Rep. David Camp, R-Mich., who chairs the tax-writing House Ways and Means Committee, released comprehensive tax reform legislation earlier this year. Though widely praised for trying to simplify the tax code and include provisions that would attract Democrats, Republicans had reservations about the effort. His subsequent decision to retire means his proposal has little chance of passing this year.
But tax reform will remain a front-burner issue, especially as the presidential election heats up. The code is in desperate need of streamlining, but future attempts need to be wary of stifling industries that are essential to our country's economic growth, particularly the energy sector.
Over the last decade, oil and natural gas firms have become a pillar of the American economy. According to Standard & Poor's Capital IQ, three oil companies alone paid in $290 billion in corporate income taxes between 2007 and 2012. And the oil and gas companies support nearly 10 million jobs that also provide tax revenue.
Yet this industry has come under heavy fire in previous tax reform campaigns. President Obama has repeatedly called for an end to the industry's “special tax breaks.” Rep. Camp's plan would have driven up the sector's tax burden by eliminating what's called the “Last-In, First-Out” (LIFO) accounting method.
LIFO allows companies to assume for tax purposes that the last inventory to be received is the first to be sold. By contrast, “First-In, First-Out” (FIFO) assumes that the first inventory received is the first to be sold.
For companies whose products cost more to make today than they did last week, it can make a huge difference. LIFO allows a company to deduct, for tax purposes, that last-in, higher-cost inventory first. That's important if that higher-cost inventory has to be replaced with even higher-cost inventory. And that's where we are with the oil and gas industry.
It's not the 1920s anymore, when driving a stake in the ground could produce a gusher. Innovative techniques such as horizontal drilling and hydraulic fracture stimulation (i.e., “fracking”) are responsible for the energy boom onshore, but those processes don't come cheap.
Moreover, developing new oil fields in deep water like the outer continental shelf of the Gulf of Mexico costs billions of dollars and can take years before the black gold starts flowing.
For example, Exxon announced in 2013 that it will spend $4 billion drilling in an oil field in the Gulf of Mexico that was first discovered in 2007. And Chevron is spending $16 billion to develop three gulf fields, with production expected to start this year. Energy-producing companies need to be allowed to use a tax option that accommodates those rising costs.
Past attempts at tax reform have proposed eliminating LIFO, which would effectively drive up tax rates faced by energy companies. That would leave less capital for firms to invest in new projects and deprive Americans of new jobs.
The country needs pro-growth tax reform, but eliminating a widely used inventory valuation method may actually cost government revenue and stifle the economic growth this country so desperately needs.