In a speech on April 22, 2009 (Earth Day), President Obama linked the importance of winning the technological race to develop clean energy sources with the economic problems associated with U.S. dependence on an oil-based society. The President said that the federal deficit and the trade deficit, as well as global warming, were all related to U.S. dependence on oil, especially imported oil. He also described a fickle attitude held by American consumers, who typically are outraged by high gasoline prices or shortages, while displaying apathy toward the issue of oil prices during periods of low prices. In a market economy, governments can, and do, alter the behavior of consumers and producers through tax and subsidy policies. If the government wants to discourage the consumption of a commodity, it can raise the cost of the good to consumers by levying taxes at various stages of the production process, or by levying a direct tax at the point of sale. Typically, the higher cost faced by the consumer will lead to reduced consumption. If the government chooses to encourage the development, or consumption, of a good, it can lower the price consumers face through subsidies, typically applied to the producers of the good, who then may pass the benefit of reduced costs on to consumers in the form of lower prices. Given the President's position on shifting U.S. energy consumption patterns toward renewable energy sources, his FY2011 budget proposal includes both subsidies for alternative energy sources and increased taxes on the oil and natural gas industries. This report analyzes the likely economic effects that might occur if the President's proposed tax increases on the oil industry are enacted by Congress. During most of the 20 th century, the oil industry enjoyed favorable tax treatment in comparison with other U.S. industries through tax provisions such as the percentage depletion allowance and the write-off of intangible drilling expenses. These benefits helped to keep petroleum product costs low and encouraged consumption. Low gasoline prices were, and are, a factor in both residential and business location decisions, holiday travel, and other aspects of American life. Many of these decisions represent economic investments that might no longer be viable if the relative price of gasoline and oil increases. For example, when the price of gasoline rose to over $4 per gallon, based on oil prices that rose to over $145 per barrel in 2008, consumers shifted their spending away from sport utility vehicles and light trucks toward more fuel efficient vehicles, reducing the sales and profitability of the U.S. automobile industry, accelerating the collapse of the industry. Shifting the U.S. energy consumption pattern from oil to alternative fuels is unlikely to occur without adjustment costs to consumers and U.S. industry. In addition, available technology makes it unlikely that rapid large-scale transformations of usage patterns can be achieved. Although hybrid fueled automobiles are becoming popular, gasoline-powered vehicles promise to dominate the U.S. auto stock for some time. Over two-thirds of U.S. oil consumption is in the transportation sector, and it is unclear how renewable fuels can be utilized to substantially alter that pattern. Under the pressure of an economic recession, which began at the end of 2007 and continues to affect the United States in 2010, a financial crisis that has required federal support for the banking system and financial markets, and the costs of new policy initiatives in health care, carbon emissions, and other areas, the level of projected federal revenues and deficits is a matter of concern in terms of achieving a structural change in preferences for petroleum products and alternative energy. The desire to shift the nation away from oil, and to try to control the federal deficit, has led to a number of proposals to increase taxes on the oil industry. Table 1 identifies the proposed tax changes for the oil industry, and the White House's estimates of the impact of each on projected deficit effects to 2015, if enacted. Many of these measures also have the effect of equalizing the treatment of the independent oil producers to that of the major oil companies. This equalization is accomplished through eliminating preferential tax treatment of the independent companies compared to that of the major oil companies. In some cases—for example, the expensing of intangible drilling expenses—the major oil companies have been excluded from the benefits of the tax provision while the benefit was still in effect for the independent oil producers. Although the White House prefers to call these proposals deficit reductions, or the elimination of tax preferences, they, for the most part, eliminate tax expenditures and would actually, or potentially, under certain market conditions, increase tax revenues. Compared to the FY2010 federal budget request, the 2011 document differs in that it eliminates the excise tax provisions on Gulf of Mexico oil and gas production. This tax provision was intended to equalize the royalty rate on certain deepwater drilling projects that were allowed to pay a zero royalty rate until specified production targets had been reached. As shown in Table 1 , the proposed revenue changes would have immediate effects in 2011 of raising over $2.6 billion. Over half of the total proposed deficit reduction from 2011 to 2015 would come from only two of the proposals. These two proposals could increase taxes on the oil industry, and influence its behavior. The repeal of the expensing of intangible drilling expenses, and the rescinding of the manufacturing tax deduction for the oil industry, would increase the industry's tax payments by $25 billion through 2020. The enhanced oil recovery tax credit allows for a credit of 15% of allowable costs associated with the use of oil recovery technologies, including the injection of carbon dioxide to supplement natural well pressure, that enhance production of older wells. The credit is only available during periods of low oil prices, determined by yearly guidance with respect to what constitutes a low price. The credit has not been in effect over the past several years. Elimination of this credit would likely not have any effect on current oil supplies, unless the price of oil is low, a market period usually associated with excess supply in the market. During periods of excess supply, it is unlikely that keeping older, high-cost, low-production-rate wells producing is the optimal strategy, based on the inability of the price of oil to cover the costs associated with operating these wells. Tertiary injection expenses, including the injectant cost, can be deducted in the current tax year. Supporters of the current favorable treatment of these expenses point to the importance of tertiary recovery in maintaining the output of older wells, as well as the environmental advantages of injecting carbon dioxide, a primary tertiary injectant, into wells. Repeal of the deduction, or less favorable tax treatment of the expenses, would be likely to reduce output if the profit margin on oil were low. In a high-oil-price environment, the repeal is likely to have a smaller effect on production levels. The marginal well tax credit was implemented as the result of a recommendation by the National Petroleum Council in 1994 to keep low-production oil and natural gas wells in production during periods of low prices for these fuels. This tax credit is designed to maximize U.S. production levels even when volatile energy markets result in low prices. It is believed that up to 20% of U.S. oil production, and 12% of natural gas production, is sourced from this category of well. The credit was enacted in 2004, but has not been necessary because market prices have been high enough since that time to justify production without the credit. The credit is not likely to be an important factor if prices remain high, or if the United States is successful in transitioning to alternative energy sources. The high-cost wells that fall into the marginal well category are likely to be some of the first to be eliminated on economic efficiency grounds if a reduction in petroleum demand is achieved. Repeal of the passive loss exception for working interests in oil and natural gas properties is a relatively small item in terms of deficit reduction contribution—$98 million from 2011 to 2015. The provision exempts working interests in gas and oil exploration and development from being categorized as "passive income (or loss)" with respect to the Tax Reform Act of 1986. This categorization permits the deduction of losses in oil and gas projects against other active income earned, and is believed to act as an incentive to induce investors to finance oil and gas projects. The most significant item in the proposed budget in terms of oil and natural gas industry tax liabilities is the repeal of the manufacturing tax deduction. As shown in Table 1 , the White House estimates that repeal of this deduction would contribute approximately $7.3 billion in federal deficit reduction for the period 2011 to 2015. The total tax revenue might increase to $17.3 billion by 2020, according to the budget proposal. This provision was enacted in 2004 as part of the American Jobs Creation Act to encourage the expansion of American employment in manufacturing. The oil industry was categorized as a manufacturing industry, and hence, eligible for the deduction, which was to be phased in over several years, beginning at 3% in 2005 and rising to a maximum of 9% in 2010. The base of the tax is net income from domestic manufacturing activities, capped by a payroll limitation. This tax deduction was intended to increase domestic employment in manufacturing at a time when there was concern that manufacturing jobs were migrating overseas. By allowing a percent deduction of net income, up to the payroll limitation, the effective cost of labor to the manufacturer was reduced. The reduction in net labor cost was intended to expand employment, increase output, and reduce prices, making domestically manufactured goods more competitive in the world market. Although the oil and natural gas industries are classified as manufacturing industries for national data reporting purposes, they differ from traditional factory manufacturing in a number of ways. Most importantly, the level of oil production is only indirectly related to the level of employment. This implies that if wage costs go down, due to the tax deduction, there is less chance that the industry will increase employment. Even if employment did increase, it would be expected to be of a minor magnitude due to the capital-intensive nature of the industry.