Today Senate Finance Chairman Sen. Max Baucus (D-Mont.) released a tax reform draft that would severely hamstring America’s energy producers by reducing their ability to redeploy capital investments. The recent American energy boon, one of the few bright spots in the American economy, is predicated on large, successive capital outlays.

An IHS study estimates that just the development of unconventional oil and natural gas resources will:

  • Require $5.1 trillion in capital expenditures between 2012 and 2035
  • Create and support nearly 2.5 million jobs by 2015 and 3.5 million in 2035
  • Annually contribute $475 billion to GDP by 2035

These economic benefits are only possible if energy companies are allowed to recover their billion dollar investments in a timely manner. Unfortunately, Sen. Baucus’s draft inhibits domestic investment, killing thousands of American energy jobs.

Baucus’s Energy Tax hikes – a deduction delayed is a deduction denied

Lengthen Intangible Drilling Cost to 5 years: Currently, independent producers can deduct 100 percent of their intangible drilling costs in the year they are incurred while integrated oil companies may deduct 70 percent of their intangible costs in the year they are incurred. The Baucus draft, much like the Obama plan, would require energy companies to recovery these costs over 5 years. Wood-Mackenzie economists analyzed the effects of a similar proposal and found that:

  • Investment through the drilling and development of oil and gas resources will decline by $407 billion over the period 2014 to 2023
  • This is driven by a reduction in drilling by an average of 8,000 wells and over 400 rigs per year
  • The impact on employment is to lose an average of 225,000 jobs per year of which an estimated 65,000 would be direct oil and gas industry jobs
  • By 2023 we expect the IDC delay case production to be 3.8 mmboed (or 14%) lower than the current case

Lengthen Tertiary Injectants and Geological and Geophysical expenditures to 5 years: In 2005, geological and geophysical costs were available to be amortized over a two year period. Since then, Congress has twice extended the G&G amortization period to seven years for the largest integrated companies. Now Sen. Baucus is looking to require small, independent energy producers to move to a five year amortization period.

Repeal Last In First Out accounting method with 8 years to pay at a new lower rate: Since 1938, companies have had a choice between using “first-in, first-out” (FIFO) and “last-in, first, out” (LIFO) to account for the profit made on a good sold. The Sen. Baucus draft would eliminate the longstanding LIFO practice and force companies to pay the government billions of dollars in “unaccounted for profits” accrued over the last 60 years.  President Obama similarly proposed to end LIFO in his FY 2014 budget which would have raised taxes by a whopping $80 billion – $28.3 billion would be paid by oil and natural gas producers.

Repeal percentage depletion: For over a century, there have been two ways to calculate the income deduction coinciding with a mineral asset’s rate of depletion: percentage depletion and cost depletion. The preferred method of deduction, percentage depletion, allows the producer to deduct the gross income derived from extracting fossil fuels or other minerals.

Under President Obama’s comparable percentage depletion repeal proposal, oil and natural gas companies would see their taxes rise by nearly $11 billion over the next ten years and hard mineral producers (think coal) taxes rise by $2 billion over the same period. 

All business outlays should be fully expensed in the year they are incurred

Not only is immediate expensing fair and simple, but it would spur economic growth permanently increasing long-run GDP by 2.28 percent. Wages over time would rise by 2.07 percent.

Picking and choosing who is allowed to deduct what when invites politicians to reward parochial interests and punish disliked industries, in this case oil and natural gas producers. Instead of continuing to carve up the tax code like Sen. Baucus’s Cost Recovery Proposal does, a more prudent tax reform plan would level the playing field for all businesses by allowing companies to fully deduct all their expenses in the year they are incurred.