Energy Tax Policy: History and Current Issues
Released: 2008-10-30T00:00:00

Introduction

Energy tax policy involves the use of the government's main fiscal instruments—taxes (financial disincentives) and tax subsidies (or incentives)—to alter the allocation or configuration of energy resources. In theory, energy taxes and subsidies, like tax policy instruments in general, are intended either to correct a problem or distortion in the energy markets or to achieve some social, economic (efficiency, equity, or even macroeconomic), environmental, or fiscal objective. In practice, however, energy tax policy in the United States is made in a political setting, being determined by the views and interests of the key players in this setting: politicians, special interest groups, bureaucrats, and academic scholars. This implies that the policy does not generally, if ever, adhere to the principles of economic or public finance theory alone; that more often than not, energy tax policy may compound existing distortions, rather than correct them.

The idea of applying tax policy instruments to the energy markets is not new, but until the 1970s, energy tax policy had been little used, except for the oil and gas industry. Recurrent energy-related problems since the 1970s—oil embargoes, oil price and supply shocks, wide petroleum price variations and price spikes, large geographical price disparities, tight energy supplies, and rising oil import dependence, as well as increased concern for the environment—have caused policymakers to look toward energy taxes and subsidies with greater frequency.

Comprehensive energy policy legislation containing numerous tax incentives, and some tax increases on the oil industry, was signed on August 8, 2005 ( P.L. 109-58 ). The law, the Energy Policy Act of 2005, contained about $15 billion in energy tax incentives over 11 years, including numerous tax incentives for the supply of conventional fuels. However, record oil industry profits, due primarily to high crude oil and refined oil product prices, and the 2006 mid-term elections, which gave the control of the Congress to the Democratic Party, has changed the mood of policymakers. Instead of stimulating the traditional fuels industry—oil, gas, and electricity from coal—in addition to incentivizing alternative fuels and energy conservation, the mood now is to take away, or rescind, the 2005 tax incentives and use the money to further stimulate alternative fuels and energy conservation. A minor step in this direction was made, on May 17, 2006, when President Bush signed a $70 billion tax reconciliation bill ( P.L. 109-222 ). This bill included a provision that further increased taxes on major integrated oil companies by extending the depreciation recovery period for geological and geophysical costs from two to five years (thus taking back some of the benefits enacted under the 2005 law). And currently, the major tax writing committees in both Houses are considering further, but more significant, tax increases on the oil and gas industry to fund additional tax cuts for the alternative fuels and energy conservation industries. These bills are being considered as part of the debate over new versions of comprehensive energy policy legislation in the 110 th Congress ( H.R. 6 ).

This report discusses the history, current posture, and outlook for federal energy tax policy. It also discusses current energy tax proposals and major energy tax provisions enacted in the 109 th Congress. (For a general economic analysis of energy tax policy, see CRS Report RL30406, Energy Tax Policy: An Economic Analysis , by [author name scrubbed].)

Background

The history of federal energy tax policy can be divided into four eras: the oil and gas period from 1916 to 1970, the energy crisis period of the 1970s, the free-market era of the Reagan Administration, and the post-Reagan era—including the period since 1998, which has witnessed a plethora of energy tax proposals to address recurring energy market problems.

Energy Tax Policy from 1918 to 1970: Promoting Oil and Gas

Historically, federal energy tax policy was focused on increasing domestic oil and gas reserves and production; there were no tax incentives for energy conservation or for alternative fuels. Two oil/gas tax code preferences embodied this policy: (1) expensing of intangible drilling costs (IDCs) and dry hole costs, which was introduced in 1916, and (2) the percentage depletion allowance, first enacted in 1926 (coal was added in 1932).

Expensing of IDCs (such as labor costs, material costs, supplies, and repairs associated with drilling a well) gave oil and gas producers the benefit of fully deducting from the first year's income ("writing off") a significant portion of the total costs of bringing a well into production, costs that would otherwise (i.e., in theory and under standard, accepted tax accounting methods) be capitalized (i.e., written off during the life of the well as income is earned). For dry holes, which comprised on average about 80% of all the wells drilled, the costs were also allowed to be deducted in the year drilled (expensed) and deducted against other types of income, which led to many tax shelters that benefitted primarily high-income taxpayers. Expensing accelerates tax deductions, defers tax liability, and encourages oil and gas prospecting, drilling, and the development of reserves.

The oil and gas percentage depletion allowance permitted oil and gas producers to claim 27.5% of revenue as a deduction for the cost of exhaustion or depletion of the deposit, allowing deductions in excess of capital investment (i.e, in excess of adjusted cost depletion)—the economically neutral method of capital recovery for the extractive industries. Percentage depletion encourages faster mineral development than cost depletion (the equivalent of depreciation of plants and equipment).

These and other tax subsidies discussed later (e.g., capital gains treatment of the sale of successful properties, the special exemption from the passive loss limitation rules, and special tax credits) reduced marginal effective tax rates in the oil and gas industries, reduced production costs, and increased investments in locating reserves (increased exploration). They also led to more profitable production and some acceleration of oil and gas production (increased rate of extraction), and more rapid depletion of energy resources than would otherwise occur. Such subsidies tend to channel resources into these activities that otherwise would be used for oil and gas activities abroad or for other economic activities in the United States. Relatively low oil prices encouraged petroleum consumption (as opposed to conservation) and inhibited the development of alternatives to fossil fuels, such as unconventional fuels and renewable forms of energy. Oil and gas production increased from 16% of total U.S. energy production in 1920 to 71.1% of total energy production in 1970 (the peak year).

Energy Tax Policy During the 1970s: Conservation and Alternative Fuels

Three developments during the 1970s caused a dramatic shift in the focus of federal energy tax policy. First, the large revenue losses associated with the oil and gas tax preferences became increasingly hard to justify in the face of increasing federal budget deficits—and in view of the longstanding economic arguments against the special tax treatment for oil and gas, as noted in the above paragraph. Second, heightened awareness of environmental pollution and concern for environmental degradation, and the increased importance of distributional issues in policy formulation (i.e., equity and fairness), lost the domestic oil and gas industry much political support. Thus, it became more difficult to justify percentage depletion and other subsidies, largely claimed by wealthy individuals and big vertically integrated oil companies. More importantly, during the 1970s there were two energy crises: the oil embargo of 1973, also known as the first oil shock, and the Iranian Revolution in 1978-1979, which focused policymakers' attention on the problems (alleged "failures") in the energy markets and how these problems reverberated throughout the economy, causing stagflation, shortages, productivity problems, rising import dependence, and other economic and social problems.

These developments caused federal energy tax policy to shift from oil and gas supply toward energy conservation (reduced energy demand) and alternative energy sources.

Three broad actions were taken through the tax code to implement the new energy tax policy during the 1970s. First, the oil industry's two major tax preferences—expensing of IDCs and percentage depletion—were significantly reduced, particularly the percentage depletion allowance, which was eliminated for the major integrated oil companies and reduced for the remaining producers. Other oil and gas tax benefits were also cut back during this period. For example, oil- and gas-fired boilers used in steam generation (e.g., to generate electricity) could no longer qualify for accelerated depreciation as a result of the Energy Tax Act of 1978 (as discussed below).

The second broad policy action was the imposition of several new excise taxes penalizing the use of conventional fossil fuels, particularly oil and gas (and later coal). The Energy Tax Act of 1978 (ETA, P.L. 95-618 ) created a federal "gas guzzler" excise tax on the sale of automobiles with relatively low fuel economy ratings. This tax, which is still in effect, currently ranges from $1,000 for an automobile rated between 21.5 and 22.5 miles per gallon (mpg) to $7,700 for an automobile rated at less than 12.5 mpg. Chief among the taxes on oil was the windfall profit tax (WPT) enacted in 1980 ( P.L. 96-223 ). The WPT imposed an excise tax of 15% to 70% on the difference between the market price of oil and a predetermined (adjusted) base price. This tax, which was repealed in 1988, was part of a political compromise that decontrolled oil prices. (Between 1971 and 1980, oil prices were controlled under President Nixon's Economic Stabilization Act of 1970—the so-called "wage-price freeze.") (For more detail on the windfall profit tax on crude oil that was imposed from 1980 until its repeal in 1988, see CRS Report RL33305, The Crude Oil Windfall Profit Tax of the 1980s: Implications for Current Energy Policy , by [author name scrubbed].)

Another, but relatively small, excise tax on petroleum was instituted in 1980: the environmental excise tax on crude oil received at a U.S. refinery. This tax, part of the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 ( P.L. 96-510 ), otherwise known as the "Superfund" program, was designed to charge oil refineries for the cost of releasing any hazardous materials that resulted from the refining of crude oil. The tax rate was set initially at 0.79¢ ($0.0079) per barrel and was subsequently raised to 9.70¢ per barrel. This tax expired at the end of 1995, but legislation has been proposed since then to reinstate it as part of Superfund reauthorization.

The third broad action taken during the 1970s to implement the new and refocused energy tax policy was the introduction of numerous tax incentives or subsidies (e.g., special tax credits, deductions, exclusions) for energy conservation, the development of alternative fuels (renewable and nonconventional fuels), and the commercialization of energy efficiency and alternative fuels technologies. Most of these new tax subsidies were introduced as part of the Energy Tax Act of 1978 and expanded under the WPT, which also introduced additional new energy tax subsidies. The following list describes these:

Residential and Business Energy Tax Credits. The ETA provided income tax credits for homeowners and businesses that invested in a variety of energy conservation products (e.g., insulation and other energy-conserving components) and for solar and wind energy equipment installed in a principal home or a business. The business energy tax credits were 10% to 15% of the investment in conservation or alternative fuels technologies, such as synthetic fuels, solar, wind, geothermal, and biomass. These tax credits were also expanded as part of the WPT, but they generally expired (except for business use of solar and geothermal technologies) as scheduled either in 1982 or 1985. A 15% investment tax credit for business use of solar and geothermal energy, which was made permanent, is all that remains of these tax credits. Tax Subsidies for Alcohol Fuels. The ETA also introduced the excise tax exemption for gasohol, recently at 5.2¢ per gallon out of a gasoline tax of 18.4¢/gal. Subsequent legislation extended the exemption and converted it into an immediate tax credit (currently at 51¢/gallon of ethanol ). Percentage Depletion for Geothermal . The ETA made geothermal deposits eligible for the percentage depletion allowance, at the rate of 22%. Currently the rate is 15%. §29 Tax Credit for Unconventional Fuels. The 1980 WPT included a $3.00 (in 1979 dollars) production tax credit to stimulate the supply of selected unconventional fuels: oil from shale or tar sands, gas produced from geo-pressurized brine, Devonian shale, tight formations, or coalbed methane, gas from biomass, and synthetic fuels from coal. In current dollars this credit, which is still in effect for certain types of fuels, was $6.56 per barrel of liquid fuels and about $1.16 per thousand cubic feet (mcf) of gas in 2004. Tax-Exempt Interest on Industrial Development Bonds. The WPT made facilities for producing fuels from solid waste exempt from federal taxation of interest on industrial development bonds (IDBs). This exemption was for the benefit of the development of alcohol fuels produced from biomass, for solid-waste-to-energy facilities, for hydroelectric facilities, and for facilities for producing renewable energy. IDBs, which provide significant benefits to state and local electric utilities (public power), had become a popular source of financing for renewable energy projects.

Some of these incentives—for example, the residential energy tax credits—have since expired, but others remain and still new ones have been introduced, such as the §45 renewable electricity tax credit, which was introduced in 1992 and expanded under the American Jobs Creation Act of 2004 ( P.L. 108-357 ). This approach toward energy tax policy—subsidizing a plethora of different forms of energy (both conventional and renewable) and providing incentives for diverse energy conservation (efficiency) technologies in as many sectors as possible—has been the paradigm followed by policymakers since the 1970s. A significant increase in nontax interventions in the energy markets—laws and regulations, such as the Corporate Average Fuel Economy (CAFE) standards to reduce transportation fuel use, and other interventions through the budget and the credit markets—has also been a significant feature of energy policy since the 1970s. This included some of the most extensive energy legislation ever enacted.

Energy Tax Policy in the 1980s: The "Free-Market Approach"

The Reagan Administration opposed using the tax law to promote oil and gas development, energy conservation, or the supply of alternative fuels. The idea was to have a more neutral and less distortionary energy tax policy, which economic theory predicts would make energy markets work more efficiently and generate benefits to the general economy. The Reagan Administration believed that the responsibility for commercializing conservation and alternative energy technologies rested with the private sector and that high oil prices—real oil prices (corrected for inflation) were at historically high levels in 1981 and 1982—would be ample encouragement for the development of alternative energy resources. High oil prices in themselves create conservation incentives and stimulate oil and gas production.

President Reagan's free-market views were well known prior to his election. During the 1980 presidential campaign, he proposed repealing the WPT, deregulating oil and natural gas prices, and minimizing government intervention in the energy markets. The Reagan Administration's energy tax policy was professed more formally in several energy and tax policy studies, including its 1981 National Energy Policy Plan and the 1983 update to this plan; it culminated in a 1984 Treasury study on general tax reform, which also proposed fundamental reforms of federal energy tax policy. In terms of actual legislation, many of the Reagan Administration's objectives were realized, although as discussed below there were unintended effects.

In 1982, the business energy tax credits on most types of nonrenewable technologies—those enacted under the ETA of 1978—were allowed to expire as scheduled; other business credits and the residential energy tax credits were allowed to expire at the end of 1985, also as scheduled. Only the tax credits for business solar, geothermal, ocean thermal, and biomass technologies were extended. As mentioned above, today the tax credit for business investment in solar and geothermal technologies, which has since been reduced to 10%, is all that remains of these tax credits. A final accomplishment was the repeal of the WPT, but not until 1988, the end of Reagan's second term. The Reagan Administration's other energy tax policy proposals, however, were not adopted. The tax incentives for oil and gas were not eliminated, although they were pared back as part of the Tax Reform Act (TRA) of 1986.

Although the Reagan Administration's objective was to create a free-market energy policy, significant liberalization of the depreciation system and reduction in marginal tax rates—both the result of the Economic Recovery Tax Act of 1981 (ERTA, P.L. 97-34 )—combined with the regular investment tax credit and the business energy investment tax credits, resulted in negative effective tax rates for many investments, including alternative energy investments, such as solar and synthetic fuels. Also, the retention of percentage depletion and expensing of IDCs (even at the reduced rates) rendered oil and gas investments still favored relative to investments in general.

Energy Tax Policy After 1988

After the Reagan Administration, several major energy and non-energy laws were enacted that amended the energy tax laws in several ways, some major.

Revenue Provisions of the Omnibus Reconciliation Act of 1990. President George H.W. Bush's first major tax law included numerous energy tax incentives: (1) for conservation (and deficit reduction), the law increased the gasoline tax by 5¢/gallon and doubled the gas-guzzler tax; (2) for oil and gas, the law introduced a 10% tax credit for enhanced oil recovery expenditures, liberalized some of the restrictions on the percentage depletion allowance, and reduced the impact of the alternative minimum tax on oil and gas investments; and (3) for alternative fuels, the law expanded the §29 tax credit for unconventional fuels and introduced the tax credit for small producers of ethanol used as a motor fuel. Energy Policy Act of 1992 ( P.L. 102-486 ). This broad energy measure introduced the §45 tax credit, at 1.5¢ per kilowatt hour, for electricity generated from wind and "closed-loop" biomass systems. (Poultry litter was added later.) For new facilities, this tax credit expired at the end of 2001 and again in 2003 but has been retroactively extended by recent tax legislation (as discussed below). In addition, the 1992 law (1) added an income tax deduction for the costs, up to $2,000, of clean-fuel powered vehicles; (2) liberalized the alcohol fuels tax exemption; (3) expanded the §29 production tax credit for nonconventional energy resources; and (4) liberalized the tax breaks for oil and gas. Omnibus Budget Reconciliation Act of 1993 ( P.L. 103-66 ). President Clinton proposed a differential Btu tax on fossil fuels (a broadly based general tax primarily on oil, gas, and coal based on the British thermal units of heat output), which was dropped in favor of a broadly applied 4.3¢/gallon increase in the excise taxes on motor fuels, with revenues allocated for deficit reduction rather than the various trust funds. Taxpayer Relief Act of 1997 ( P.L. 105-34 ) . This law included a variety of excise tax provisions for motor fuels, of which some involved tax reductions on alternative transportation fuels, and some involved increases, such as on kerosene, which on balance further tilted energy tax policy toward alternative fuels. Tax Relief and Extension Act. Enacted as Title V of the Ticket to Work and Work Incentives Improvement Act of 1999 ( P.L. 106-170 ), it extended and liberalized the 1.5¢/kWh renewable electricity production tax credit, and renewed the suspension of the net income limit on the percentage depletion allowance for marginal oil and gas wells.

As this list suggests, the post-Reagan energy tax policy returned more to the interventionist course established during the 1970s and primarily was directed at energy conservation and alternative fuels, mostly for the purpose of reducing oil import dependence and enhancing energy security. However, there is an environmental twist to energy tax policy during this period, particularly in the Clinton years. Fiscal concerns, which for most of that period created a perennial search for more revenues to reduce budget deficits, have also driven energy tax policy proposals during the post-Reagan era. This is underscored by proposals, which have not been enacted, to impose broad-based energy taxes such as the Btu tax or the carbon tax to mitigate greenhouse gas emissions.

Another interesting feature of the post-Reagan energy tax policy is that while the primary focus continues to be energy conservation and alternative fuels, no energy tax legislation has been enacted during this period that does not also include some, relatively minor, tax relief for the oil and gas industry, either in the form of new tax incentives or liberalization of existing tax breaks (or both).

Energy Tax Incentives in Comprehensive Energy Legislation Since 1998

Several negative energy market developments since about 1998, characterized by some as an "energy crisis," have led to congressional action on comprehensive energy proposals, which included numerous energy tax incentives.

Brief History of Comprehensive Energy Policy Proposals

Although the primary rationale for comprehensive energy legislation has historically been spiking petroleum prices, and to a lesser extent spiking natural gas and electricity prices, the origin of bills introduced in the late 1990s was the very low crude oil prices of that period. Domestic crude oil prices reached a low of just over $10 per barrel in the winter of 1998-1999, among the lowest crude oil prices in history after correcting for inflation. From 1986 to 1999, oil prices averaged about $17 per barrel, fluctuating between $12 and $20 per barrel. These low oil prices hurt oil producers, benefitted oil refiners, and encouraged consumption. They also served as a disincentive to conservation and investment in energy efficiency technologies and discouraged production of alternative fuels and renewable technologies. To address the low oil prices, there were many tax bills in the first session of the 106 th Congress (1999) focused on production tax credits for marginal or stripper wells, but they also included carryback provisions for net operating losses, and other fossil fuels supply provisions.

By summer 1999, crude oil prices rose to about $20 per barrel, and peaked at more than $30 per barrel by summer 2000, causing higher gasoline, diesel, and heating oil prices. To address the effects of rising crude oil prices, legislative proposals again focused on production tax credits and other supply incentives. The rationale was not tax relief for a depressed industry but tax incentives to increase output, reduce prices, and provide price relief to consumers.

In addition to higher petroleum prices there were forces—some of which were understood (factors such as environmental regulations and pipeline breaks) and others that are still are not so clearly understood—that caused the prices of refined petroleum products to spike. In response, there were proposals in 2000 to either temporarily reduce or eliminate the federal excise tax on gasoline, diesel, and other special motor fuels. The proposals aimed to help consumers (including truckers) cushion the financial effect of the price spikes. The Midwest gasoline price spike in summer 2000 kept interest in these excise tax moratoria alive and generated interest in proposals for a windfall profit tax on oil companies, which, by then, were earning substantial profits from high prices.

Despite numerous bills to address these issues, no major energy tax bill was enacted in the 106 th Congress. However, some minor amendments to energy tax provisions were enacted as part of non-energy tax bills. This includes Title V of the Ticket to Work and Work Incentives Improvement Act of 1999 ( P.L. 106-170 ). Also, the 106 th Congress did enact a package of $500 million in loan guarantees for small independent oil and gas producers ( P.L. 106-51 ).

Energy Tax Action in the 107th Congress

In early 2001, the 107 th Congress faced a combination of fluctuating oil prices, an electricity crisis in California, and spiking natural gas prices. The gas prices had increased steadily in 2000 and reached $9 per thousand cubic feet (mcf) at the outset of the 107 th Congress. At one point, spot market prices reached about $30 per mcf, the energy equivalent of $175 per barrel of oil. The combination of energy problems had developed into an "energy crisis," which prompted congressional action on a comprehensive energy policy bill—the first since 1992—that included a significant expansion of energy tax incentives and subsidies and other energy policy measures.

In 2002, the House and Senate approved two distinct versions of an omnibus energy bill, H.R. 4 . While there were substantial differences in the nontax provisions of the bill, the energy tax measures also differed significantly. The House bill proposed larger energy tax cuts, with some energy tax increases. It would have reduced energy taxes by about $36.5 billion over 10 years, in contrast to the Senate bill, which cut about $18.3 billion over 10 years, including about $5.1 billion in tax credits over 10 years for two mandates: a renewable energy portfolio standard ($0.3 billion) and a renewable fuel standard ($4.8 billion). The House version emphasized conventional fuels supply, including capital investment incentives to stimulate production and distribution of oil, natural gas, and electricity. This focus assumed that recent energy problems were due mainly to supply and capacity shortages driven by economic growth and low energy prices. In comparison, the Senate bill would have provided a much smaller amount of tax incentives for fossil fuels and nuclear power and somewhat fewer incentives for energy efficiency, but provided more incentives for alternative and renewable fuels. The conference committee on H.R. 4 could not resolve differences, so the bills were dropped on November 13, 2002.

Energy Tax Action in the 108th Congress

On the House side, on April 3, 2003, the Ways and Means Committee (WMC) voted 24-12 for an energy tax incentives bill ( H.R. 1531 ) that was incorporated into H.R. 6 and approved by the House on April 11, 2003, by a vote of 247-175. The House version of H.R. 6 provided about $17.1 billion of energy tax incentives and included $83 million of non-energy tax increases, or offsets. This bill was a substantially scaled-down version of the House energy tax bill, H.R. 2511 (107 th Congress), which was incorporated into H.R. 4 , the House energy bill of the 107 th Congress that never became law. After returning from the August 2003 recess, a House and Senate conference committee negotiated differences among provisions in three energy policy bills: the House and Senate versions of H.R. 6 , and a substitute to the Senate Finance Committee (SFC) bill—a modified (or amended) version of S. 1149 substituted for Senate H.R. 6 in conference as S.Amdt. 1424 and S.Amdt. 1431 .

On November 14, 2003, House and Senate conferees reconciled the few remaining differences over the two conference versions of H.R. 6 , which primarily centered on several energy tax issues—ethanol tax subsidies, the §29 unconventional fuels tax credit, tax incentives for nuclear power, and clean coal. On November 18, 2003, the House approved, by a fairly wide margin (246-180), the conference report containing about $23.5 billion of energy tax incentives. However, the proposed ethanol mandate would further reduce energy tax receipts—the 10-year revenue loss was projected to be around $26 billion. On November 24, Senate Republicans put aside attempts to enact H.R. 6 . A number of uneasy alliances pieced together to bridge contentious divides over regional issues as varied as electricity, fuel additives (MTBE), and natural gas subsidies, failed to secure the necessary 60 votes to overcome a Democratic filibuster before Congress's adjournment for the holiday season. This represented the third attempt to pass comprehensive energy legislation, a top priority for many Republicans in Congress and for President Bush.

Senator Domenici introduced a smaller energy bill as S. 2095 on February 12, 2004. S. 2095 included a slightly modified version of the amended energy tax bill S. 1149 ; the tax provisions of S. 2095 were added to the export tax repeal bill S. 1637 , on April 5, 2004. The Senate approved S. 1637 , with the energy tax measures, on May 11. H.R. 4520 , the House version of the export tax repeal legislation, did not contain energy tax measures; they were incorporated into H.R. 6 .

Some energy tax incentives were enacted on October 4, 2004, as part of the Working Families Tax Relief Act of 2004 ( P.L. 108-311 ), a $146 billion package of middle class and business tax breaks. This legislation, which was signed into law on October 4, 2004, retroactively extended four energy tax subsidies: the §45 renewable tax credit, suspension of the 100% net income limitation for the oil and gas percentage depletion allowance, the $4,000 tax credit for electric vehicles, and the deduction for clean fuel vehicles (which ranges from $2,000 to $50,000). The §45 tax credit and the suspension of the 100% net income limitation had each expired on January 1, 2004; they were retroactively extended through December 31, 2005. The electric vehicle credit and the clean-vehicle income tax deduction were being phased out gradually beginning on January 1, 2004. P.L. 108-311 arrested the phase-down—providing 100% of the tax breaks—through 2005, but resumed it beginning on January 1, 2006, when only 25% of the tax break was available. (For more information, see CRS Report RL32265, Expired and Expiring Energy Tax Incentives , by [author name scrubbed].)

The American Jobs Creation Act of 2004 ( P.L. 108-357 ), commonly referred to as the "FSC-ETI" or "jobs" bill, was enacted on October 22, 2004. It included about $5 billion in energy tax incentives.

Energy Action in the 109th Congress

The 109 th Congress enacted the Energy Policy Act of 2005 ( P.L. 109-58 ), which included the most extensive amendments to U.S. energy tax laws since 1992, and the Tax Relief and Health Care Act of 2006, which extended the energy tax subsidies enacted under the 2005 Energy Policy Act (EPACT05).

The Energy Policy Act of 2005 (P.L. 109-58)

On June 28, 2005, the Senate approved by an 85-12 vote a broadly based energy bill ( H.R. 6 ) with an 11-year, $18.6 billion package of energy tax breaks tilted toward renewable energy resources and conservation. Joint Committee on Taxation figures released on June 28 show that the bill included about $0.2 billion in non-energy tax cuts and more than $4.7 billion in revenue offsets, meaning the bill had a total tax cut of $18.8 billion over 11 years, offset by the $4.7 billion in tax increases. The House energy bill, which included energy tax incentives totaling about $8.1 billion over 11 years, and no tax increases, was approved in April. This bill was weighted almost entirely toward fossil fuels and electricity supply. On July 27, 2005, the conference committee on H.R. 6 reached agreement on $11.1 billion of energy tax incentives, including $3 billion in tax increases (both energy and non-energy). The distribution of the cuts by type of fuel for each of the three versions of H.R. 6 is shown in Table 1 .

One way to briefly compare the two measures is to compare revenue losses from the energy tax incentives alone and the percentage distribution by type of incentive as a percent of the net energy tax cuts (i.e., the columns marked "%" divided by the dollar figures in row 11). The net revenue losses over an 11-year time frame from FY2005 to FY2015 were estimated by the Joint Committee on Taxation. The total revenue losses are reported in two ways. The absolute dollar value of tax cuts over 11 years and the percentage distribution of total revenue losses by type of incentive for each measure.

Table 1 shows that the conference report provided about $1.3 billion for energy efficiency and conservation, including a deduction for energy-efficient commercial property, fuel cells, and micro-turbines, and $4.5 billion in renewables incentives, including a two-year extension of the tax code §45 credit, renewable energy bonds, and business credits for solar. A $2.6 billion package of oil and gas incentives included seven-year depreciation for natural gas gathering lines, a refinery expensing provision, and a small refiner definition for refiner depletion. A nearly $3 billion coal package provided for an 84-month amortization for pollution control facilities and treatment of §29 as a general business credit. More than $3 billion in electricity incentives leaned more toward the House version, including provisions providing 15-year depreciation for transmission property, nuclear decommissioning provisions, and a nuclear electricity production tax credit. It also provided for the five-year carryback of net operating losses of certain electric utility companies. A Senate-passed tax credit to encourage the recycling of a variety of items, including paper, glass, plastics, and electronic products, was dropped from the final version of the energy bill ( H.R. 6 ). Instead, conferees included a provision requiring the Treasury and Energy departments to conduct a study on recycling. The House approved the conference report on July 28, 2005; the Senate on June 28, 2005, one month later on July 28, 2005, clearing it for the President's signature on August 8 ( P.L. 109-58 ).

Four revenue offsets were retained in the conference report: reinstatement of the Oil Spill Liability Trust Fund; extension of the Leaking Underground Storage Tank (LUST) trust fund rate, which would be expanded to all fuels; modification of the §197 amortization, and a small increase in the excise taxes on tires. The offsets total roughly $3 billion compared with nearly $5 billion in the Senate-approved H.R. 6 . Because the oil spill liability tax and the Leaking Underground Storage Tank financing taxes are imposed on oil refineries, the oil and gas refinery and distribution sector (row 2 of Table 1 ) received a net tax increase of $1,769 ($2,857-$1,088).

The Tax Increase Prevention and Reconciliation Act (P.L. 109-222)

After expanding energy tax incentives in the EPACT05, the 109 th Congress moved to rescind oil and gas incentives, and even to raise energy taxes on oil and gas, in response to the high energy prices and resulting record oil and gas industry profits. Many bills were introduced in the 109 th Congress to pare back or repeal the oil and gas industry tax subsidies and other loopholes, both those enacted under EPACT05 as well as those that preexisted EPACT05. Many of the bills focused on the oil and gas exploration and development (E&D) subsidy—expensing of intangible drilling costs (IDCs). This subsidy, which has been in existence since the early days of the income tax, is available to integrated and independent oil and gas companies, both large and small alike. It is an exploration and development incentive, which allows the immediate tax write-off of what economically are capital costs, that is, the costs of creating a capital asset (the oil and gas well).

Public and congressional outcry over high crude oil and product prices, and the oil and gas industry's record profits, did lead to a paring back of one of EPACT05's tax subsidies: two-year amortization, rather than capitalization, of geological and geophysical (G&G) costs, including those associated with abandoned wells (dry holes). Prior to the EPACT05, G&G costs for dry holes were expensed in the first year and for successful wells they were capitalized, which is consistent with economic theory and accounting principles. The Tax Increase Prevention and Reconciliation Act, ( P.L. 109-222 ), signed into law May 2006, reduced the value of the subsidy by raising the amortization period from two years to five years, still faster than the capitalization treatment before the 2005 act, but slower than the treatment under that act. The higher amortization period applies only to the major integrated oil companies—independent (unintegrated) oil companies may continue to amortize all G&G costs over two years—and it applies to abandoned as well as successful properties. This change increased taxes on major integrated oil companies by an estimated $189 million over 10 years, effectively rescinding about 20% of the nearly $1.1 billion 11-year tax for oil and gas production under EPACT05.

The Tax Relief and Health Care Act of 2006 (P.L. 109-432)

At the end of 2006, the 109 th Congress enacted a tax extenders package that included extension of numerous renewable energy and excise tax provisions. Many of the renewable energy provision in this bill had already been extended under the Energy Policy Act of 2005 and were not set to expire until the end of 2007 or later.

The Tax Relief and Health Care Act of 2006 provided for one-year extensions of these provisions.

Current Posture of Energy Tax Policy

The above background discussion of energy tax policy may be conveniently summarized in Table 2 , which shows current energy tax provisions—both special (or targeted) energy tax subsidies and targeted energy taxes—and related revenue effects. A minus sign ("-") indicates revenue losses, which means that the provision is a tax subsidy or incentive, intended to increase the subsidized activity (energy conservation measures or the supply of some alternative and renewable fuel or technology); no minus sign means that the provision is a tax, which means that it should reduce supply of, or demand for, the taxed activity (either conventional fuel supply, energy demand, or the demand for energy-using technologies, such as cars).

Note that the table defines those special or targeted tax subsidies or incentives as those that are due to provisions in the tax law that apply only to that particular industry and not to others. Thus, for example, in the case of the oil and gas industry, the table excludes tax subsidies and incentives of current law that may apply generally to all businesses but that may also confer tax benefits to it. There are numerous such provisions in the tax code; a complete listing of them is beyond the scope of this report. However, the following example illustrates the point: The current system of depreciation allows the writeoff of equipment and structures somewhat faster than would be the case under both general accounting principles and economic theory; the Joint Committee on Taxation treats the excess of depreciation deductions over the alternative depreciation system as a tax subsidy (or "tax expenditure"). In FY2006, the JCT estimates that the aggregate revenue loss from this accelerated depreciation deduction (including the expensing under IRC §179) is $6.7 billion. A certain, but unknown, fraction of this revenue loss or tax benefits accrues to the domestic oil and gas industry, but separate estimates are unavailable. This point applies to all the industries reflected in Table 2 .

Energy Tax Policy in the 110th Congress

Continued high crude oil and petroleum product prices and oil and gas industry profits, and the political realignment of the Congress resulting from the 2006 Congressional elections continued the energy policy shift toward increased taxes on the oil and gas industry, and the emphasis on energy conservation and alternative and renewable fuels rather than conventional hydrocarbons. In the 110 th Congress, the shift became reflected in proposals to reduce oil and gas production incentives or subsidies, which were initially incorporated into, but ultimately dropped from comprehensive energy policy legislation. In the debate over these two comprehensive energy bills, raising taxes on the oil and gas industry, by either repealing tax incentives enacted under EPACT05, by introducing new taxes on the industry, or by other means was a key objective, motivated by the feeling that additional tax incentives were unnecessary—record crude oil and gasoline prices and industry profits provides sufficient (if not excessive) incentives.

In early December 2007, it appeared that the congressional conferees had reached agreement on another comprehensive energy bill, the Energy Independence and Security Act ( H.R. 6 ), and particularly on the controversial energy tax provisions. The Democratic leadership in the 110 th Congress proposed to eliminate or reduce tax subsidies for oil and gas and use the additional revenues to increase funding for their energy policy priorities: energy efficiency and alternative and renewable fuels (i.e., reducing fossil fuel demand) rather than an energy (oil and gas) supply increase. In addition, congressional leaders wanted to extend many of the energy efficiency and renewable fuels tax incentives that either had expired or were about to expire.

The compromise on the energy tax title in H.R. 6 proposed to raise taxes by about $21 billion to fund extensions and liberalization of existing energy tax incentives. However, the Senate stripped the controversial tax title from its version of the comprehensive energy bill ( H.R. 6 ) and then passed the bill (86-8) on December 13, 2007, leading to the President's signing of the Energy Independence and Security Act of 2007 ( P.L. 110-140 ), on December 19, 2007. The only tax-related provisions that survived were (1) an extension of the Federal Unemployment Tax Act surtax for one year, raising about $1.5 billion, (2) higher penalties for failure to file partnership returns, increasing revenues by $655 million, and (3) an extension of the amortization period for geological and geophysical expenditures from five to seven years, raising $103 million in revenues. The latter provision was the only tax increase on the oil and gas industry in the final bill. Those three provisions would offset the $2.1 billion in lost excise tax revenues going into the federal Highway Trust Fund as a result of the implementation of the revised Corporate Average Fuel Economy standards. The decision to strip the much larger $21 billion tax title stemmed from a White House veto threat and the Senate's inability to get the votes required to end debate on the bill earlier in the day. Senate Majority Leader Harry Reid's (D-Nev.) effort to invoke cloture fell short by one vote, in a 59-40 tally.

Since then, the Congress had tried several times to pass energy tax legislation, and thus avoid the impending expiration of several popular energy tax incentives, such as the "wind" energy tax credit under Internal Revenue Code (IRC) §45, which, since its enactment in 1992, had lapsed three times only to be reinstated. Several energy tax bills have passed the House but not the Senate, where on several occasions, the failure to invoke cloture failed to bring up the legislation for consideration. Senate Republicans objected to the idea of raising taxes to offset extension of expiring energy tax provisions, which they consider to be an extension of current tax policy rather than new tax policy. In addition, Senate Republicans objected to raising taxes on the oil and gas industry, such as by repealing the (IRC) §199 deduction, and by streamlining the foreign tax credit for oil companies. The Bush administration repeatedly threatened to veto these types of energy tax bills, in part because of their proposed increased taxes on the oil and gas industry.

H.R. 5351

Frustrated with the lack of action on energy tax legislation over the last two years, House Democrats introduced and approved several such bills, such as H.R. 5351 , which was approved by the House on February 27, 2008. House Speaker Pelosi and other Democrats sent President Bush a letter February 28, 2008, urging him to reconsider his opposition to the Democratic renewable energy plan, arguing that their energy tax plan would "correct an imbalance in the tax code."

H.R. 6049

As noted, several times the House had approved energy tax legislation, and several times in the Senate such legislation failed a cloture vote and thus could not be brought to the floor for debate. The latest was H.R. 6049 , the House tax extenders bill, which was approved by the House on May 21, 2008, but failed three cloture votes in the Senate.

H.R. 6899

In the House, energy tax provisions were part of H.R. 6899 , House Democratic leadership's draft of broad-based energy policy legislation, the Comprehensive American Energy Security and Consumer Protection Act. Passed on September 16, 2008, the bill reverses the long-standing opposition of Democratic leaders to expanding oil and gas drilling offshore by allowing oil and gas exploration and production in areas of the outer continental shelf that are currently off limits, except for waters in the Gulf of Mexico off the Florida coast. Under the bill, states could allow such drilling between 50 and 100 miles offshore, while the federal government could permit drilling from 100 to 200 miles offshore. Revenue from the new offshore leases would be used to assist the development of alternative energy, and would not be shared by the adjacent coastal states. The bill also repeals the current ban on leasing federal lands for oil shale production if states enact laws providing for such leases and production. H.R. 6899 also enacts a renewable portfolio standard, a mandate or requirement that power companies must generate 15% of their energy from renewable sources by 2020.

The energy tax provisions in H.R. 6899 (Title XIII, the Energy Tax Incentives Act of 2008) are largely the same as those in H.R. 5351

Substitute Amendment of S. 3478

In the Senate, legislative efforts on energy tax incentives and energy tax extenders had centered around S. 3478 , the Energy Independence and Investment Act of 2008, a $40 billion energy tax bill offered by Finance Committee Chairman Max Baucus and ranking Republican Charles Grassley. Senate Majority Leader Harry Reid said on September 12 that S. 3478 was "must-pass" legislation. Reid told reporters the energy tax package, which includes extensions of tax incentives for renewable energy, should be prioritized even ahead of the broader energy policy bills being considered, and the rest of the non-energy tax extenders package. Reid said he hopes to bring the bill to the floor during the week of September 15, but noted that the schedule depends on whether Senate Republicans will agree to move to the legislation.

Although most of the tax incentives in the bill are extensions of existing policy and are not controversial, the legislation would need to be paid for through new sources of revenue. One proposed offset—which had been previously blocked by some Republicans—would have completely repealed the IRC §199 manufacturing deduction for the five major oil and gas producers, raising $13.9 billion over 10 years. The bill also would have included a new 13% excise tax on oil and natural gas pumped from the Outer Continental Shelf, a proposal to eliminate the distinction between foreign oil-and-gas extraction income and foreign oil-related income, and an extension and increase in the oil spill tax through the end of 2017. In total, tax increases on the oil and gas industry would account for $31 billion of the $40 billion total cost of the legislation. The final major offset would have come from a requirement on securities brokers to report on the cost basis for transactions they handle to the Internal Revenue Service, a provision expected to raise about $8 billion in new revenues over 10 years.

The Economic Stabilization Act of 2008 (P.L. 110-343)

As noted above, some Republicans had, in the past, objected to the idea of raising taxes to offset extension of expiring energy tax provisions, which they consider to be an extension of current tax policy rather than new tax policy. In addition, some Senate Republicans have objected to raising taxes on the oil and gas industry, particularly by repealing the IRC §199 deduction. The Bush Administration threatened also to veto any energy tax bill that would increase taxes on the oil and gas industry. At this writing, it appears that inclusion of the §199 deduction repeal as an offset might preclude the energy tax bill from coming to the Senate floor—some believe that it would fail another cloture vote—so this provision might not survive the process.

Given continued Republican opposition (including a possible Presidential veto), and to avoid another legislative impasse—a failed cloture vote—Senators Baucus and Grassley released a scaled-down version of S. 3478 . This energy tax extenders package (i.e., the substitute of S. 3478 ) is a substitute amendment to the previously House-approved energy tax extenders bill H.R. 6049 ; is valued at nearly $17 billion, less than half the size of S. 3478 ; and is fully offset. The modified draft bill would also raise revenue by increasing the tax burden on the oil industry. Unlike the original version of S. 3478 , however, which would have repealed the §199 for major integrated oil companies completely, the substitute bill would freeze the value of the manufacturing deduction for all oil companies at 6%, the current rate. This modification is estimated to raise $4.9 billion over 10 years, about 2/3 less than complete repeal. Because of smaller tax increases, the bill's remaining provisions—measures to increase tax subsidies for renewable fuels and for energy efficiency—had to be cut back. Thus, the scaled-down bill drops the nuclear electricity production tax credit provision, scales back the §45 renewable electricity tax credit, and generally shortens the extension periods.

The substitute amendment of S. 3478 ( S.Amdt. 5633 ) was added to H.R. 6049 , which also includes an AMT patch, disaster tax relief, and extensions of (non-energy) individual and business tax provisions. It was passed by the Senate on September 23, by a vote of 93-2. There was only one change to the original Baucus/Grassley substitute version: Language extending a 10¢ per-gallon credit for small producers of alcohol fuels was eliminated in the final bill.

Finally, H.R. 6049 , including the energy tax amendments approved by the Senate, were added to the economic stabilization legislation ( H.R. 1424 ) as Subdivision B, the Energy Improvement and Extension Act of 2008. On October 3, President Bush signed this legislation, the Economic Stabilization Act of 2008 ( P.L. 110-343 ), which includes $17 billion in energy tax incentives, primarily extensions of pre-existing provisions, but also including several new energy tax incentives: $10.9 billion in renewable energy tax incentives aimed at clean energy production, $2.6 billion in incentives targeted toward cleaner vehicles and fuels, and $3.5 billion in tax breaks to promote energy conservation and energy efficiency. The cost of the energy tax extenders legislation is fully financed, or paid for, by raising taxes on the oil and gas industry (mostly by reducing oil and gas tax breaks) and by other tax increases. The oil and gas tax increases comprise cutbacks in the IRC §199 manufacturing deduction for income attributable to oil and gas production, which will be frozen at 6% (rather than increasing to 9% as scheduled), reforming the foreign tax credit provisions, and by increasing the per-barrel tax rate on refinery crude oil under the Oil Spill Liability Trust Fund provisions.

Windfall Profit Tax Legislation

Over the past ten years, surging crude oil and petroleum product prices have increased oil and gas industry revenues and generated record profits particularly for the top five major integrated companies (also known as the "super-majors"): Exxon-Mobil, Royal Dutch Shell, BP, Chevron, and Conoco/Phillips. These companies, which reported a predominate share of those profits, generated over $100 billion dollars in profits on nearly $1.5 trillion of revenues in 2007. From 2003 to 2007, revenues increased by 51%; net income (profits) increased by 85%. Oil output for the five majors over this time period declined by over 2%, from 9.85 to 9.63 million barrels per day. Since oil industry income has been largely price driven, with no increase in output, and with little new production resulting from increased oil industry investment, many believe that a portion of the increased income over this period represents a windfall and unearned gain, i.e., income not earned by any additional effort on the part of the firms, but due primarily to record crude oil prices, which are set in the world oil marketplace.

Numerous bills have been introduced in the Congress over this period to impose a windfall profit tax (WPT) on oil. Most of the bills were introduced in the 109 th and 110 th Congresses, after the enactment of the Energy Policy Act of 2005, which provided additional oil and gas industry tax incentives, on top of the industry's traditional tax subsidies. S. 3044 , for instance, would roll back $17 billion in existing tax breaks over 10 years for the largest oil companies and impose a 25% windfall profit tax on major oil companies; revenues would be earmarked to expanding renewable energy development. In general, an excise-tax based WPT, like the one in effect from 1980-1988, would increase marginal oil production costs, reduce domestic oil supply, and raise petroleum imports, making the United States more dependent on foreign oil, undermining goals of energy independence and energy security. By contrast, the income-tax based WPT would be more economically neutral (less distortionary) in the short-run: sizeable revenues could be raised without reducing domestic oil supplies, which means oil imports would not tend to increase. Neither the excise-tax based or income-tax based WPT are expected to have significant price effects: neither tax would increase the price of crude oil, which means that refined petroleum product prices, such as pump prices, would likely not tend to increase.

In lieu of these two types of WPT, an administratively simple way of increasing the tax burden on the oil industry, and therefore recouping some of the excess or windfall profits, particularly from major integrated producers, would raise the corporate tax rate, by, for instance repealing or reducing the domestic manufacturing activities deduction under IRC §199. This deduction is presently 6% of a firm's net income and is available generally to all domestic manufacturing businesses (service firms are excluded), including almost all oil firms. Repealing this deduction for the major integrated oil companies, and freezing it at 6% for the remaining qualifying oil companies is estimated by the Joint Committee on Taxation to generate about $10 billion over 10 years.

For an analysis of windfall profit legislation, see CRS Report RL34689, Oil Industry Financial Performance and the Windfall Profits Tax , by [author name scrubbed] and [author name scrubbed].

Energy Tax Provisions in the Farm Bill (P.L. 110-234)

It should also be mentioned that there are several, relatively small, energy tax provisions in the farm bill ( H.R. 2419 ), which was just recently enacted ( P.L. 110-234 ). These provisions, all intended to promote alternative and renewable fuels from agricultural resources.

For Additional Reading

U.S. Congress, Senate Budget Committee, Tax Expenditures: Compendium of Background Material on Individual Provision , Committee Print, December 2006, 109 th Cong., 2 nd sess.

U.S. Congress, Joint Tax Committee, " Description of the Tax Provisions in H.R. 2776 , The Renewable Energy and Energy Conservation Tax Act of 2007, " June 19, 2007 (JCX-35-07).

U.S. Congress, Joint Tax Committee, " Description of the Chairman ' s Modification to the Provisions of the Energy Advancement and Investment Act of 2007, " June 19, 2007 (JCX-33-07).

U.S. Congress, Joint Tax Committee, Description And Technical Explanation of the Conference Agreement of H.R. 6 , Title XIII, " Energy Tax Policy Tax Incentives Act of 2005, " July 27, 2005.

CRS Report RS21935, The Black Lung Excise Tax on Coal , by [author name scrubbed].

CRS Report RL33302, Energy Policy Act of 2005: Summary and Analysis of Enacted Provisions , by [author name scrubbed] et al. (pdf)

CRS Report RL30406, Energy Tax Policy: An Economic Analysis , by [author name scrubbed].

CRS Report RL30406, Energy Tax Policy: An Economic Analysis , by [author name scrubbed].

CRS Report RL33763, Oil and Gas Tax Subsidies: Current Status and Analysis , by [author name scrubbed].

CRS Report RS22558, Tax Credits for Hybrid Vehicles , by [author name scrubbed].

CRS Report RS22322, Taxes and Fiscal Year 2006 Budget Reconciliation: A Brief Summary , by David L. Brumbaugh.

CRS Report RL33305, The Crude Oil Windfall Profit Tax of the 1980s: Implications for Current Energy Policy , by [author name scrubbed].

CRS Report RL34669, Side-by-Side Comparison of Energy Tax Bills in the House ( H.R. 6049 ) and Senate ( S. 3478 ), by [author name scrubbed].

CRS Report RL34676, Side-by-Side Comparison of the Energy Tax Provisions of H.R. 6899 and the Proposed Substitute of S. 3478 , by [author name scrubbed].

CRS Report RL34689, Oil Industry Financial Performance and the Windfall Profits Tax , by [author name scrubbed] and [author name scrubbed].