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The costs and benefits of eliminating the corporate income tax

By Andrew Evans
web posted October 19, 2009

"Anadarko wins court fight over Gulf royalties" screams the headline in the business section of the Houston Chronicle.

At issue is the question of Federal royalty (read: corporate income tax) waivers for companies drilling in the Gulf of Mexico. On October 5, the Supreme Court upheld a 5th US Circuit of Appeals decision that the Interior Department had illegally rescinded Anadarko's royalty waivers, establishing a precedent for twenty-one similar cases that—according to U.S. Solicitor General Elena Kagan—will cost the US government "probably at least $19 billion."

What exactly is going on here?

"Royalties" are basically the government's euphemism for taxes on the money a business makes: penalties on productivity, in other words. In an attempt to stimulate Gulf Coast oil production, Congress passed a law in 1995 that allowed companies to waive their royalties so long as their production stayed under a certain volume of oil. Quite naturally, companies such as Anadarko took this golden opportunity and focused all their energies on producing exactly that amount of oil—making maximum profits on the free market while still paying zero royalties to the government. Production and efficiency soared until companies began reaching this "penalty line" at which royalties must again be paid. Since no one wanted to pay royalties, supply began to stagnate. With demand increasing steadily, it's no surprise that the price—and profits—for companies like Anadarko went steadily upward as well. The Interior Department did not like this and decided to arbitrarily impose a price ceiling on royalty waivers rather than the volume ceiling that Congress had initially set up. Anadarko sued, and the courts (and now the Court) agree that the Interior Department illegally charged Anadarko millions of dollars in royalties.

So what are the implications of this decision?

According to Rep. Ed Markey, D-Mass., it means that "the oil industry now stands to see a geyser of tens of billions of dollars in windfall profits at the expense of American taxpayers." But is that really the case? All that the courts have done is strike down the Interior Department's arbitrary re-writing of a rather explicit Congressional law; nothing new is being done—in fact "new" things are being destroyed! So Markey is wrong in assuming that some new, evil source of profit-making is being enacted; rather, his own Congress' previous decision has been upheld. Whether that decision was wise in the first place is another matter entirely.

Markey's sentiments seem to be shared by the author of the article, who paints the case in terms of the oil companies bleeding the government of its hard earned money. The opposite is true: royalties on corporate profits bleed (tax) the oil industry of its hard earned money. If it's true that you get less of what you tax, then as long as the U.S. government taxes corporate profits, we'll have less corporate profits. So why not remove taxes on corporate profits entirely? The outcome is easy enough to predict: efficiency and volume will increase while price will decrease. That is exactly what happened when Congress removed penalties on corporate profits for oil companies in 1995. But that law was not perfect. Rather than simply eliminating royalties altogether, Congress imposed a volume ceiling at which royalties kicked back in. What did Congress expect other than to see oil companies race forward to achieve that volume and then cease innovation once their incentives dropped away?

So what happens if Congress eliminates corporate income taxes for oil companies across the board? It is safe to predict that the oil industry will once again have incentive to innovate, and we will see American production of oil increase in volume and efficiency. However, our government will receive less money in taxes. Let us now consider the costs and benefits to determine the desirability of eliminating entirely corporate income taxes for oil companies.

Costs: Eliminating the tax on corporate incomes will significantly lower our government's revenue. This means that the government will have less money to spend on programs such as bailouts and Cash for Clunkers.

Benefits: Eliminating the tax on corporate incomes will significantly increase the oil industry's ability to re-invest in itself and expand America's domestic oil industry. This will reduce our dependence on foreign oil and stimulate our domestic economy by providing jobs, profits, and lower prices for American consumers.

So the question becomes, "Do the benefits outweigh the costs?" Perhaps you disagree with my rather general lists of costs and benefits, but I would argue that eliminating the corporate income tax for oil companies would greatly stimulate the economic growth and innovation that is so necessary to that sector of our economy. I would go farther and argue that we should eliminate the corporate income tax across the board—for all industries—with the aim of stimulating the growth of domestic industry in general. By all means tax personal income and/or personal consumption, but by taxing corporations—the entities that create and innovate—and reducing their ability to re-invest and grow themselves, we are handicapping our nation's domestic industry at the benefit of foreign nations who gladly take up the slack. And until we remove the parking brake from the car that is our nation's domestic industry, we're not going anywhere. Clunk. ESR

Andrew Evans is a senior in high school and this is his first contribution to Enter Stage Right.


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