My focus is somewhat narrower than Becker’s; it will be on subsidizing the U.S. oil industry by means of tax breaks.
The current and I think healthy concern with the growing gap between federal revenue and federal spending has focused attention on all sorts of questionable fiscal arrangements. One of these is tax subsidies. Conservatives have managed to make tax increases seem un-American, yet it is obvious that the few politically feasible spending cuts, both present and future, that are under discussion cannot begin to close the revenue-expenditure gap. Hence the attention to tax subsidies. The term is misleading. A tax subsidy is not an expenditure, but a selective tax reduction, as distinct from some general or uniform reduction. Hence to eliminate a tax subsidy is to raise taxes. But eliminating a tax “subsidy” sounds like reducing wasteful government spending rather than raising taxes, so it has more popular appeal than an explicit tax increase.
But that doesn’t mean that it’s any more feasible politically. The American political system is not that democratic, or at least not that populist. The fact that tax subsidies tend to be targeted on particular activities means that a proposal to eliminate a tax subsidy catalyzes interest-group opposition, often formidable since if the interest group were weak, the tax subsidy would not have been legislated in the first place. Tax subsidies are eliminated from time to time, and it would be interesting to speculate on the conditions that make that possible, but I will not attempt that here.
Not all subsidies are bad; not all tax subsidies are bad, for there is no economic reason for thinking that all activities should be taxed at the same rate. A subsidy is defensible on economic grounds if it encourages the production of benefits that would be underproduced from an overall social-welfare standpoint were it not for subsidy. That is the argument for allowing expenditures for research and development to be written off (deducted from taxable income) on an accelerated schedule; R&D is underproduced from an overall social-welfare standpoint because even with a patent system one firm’s R&D is quite likely to confer benefits on other firms for which the firm conducting the R&D will not be compensated; note in this connection that one requirement for a patent is that the applicant disclose the invention, and that disclosure may convey valuable information to competitors even though they cannot practice the patented invention without the patentee’s authorization.
Is there a similar case for giving oil producers subsidies? The principal tax subsidies for the oil industry are as follows: a “domestic manufacturing deduction” that allows oil and gas companies to deduct an extra 6 percent of their taxable income; a deduction for “intangible costs,” which are costs for investments in oil exploration or production that have no salvage value, such as clearing land to enable an oil well to be drilled—the oil companies are not required to amortize these costs over the entire expected life of the oil well—and last the companies are permitted to deduct royalties they pay to foreign government, on the ground that royalties paid to a government are really a tax.
The aggregate values of these subsidies to the U.S. oil industry is approximately $5 billion a year, almost as much as the industry pays in federal income tax ($5.7 billion). The industry's total profits exceed $30 billion, so it would not be facing a crushing burden if the subsidies were to be eliminated; the Obama Administration proposes to eliminate only $2 billion of the subsidies.
The first two types of subsidy (the domestic manufacturing and intangible costs deductions) are likely to increase domestic oil production, and the industry argues that expanded domestic production creates external benefits (that is, benefits not reaped by the oil companiess) by reducing our dependence on foreign oil, much of it produced by hostile or unstable countries. (The third subsidy, treating royalties paid to foreign governments as deductible taxes, can’t be defended on this ground—it encourages American oil companies to increase their production abroad.) This is true, but the effect is probably small, especially relative to imposing a stiff tariff on oil imports (as suggested by Becker). The tariff would actually generate revenue for the federal government without being called a tax (though that is what a tariff is), reduce the income of foreign oil-producing countries, and increase domestic production by making foreign oil more costly. In addition, as Becker also mentions, more U.S. public lands, and more territorial waters of the Gulf, Atlantic, and Pacific coasts, could be opened to drilling for oil.
The advocates of eliminating the tax subsidies for the oil companies argue that the oil industry’s profits are excessive in relation to the high prices of gasoline at the point, but eliminating the subsidies would result in higher, rather than lower, gasoline prices because it would reduce overall production of oil.
But that wouldn’t be a bad thing! Our problems with oil are not limited to oil imports, but include the environmental damage (particularly the effect on climate) caused by the burning of oil, oil spills, and traffic congestion. High prices for gasoline, which reduce demand and therefore consumption, are the equivalent of a pollution tax, and should be encouraged. They would also reduce imports.
So both the advocacy of the tax subsidies for the oil industry and the advocacy for eliminating them are unsound, but the case for eliminating them is strong. Oil is not our future, and the expansion of the industry should not be encouraged. The oil companies even acknowledge, or at least pretend to acknowledge, a willingness to give up their subsidies if subsidies to other industries are likewise abolished. This is not a good argument either, because those subsidies, though most of them are no more justifible than the tax subsidies for the oil industry, do not impose costs on that industry. The argument amounts to saying that since the world is imperfect, I should be free to cheat and steal.