Cutting the Federal Budget Wisely

This week the administration issued its third budget since taking office in January 2009. In a year otherwise focused on belt-tightening, the proposal includes a 12% increase for the Department of Energy, focused on additional R&D for renewables and nuclear power. The increase would be offset by cuts in fossil energy programs and the elimination elsewhere in the budget of various tax deductions and tax credits--"tax expenditures" in Beltway parlance--that benefit the US oil and gas industry. Also new for this year are proposed additional fees on the industry to cover the increased cost of issuing drilling permits in the aftermath of the Deepwater Horizon accident, along with another provision to raise the cost of holding inactive oil and gas leases. Aside from the politics involved, this exercise reminds me of the periodic waves of cost-cutting I experienced at Texaco, Inc. in the 1980s and '90s. Unfortunately, the government hasn't yet learned the vital lesson that my former company and many in other industries finally figured out after years of experience: Reducing expenses only helps your bottom line when the items you are cutting contribute less in revenue than they cost.

Start with the oil and gas subsidies, which I've discussed previously. The newly submitted budget estimates these at approximately $4 billion per year. As we heard the President say in his latest State of the Union address, "I'm asking Congress to eliminate the billions in taxpayer dollars we currently give to the oil companies. (Applause.) I don't know if--I don't know if you've noticed, but they're doing just fine on their own. (Laughter.) So instead of subsidizing yesterday's energy, let's invest in tomorrow's." It's a guaranteed applause line, as the White House's own text indicates, despite including potentially serious errors of fact.

Now, one could argue in the abstract whether a tax credit or deduction constitutes a gift of "taxpayer money" (i.e., the government's) or an opportunity for the taxpayer in question to remit less of his own money to the government. I know how I feel about that when it comes to filing my form 1040. One might even arrive at different answers in different situations. As a practical matter, however, what counts in the current context is not whose money this is in the first place, but whether taking more of it leaves either the federal government or the US economy better off. Even from the perspective of tax revenue, a recent study found that after an initial increase, the long-term impact of higher taxes on the oil & gas industry resulted in reduced government revenue. Higher taxes on US oil & gas production will translate into less of both--and so less to tax--while also yielding more future imports and higher trade deficits, along with reduced energy security.

The President's remarks also suggested incorrectly that oil and gas are yesterday's energy, and not also today's and tomorrow's. In 2009 oil and gas accounted for 62% of our energy consumption, and the US Department of Energy expects them to continue to supply as much as 57% of our needs in 2035, after subtracting the contribution of liquid biofuels. Treating these key energy sources as undesirable could have serious consequences for our energy and economic security in the years ahead. Nor would it assist our efforts to reduce greenhouse gas emissions. Natural gas can contribute significantly to reducing the emissions from the power sector, which accounts for 40% of US CO2 emissions, and the main opportunities for reducing emissions from transportation, where most of our oil use takes place, are on the user side--conservation and more efficient cars, trucks and planes--and not on the extraction, refining and distribution side of the industry.

If the administration couldn't get these tax changes enacted in the previous Congress, they stand even less chance this term. However, that might not be the case for the additional "user fees" and lease fees, since they are new this year. The former are related to the redesign of the oversight agency for offshore drilling and were recommended by the Presidential commission investigating the accident. As I noted when their report came out, we already have a mechanism for recouping the expenses that the Bureau of Ocean Energy, Management, Regulation and Enforcement (formerly the Minerals Management Service) incurs in the course of reviewing leases and drilling permits and monitoring offshore activity. That mechanism is the lease bids and royalties that brought in $8 billion from onshore and offshore oil and gas in fiscal 2010. In a good year these sums could cover the entire Interior Dept. budget, let alone that of BOEMRE. Adding new fees on top of the existing royalties further reduces the attractiveness of drilling in US waters, on top of the "moratorium/permitorium" --now in its tenth month--for which critics finally received a belated explanation earlier this month. The net result of new fees would be less drilling here and more drilling in places like offshore Brazil.

Then there's the notion of "establishing fees for new non-producing oil and gas leases (both onshore and offshore) to encourage more timely production." This is clearly an outgrowth of the "idle leases" canard that was making the rounds in 2008. However, in light of protracted delays in issuing new permits and the likelihood that fewer permits will be issued in the future than in the past, it seems almost Kafkaesque to penalize companies for not drilling sooner on more of their leases. In truth, companies already pay twice for non-producing leases: once when they pay a bid bonus to acquire the lease, and then every year in the form of a lease rent that is due as long as the lease remains undeveloped. Companies factor this into the bonuses they bid, along with their assessment of the likelihood that a lease contains commercial quantities of oil or gas. Additional fees on non-producing leases seem likely to result in one or more of the following outcomes: lower bonus bids, fewer bids, and an increased focus outside the US. None of that would help either the deficit or energy security.

I'm entirely supportive of the government cutting expenses, including unwarranted subsidies, in order to begin the difficult task of bringing the federal budget closer to balance within the next few years. This seems essential if we're to avoid serious consequences for our credit rating, interest rates, and exchange rate. However, along the lines of what I saw when the oil industry reduced expenses in the aftermath of the big oil price drops of the mid-1980s and 1998-9, it would be counterproductive to do so in a manner that would actually result in lower overall tax receipts, while reducing domestic energy production in the bargain. Ultimately, it makes a lot more sense to target repealing the tax expenditures in question as part of the broader tax reform that seems inevitable if we want to get the deficit under control. That would eliminate specific tax breaks but simultaneously reduce overall corporate tax rates to make US industry more competitive globally, not less. A budget that proposes to double corporate income tax receipts by 2013--to a level higher than their 2007 asset bubble peak--is out of step with the competitiveness agenda that the administration has espoused, aside from its shortcomings in narrowing the long-term deficit.