 years||$40|
|Exception from passive loss limitation for working interests in oil and gas properties||$20|
|Support renewable fuels and alternative fuels|
|Payments for specified energy property in lieu of tax credits2||$1,050|
|Energy investment credit||$270|
|Credit for holding clean renewable energy bonds||$70|
|Alcohol fuel credits||$50|
|Bio-Diesel and small agri-biodiesel producer tax credits||$30|
|Encourage energy efficiency or conservation|
|Credit for energy efficiency improvements to existing homes||$570|
|Exclusion of utility conservation subsidies||$140|
|Tax credit and deduction for clean-fuel burning vehicles||$130|
|Credit for energy efficient appliances||$130|
|Credit for residential purchases/installations of solar and fuel cells||$110|
|Allowance of deduction for certain energy efficient commercial building property||$60|
|Credit for construction of new energy efficient homes||$30|
|Qualified energy conservation bonds||$0|
|New technology credit||$430|
|Exclusion of interest on energy facility bonds||$10|
|Deferral of gain from dispositions of transmission property to implement FERC restructuring policy||-$103|
Source: Subsidyscope analysis of FY2009 data in Analytical Perspectives. OMB. Budget of the U.S. Government, Fiscal Year 2011. p. 209.Notes:
- The Energy Information Administration (EIA) notes that as of 2008, the alternative fuel production credit was primarily used for refined coal, therefore Subsidyscope classifies it as supporting fossil fuels. See EIA, "Federal Financial Interventions and Subsidies in Energy Markets 2007," April 2008. p. 117.
- Subsidyscope adds this program as a separate line item while the Treasury includes it as a footnote. See more on this program in the description below.'
- This negative tax expenditure represents a loss to properties (a gain to the Treasury) that offsets prior years' gains to the properties.
- Summing tax expenditures often provides a reasonably good estimate for the total cost of groups of tax expenditures, though it does not capture the potential interactions among tax expenditures if any single one is changed or repealed.
Tax Expenditures in the Energy Sector
Various federal taxes and exceptions to such taxes are specifically linked to energy production, consumption or efficiency, such as the income tax credit for energy efficiency improvements or the excise taxes on gasoline and diesel fuels. Subsidyscope relies on the Treasury's estimates of tax expenditures in the corporate and individual income tax, which are compiled in the Analytical Perspectives of the President's Budget. (See Subsidyscope's page here for more on the differences between existing government estimates and on tax expenditures, generally.)
So far, Subsidyscope has not included excise taxes, or reductions in excise taxes, in our tally of subsidies because Subsidyscope relies on the estimates of tax expenditures presented in the President's Budget, which do not include excise tax expenditures.6 Subsidyscope intends to examine the issue of excise taxes and exceptions to excise taxes in the future. Such taxes and exceptions to those taxes exist in the energy sector. For example, the ethanol tax credit, which is an exception to the excise tax on motor fuel, is estimated to have reduced excise taxes by $3 billion in fiscal year 2007 and is expected to exceed $5 billion in reduced payments by fiscal year 2010, according to the Energy Information Administration.7
The following section discusses the energy-related income tax subsidies that resulted in the greatest loss of revenue to the federal government in fiscal year 2009. For that year, these six tax expenditures accounted for more than three-quarters of the estimated revenue loss to the Treasury.
Description of Top Energy-Related Tax Expenditures
Expensing of Exploration and Development Costs
In fiscal year 2009, the largest tax expenditure in the energy sector was the allowance of expensing of exploration and development costs of fuels, with an estimated revenue loss of $1.6 billion.8 Some of the costs of exploration and development of oil, gas and certain other fuels, also called "intangible drilling costs" (IDCs), are part of the incidental and necessary expenditures of preparing a site for oil production. These costs include labor and repairs to drilling equipment, among other expenditures. Under a normal income tax, the rules would allow depreciation of these costs before the calculation of taxes owed, but not full expensing. This ability to immediately expense exploration and development costs decreases the amount of income that can be taxed, thus creating a subsidy.9 Originally implemented in 1916, this subsidy is based on the rationale that it reduces uncertainty for oil companies and encourages exploration, which can increase domestic production, reduce imports and enhance energy security.10
In its assessment of this expensing provision, the Congressional Research Service (CRS) notes that this subsidy may reduce dependence on imported oil in the short run, but it may deplete the nation's oil resources more quickly in the long run. The Congressional Budget Office (CBO) notes that the rationale for this tax subsidy has shifted over time, saying that earlier advocates argued that the costs of exploration and development were ordinary operating expenses, while more recently proponents also argue that oil and natural gas are strategic natural resources essential to the nation's security.11
Payments for Specified Energy Property in Lieu of Tax Credits
The American Reinvestment and Recovery Act of 2009 (ARRA) of 2009 authorized a program through which owners of certain energy property, such as wind farms, who place the property into service for renewable energy projects can receive cash grants in lieu of investment tax credits (ITCs). The Treasury estimates the effect of this grant on outlays to be $1.1 billion in fiscal year 2009 with further increases in fiscal years 2010 and 2011.12
Administered by the Treasury with assistance from the Department of Energy (DOE), the program's guidance notes that demand for investment tax credits had diminished. By offering grants in lieu of tax credits, firms can receive a benefit regardless of their tax liability. According to the guidance, the program will boost investment in renewable energy projects, in order to create jobs in the near-term and expand clean and renewable energy in the long-term.13
While this program is not presented in the table of energy sector tax expenditures in the President's Fiscal Year 2011 Budget, it is presented in a footnote to the table.14 Subsidyscope included the program in the tax expenditure total because its revenue effects are calculated by the Treasury in this footnote. Further, OMB determined that this grant is not considered federal financial assistance,15 and as such it will not ultimately be reported to USAspending.gov and captured in Subsidyscope's database of direct expenditures. However, the program differs from a standard tax expenditure in that the beneficiary information is publicly available on the Treasury Web site.16
Temporary 50 Percent Expensing for Equipment Used in the Refining of Liquid Fuels
The Energy Policy Act of 2005 temporarily allows refineries to expense half of the cost of qualified refinery equipment, with no limit on the amount of the deduction. The remaining half of the cost is subject to normal tax depreciation rules.17 For fiscal year 2009, the estimated revenue loss for this temporary expensing provision was $770 million.
Credit for Energy Efficiency Improvements to Existing Homes
As part of the Energy Policy Act of 2005, Congress passed provisions allowing homeowners to claim a tax credit if they retrofit their homes with energy efficient materials that reduce heat loss in the winter and cooling loss in the summer or if they use more energy efficient heating or cooling systems.18 In fiscal year 2009, the estimated revenue loss for subsidizing energy efficiency improvements to existing homes through this tax credit totaled $570 million.
New Technology Credit (Also Called the Energy Production Credit)
In fiscal year 2009, the new technology credit cost the government an estimated $430 million. The President's FY2011 budget notes that this credit is for "certain electricity produced from wind energy, biomass, geothermal energy, solar energy, small irrigation power, municipal solid waste, or qualified hydropower and sold to an unrelated party. In addition to the electricity production credit, an income tax credit is allowed for the production of refined coal and Indian coal at qualified facilities."19
Excess of Percentage Over Cost Depletion
In addition to expensing intangible drilling costs, certain natural resource extraction companies may be able to deduct a portion of their gross income related to the use and depletion of the asset itself (e.g., oil or mineral reserve) in order to recover part of their capital investment in the resource. In fiscal year 2009, the estimated revenue loss for this tax subsidy was $340 million.20 It has been much higher in past years, peaking at over $1.2 billion in 2004, and is projected to increase again after fiscal year 2009 (see Figure 2).
Normally, accounting practices allow firms to deduct the cost of the depletion of assets from gross income before calculating taxes owed; this allows for the recovery of the capital investment over the period the assets produce income. However, under percentage depletion, firms may deduct a fixed percentage of the "gross income" or revenue they receive from the sale of the mineral. CRS notes that deducting costs this way typically means the deductions exceed the costs of the capital invested in acquiring and developing the reserve.21 Similar to the expensing of exploration and development costs, this subsidy is created by allowing a reduction in taxable income higher than that which would be allowed under normal accounting practices. The subsidy in this case is the difference between what the firm would have received using cost depletion and percentage depletion.22
Figure 2: Percentage Depletion Allowancefrom FY 1998 to FY 2015 ($ millions)
Source: Subsidyscope analysis of Analytical Perspectives, OMB. President's Budget, Fiscal Years, 2000-2011. Numbers provided are from the most recent estimate available.Note:
Tax expenditure estimates and projections are based on current law as of December 31, 2009.
Broad, Cross-sectoral Tax Expenditures
There are various tax expenditures that are used in the energy sector but are available to industries across the economy. The revenue loss of these provisions is not always calculated by the government at the sector level. Where estimates are available, such as for the "Credit for holding clean energy renewable bonds," Subsidyscope provides them and includes them in Table 1. For others, such as accelerated depreciation, there is some research indicating that the benefits to the energy sector are disproportionately higher than other sectors that are less capital intensive. Unfortunately, reliable estimates of the portion that goes to the energy sector are not yet available.
Accelerated Depreciation and Foreign Tax Credit
When a business asset loses value over time it is said to depreciate; such a loss is considered one of the costs of doing business. Special tax depreciation rules can be used to encourage or discourage some types of investments over other investments, which introduces a subsidy. The U.S. tax code allows for accelerated depreciation of certain capital, which means that the tax depreciation is more rapid than economic depreciation. Because the energy sector is very capital and infrastructure intensive, it is likely that it benefits from this tax expenditure to a higher proportion than its share of GDP. In fact, experts note that nuclear power and electricity generated from renewable sources receive particularly generous tax treatment from accelerated depreciation.23
Unfortunately, the government does not currently publish energy-specific tax expenditure estimates of accelerated depreciation so these subsidies are omitted from our estimate of tax expenditure subsidies. To remedy this, Subsidyscope has requested data from the IRS that will allow us to analyze accelerated depreciation by sector and, eventually, include these benefits in our totals for this and other sectors.
Companies in the energy sector, as well as in other sectors, may also benefit from tax provisions such as the Foreign Tax Credit. This tax provision allows companies to take a credit on their U.S. income tax return for certain foreign taxes paid, in order to reduce double taxation.24 Similar to accelerated depreciation, the government does not currently publish energy-specific tax expenditure estimates of the foreign tax credit so these subsidies are omitted from our estimate of tax expenditure subsidies. Subsidyscope is exploring ways to reliably identify and assign this tax advantage to individual sectors.
- Number derived by adding up the tax expenditures in Table 1. See table notes for more information on summing tax expenditures and what it is included in this number.
- In order to truly compare tax expenditure estimates with budget transfers, one should convert tax expenditures into an outlay equivalent, or the amount of money that would be required to deliver the same after-tax amount of benefit to an individual or corporation. For more detail, see: Carasso, Adam, and Gene Steurle. "Tax Expenditures: Revenue Loss versus Outlay Equivalents." October 13, 2003. The Urban-Brookings Tax Policy Center.
- Subsidyscope analysis of FY2009 data in Office of Management and Budget (OMB). "Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2011." p. 209.
- Subsidyscope relies on the Department of the Treasury's (Treasury) tax expenditure estimates presented in the President's Budget; the Joint Committee on Taxation also estimates tax expenditures and has a different methodology for doing so. See this Subsidyscope page for more on these estimates and how they differ. Further, on energy tax expenditures in particular, some hold that there is no bright line between a "general" and "an energy-specific" tax policy, despite the classification in the budget of certain tax expenditures as being specific to energy. For a discussion of this, and general difficulties in producing precise subsidy numbers generally, see: Koplow, Doug. "EIA Energy Subsidy Estimates: A Review of Assumptions and Omissions." March 2010. Earth Track, Inc. Subsidyscope has requested data from the IRS that will allow us to analyze accelerated depreciation by sector. Currently we have no government estimate of how much the energy sector benefits from this tax subsidy, but it could potentially be in the billions.
- Metcalf, Gilbert. "Using Tax Expenditures to Achieve Energy Policy Goals." National Bureau of Economic Research Working Paper Series. No. 13753. Cambridge, MA. January 2008. p. 6.
- EIA. "Federal Financial Interventions and Subsidies in Energy Markets in 2007." April 2008. p. 22.
- OMB. "Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2011." p. 209.
- Congressional Research Service (CRS). "Tax Expenditures: Compendium of Background Material on Individual Provisions." Prepared for the United States Senate Committee on the Budget. December 2008. pp. 129-133.
- Ibid., p. 132.
- CBO. "Budget Options." February 2007. p. 295.
- OMB. "Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2011." p. 213. Future years estimates are: $3,090 million in 2010; $4,460 million in 2011; $4,240 million in 2012; $2,360 million in 2013; $230 million in 2014; and $30 million in 2015.
- U.S. Department of the Treasury, Office of the Fiscal Assistant Secretary. "Payments for Specified Energy Property in Lieu of Tax Credits under the American Recovery and Reinvestment Act of 2009." July 2009 and revised March 2010. p. 3.
- The program is mentioned in Footnote 1 on page 213 of the Analytical Perspectives document accompanying the FY2011 budget. The text of the footnote refers to the 'Energy investment credit,' which is line 16 in Table 16-1. However, the number of the footnote appears to be accidentally listed with line 17 of that table.
- U.S. Department of the Treasury. "ARRA Section 1603 –Grants For Specified Energy Property In Lieu of Tax Credits." Presentation by Ellen Neubauer. September 2009. p. 10.
- As of August 17, 2010, Treasury shows nearly $5.2 billion had been granted to 1113 projects, see Treasury's spreadsheet for more information on recipients.
- Holt, Mark and Glover, Carol. Congressional Research Service. "Energy Policy Act of 2005: Summary and Analysis of Enacted Provisions." March 8, 2006.
- CRS. "Tax Expenditures: Compendium of Background Material on Individual Provisions." Prepared for the United States Senate Committee on the Budget. December 2008. p. 156.
- OMB. "Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2011." p. 226.
- This estimate is for fuel-related extractions only. There is a separate line item for "Excess percentage over cost depletion for nonfuel minerals" in the Analytical Perspectives, and it will be included in Subsidyscope's analysis of the Natural Resources Sector.
- CRS. "Tax Expenditures: Compendium of Background Material on Individual Provisions." Prepared for the United States Senate Committee on the Budget. December 2008. p. 118.
- Ibid., p. 120.
- Metcalf, Gilbert. "Federal Tax Policy towards Energy." Tax Policy and the Economy. Vol. 21. August 2007. p. 157.
- Internal Revenue Service. "Foreign Tax Credit." Last updated September 20, 2009.