Order Code IB10054
Issue Brief for Congress
Received through the CRS Web
Energy Tax Policy
Updated August 23, 2002
Salvatore Lazzari
Resources, Science, and Industry Division
Congressional Research Service ˜ The Library of Congress
CONTENTS
SUMMARY
MOST RECENT DEVELOPMENTS
BACKGROUND AND ANALYSIS
Introduction
Background
Energy Tax Policy from 1918-1970: Promoting Oil and Gas
Energy Tax Policy During the 1970s: Conservation and Alternative Fuels
Reagan’s Free-Market Energy Tax Policy
Energy Tax Policy After Reagan
Energy Tax Proposals in the 107th Congress
Tax Provisions in the Comprehensive Energy Policy Legislation
The Senate Energy Bills (S. 389, S. 596, and S. 517)
The House Approved Bill (H.R. 4)
Bush Administration Proposals
Tax Issues Relating to Electricity Restructuring
LEGISLATION
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Energy Tax Policy
SUMMARY
Historically, federal energy tax policy
The Clinton Administration’s energy tax
promoted the supply of oil and gas. However,
policy was focused on reducing the demand
the 1970s witnessed 1) a significant cutback in
for petroleum by encouraging energy effi-
the oil and gas industry’s tax preferences, 2)
ciency and providing incentives to promote
the imposition of new excise taxes on oil, and
the supply of alternative fuels and the demand
3) the introduction of numerous tax prefer-
for technologies that use these fuels. The
ences for energy conservation, the develop-
Clinton Administration also emphasized the
ment of alternative fuels, and the commercial-
environmental benefits of reducing green-
ization of the technologies for producing these
house gases and addressing possible global
fuels (renewables such as solar, wind, and
climate change.
biomass, and non-conventional fossil fuels
such as shale oil and coalbed methane).
President Bush issued a comprehensive
energy policy initiative in May 2001, and
The Reagan Administration, using a free-
more recently, a global climate change
market approach, advocated repeal of the
initiative, which include limited energy tax
windfall profit tax on oil and the repeal or
measures. The Bush Administration had
phase-out of most energy tax preferences —
originally criticized such measures as being
for oil and gas, as well as alternative fuels.
inconsistent with its free market philosophy.
Due to the combined effects of the Economic
Recovery Tax Act and the energy tax subsi-
Omnibus energy legislation (H.R. 4) that
dies that had not been repealed, which to-
is now in conference would expand energy tax
gether created negative effective tax rates in
incentives significantly. The House passed
some cases, the actual energy tax policy dif-
the bill on August 2, 2001, and the Senate
fered from the stated policy.
approved its version April 25, 2002. Several
energy tax issues are addressed in these bills:
The Bush and Clinton years witnessed a
1) tax incentives to increase the supply of oil
return to a much more activist energy tax
and gas, and the demand for coal; 2) energy
policy, targeted, as in the 1970s, to energy
tax issues relating to energy conservation and
conservation and alternative fuels. While the
energy efficiency; 3) energy tax issues relating
ultimate concern is to reduce the demand for
to alternative fuels; 4) selected issues relating
imported oil, energy tax policy is being view-
to electricity restructuring; and 5) expiring
ed as a tool for achieving environmental and
energy tax provisions. (For more details, see
fiscal objectives. The current posture of en-
CRS Report RL31427, Omnibus Energy
ergy tax policy is weighted toward energy
Legislation: H.R. 4 Side-by-side Comparison.)
conservation — particularly petroleum in
transportation — and alternative fuels supply.
Certain energy tax provisions that had
expired were extended retroactively as part of
an economic stimulus bill (P.L. 107-147).
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MOST RECENT DEVELOPMENTS
On April 25, the Senate approved its version of an omnibus energy bill (H.R. 4) that had
been passed by the House August 2, 2001. Both versions of the legislation include numerous
energy tax provisions. A conference committee is currently meeting to resolve differences
in the two versions of H.R. 4. (For more details, see CRS Report RL31427, Omnibus Energy
Legislation: H.R. 4 Side-by-side Comparison.)
On March 9, President Bush signed the Job Creation and Worker Assistance Act of
2002 (P.L. 107-147), a $42 billion, ten-year tax cut that retroactively extends several energy
tax provisions that had expired on December 31, 2001.
BACKGROUND AND ANALYSIS
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. Energy taxes and subsidies are intended to either correct
a problem or distortion in the energy markets or to achieve some social, economic
(efficiency, equity, or even macroeconomic), environmental, or fiscal objective.
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. 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, 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.
This issue brief discusses the history, current posture, and the outlook for federal energy
tax policy. It also discusses recent energy tax proposals, focusing on the major energy tax
provisions included in omnibus energy legislation (H.R. 4) that is now in conference. (For
a general economic analysis of energy tax policy, see CRS Report RL30406, Energy Tax
Policy: An Economic Analysis.)
Background
The history of federal energy tax policy can basically 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.
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Energy Tax Policy From 1918-1970: 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 percentage depletion allowance for oil and gas 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 a progressively worsening fiscal
picture – increasing federal budget deficits – and in view of the longstanding economic
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arguments against the special tax treatment for oil and gas. 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 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 the increased use of fiscal subsidies or incentives – special
tax credits, deductions, exclusions etc.– to shift from oil and gas supply toward energy
conservation and alternative energy sources.
Three broad actions through the tax code were taken 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 (for example,
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 on oil
and gas (and later coal). Chief among these was the windfall profit tax (WPT) on oil first
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”).
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, which was 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 9.7¢ 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. (See CRS Issue Brief
IB10011.)
The third broad action taken during the 1970s to implement the new and refocused
energy tax policy was the introduction of numerous tax incentives for energy conservation,
the development of alternative fuels (renewable and non-conventional 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 (ETA, P.L. 95-618), and
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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. President Clinton’s FY2001 budget included a solar
credit that is very similar to the 1978 residential energy tax credits. 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, currently at 5.3¢ per gallon (out of a gasoline tax of
18.4¢/gal.). Subsequent legislation extended the exemption and introduced
the alcohol fuels “blenders” tax credits (which are in lieu of the exemption),
and the 10¢/gal., small ethanol producers tax credit. The 1998
Transportation Equity Act (P.L. 105-178) extended the exemption, which
was scheduled to expire, but at reduced rates. (For more information see
CRS Report 98-435 E, Alcohol Fuels Tax Incentives.)
! Gas Guzzler Tax. The ETA created a federal “gas guzzler” excise tax on
the sale of automobiles with relatively low fuel economy ratings. The tax
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. This tax is still in effect.
! 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 either
geo-pressurized brine, Devonian shale, tight formations, and coalbed
methane, gas from biomass, and synthetic fuels from coal. Adjusted for
inflation, this credit, which is still in effect for wells, mines, or plants placed
in service by June 30, 1998 (for coal and biomass facilities) and December
31, 1991 (for all other facilities and wells), was over $6.00 per barrel of
liquid fuels and about $1.00 per thousand cubic feet (mcf) of gas in 1999.
The credit for tight sands gas has been fixed at the 1979 rate of $0.50 per
mcf. (For more information, see CRS Report 97-679 E, Economic Analysis
of the Section 29 Tax Credit for Unconventional Fuels.)
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! 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.
(During the 1970s there was also a significant increase in the number of energy laws and
regulations, such as the CAFÉ (Corporate Average Fuel Economy) standards to reduce
transportation fuel use, and other interventions through the budget and the credit markets.
This included some of the most extensive energy legislation ever enacted. These non-tax
policy measures are not discussed here.)
Reagan’s Free-Market Energy Tax Policy
The Reagan era, the period from 1981-1989, witnessed the first attempt to create a more
free-market energy tax policy by deregulating the energy markets, and by both reducing taxes
and eliminating tax subsidies, both for conservation, alternative fuels, and oil and gas.
President Reagan’s free-market views were well known prior to his election. During
the 1980 presidential campaign, he proposed repeal of the WPT, the deregulation of oil and
natural gas, and the minimization of government intervention, including reduced spending
and taxes. The Reagan Administration opposed using the tax law to promote either 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 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.
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 non-
renewable 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. And 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 the Reagan term.
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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:
! ‘Expensing’ was retained, but there were cutbacks for integrated oil
producers (who would be allowed to expense only 70% of such costs
and amortize – deduct evenly over time – the remaining 30%) and
other reductions;
! Percentage depletion would not apply to lease bonuses, advance
royalties, or any other payments made without regard to actual
production from the property. This amendment applied to geothermal
wells as well as oil and gas properties. Another section of TRA denied
capital gains treatment on certain dispositions of interest in oil and gas
property (and to geothermal property);
! The TRA replaced the old minimum taxes with a new alternative
minimum tax that placed limits on the tax benefits to oil/gas
producers from the expensing of IDCs and the percentage depletion
allowance. (Taxpayers must compute both the standard income tax
and the alternative minimum tax imposed on a variety of tax
preferences or subsidies, and pay the larger of the two.) However, in
an effort to mitigate any burdensome effects of this new tax, only the
excess of the deduction above 65% of net income was to be treated as
a preference item;
! Investments in oil and gas properties were exempted from the passive
loss limitation rules that were intended to curb tax shelter investments
– a working interest in an oil and gas property was not treated as a
passive activity. Thus any losses and credits derived from oil and gas
investment activity could be used as a tax shelter to offset the
taxpayer’s other income without limitations under the passive loss
rules.
While 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. (See, for instance: CRS Report 84-85 E. Effective Tax
Rates on Solar/Wind and Synthetic Fuels as Compared to Conventional Energy Resources.)
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. Other energy
tax policy developments during the Reagan era were as follows:
! The Deficit Reduction Act of 1984 (P.L. 98-369) tinkered with several
energy tax provisions including the WPT and percentage depletion. Also,
the 1984 tax law extended several of the tax incentives for alcohol fuels: (1)
the tax exemption for alcohol fuels mixtures was raised from 5¢ to 6¢; (2)
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the law retained the prior 9¢-per-gallon exemption for neat alcohol fuels,
i.e., those that are at least 85% alcohol, derived from alternative substances,
but it provided for a new exemption of 4.5¢ per gallon for alcohol fuels
derived from natural gas; (3) the alcohol “blenders” credit was raised from
50 cents to 60 cents per gallon; and (4) the duty on alcohol imported for use
as a fuel was increased from 50 cents to 60 cents per gallon.
! In 1986 two environmental excise taxes were enacted on oil: 1) under the
Superfund Amendments and Reauthorization Act of 1986 (P.L. 99-499), an
increase in the Superfund oil tax from 0.79¢ to 8.2¢-per-barrel on domestic
oil received and to 11.7¢ per barrel on imported petroleum. This tax
differential violated the General Agreements on Tariffs and Trade (GATT),
and the Steel Trade Liberalization Program Implementation Act of 1989
(P.L. 101-221) made the rates uniform at 9.7¢ per barrel; and 2) under the
Omnibus Budget Reconciliation Act of 1986 (P.L. 99-510), imposition of
the Oil Spill Liability Trust Fund excise tax at 1.3¢ per barrel, which was
subsequently raised to 5.0¢/barrel. Both these taxes expired at the end of
1995.
! In addition, the TRA of 1986 reduced the excise tax exemption for “neat”
alcohol fuels, from 9¢ per gallon to 6¢ per gallon. It also permitted alcohol
imported from certain Caribbean countries to enter free of the 60¢-per-
gallon duty. The TRA also repealed the tax-exempt financing provision for
alcohol-producing facilities and for certain steam-generating facilities.
Energy Tax Policy After Reagan
After the Reagan Revolution, 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
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. This tax credit expired at the end of 2001 for new facilities.)
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
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tax exemption; 3) expanded the §29 production tax credit for non-
conventional energy resources; 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 tax cut legislation also
included a variety of excise tax provisions pertaining to motor fuels excise
taxes, some of which involved tax reductions on alternative transportation
fuels, and some of which involved increases, such as on kerosene, which on
balance further tilted energy tax policy toward alternative fuels.
! Tax Relief and Extension Act ( H.R. 2923). Enacted as part of P.L. 106-170,
the Ticket to Work and Work Incentives Improvement Act of 1999, Title V
of the law, the Tax Relief and Extension Act of 1999, extended and
liberalized the 1.5¢ renewable electricity production tax credit, and renewed
the suspension of the net income limitation for 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 more recent years, as the discussion of President
Clinton’s proposals will demonstrate. Fiscal concerns, which for most of that period created
a perennial search for more revenues to reduce budget deficits, has 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 an existing tax breaks (or both).
As an indication of the current posture of federal energy tax policy, Table 1 on page 16
summarizes current energy tax provisions and the corresponding revenue effects. A “-” 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 either reduces supply of, or the demand for, the taxed activity
(either conventional fuel supply, energy demand, or the demand for energy-using
technologies, such as cars).
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Energy Tax Proposals in the 107th Congress
Energy price volatility over the last four years has provided impetus to omnibus energy
policy legislation in the 107th Congress (H.R. 4). Now in conference, the omnibus energy
bill was approved by the House on August 2, 2001, and by the Senate April 25, 2002. To
understand the context of this legislation, one needs to review both the recurrent energy
market problems over this time period, which some had viewed as an “energy crisis.”
First, there have been wide fluctuations in crude oil prices. 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 1986-1999 oil prices averaged about
$17.00 per barrel, fluctuating from between $12 and $20 per barrel. Low oil prices hurt oil
producers (upstream operations), reducing profits and output, while benefitting oil refiners
(downstream operations). In addition, they also encourage consumption (and are
disincentives to conserve and invest in energy efficiency technologies) and discourage
production of alternative fuels and renewable technologies. To address the low oil prices,
there were many tax bills introduced during the first session of the 106th Congress (1999) to
provide economic relief through the tax code for the ailing domestic oil and gas producing
industry, particularly small independent drillers and producers. Proposals mainly 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 the summer of 1999, crude oil prices had recovered to about $20 per barrel; and by
the summer of 2000 prices peaked at well over $30 per barrel, due largely to output
reductions by the Organization of Petroleum Exporting Countries (OPEC), but also because
of the increased energy demand accompanying increasing growth in the world’s (particularly
the Asian) economies. To address the high crude prices, which also caused high gasoline,
diesel, and heating oil prices, legislative proposals focused on many of the same energy tax
proposals made during 1999 to address the low crude prices: 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.
But in addition to high 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 these petroleum products to
spike. In response to these energy market problems, there were many proposals in the spring
and summer of 2000 to temporarily either reduce or eliminate the federal excise tax on
gasoline and diesel fuel, and other special motor fuels. These proposals were viewed as a
way of helping consumers (including truckers) cushion the financial effect of the price
spikes. (For an analysis of this legislation, see CRS Report RL30497, Suspending the Gas
Tax: Analysis of S. 2285.) The spike in gasoline prices in the Midwest during the summer
of 2000 kept interest in these excise tax moratoria alive; it also engendered some interest in
proposals to impose a windfall profit tax on oil companies, which were, by then, earning
substantial profits due to the high prices. (For more detail on the windfall profit tax on crude
oil that was imposed from 1980 until its repeal in 1988, see CRS Report 90-442, The
Windfall Profit Tax on Crude Oil: Overview of the Issues.)
Despite the numerous proposals to address these energy problems over the last four
years, no major energy tax bill has been approved, although there have been three relatively
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minor amendments to energy tax provisions as part of non-energy tax bills during this period.
Examples are Title V of the Ticket to Work and Work Incentives Improvement Act of 1999,
P. L. 106-170, signed by President Clinton on December 17, 1999, and the Job Creation and
Worker Assistance Act of 2002 (P.L. 107-147), ) signed into law by President Bush on
March 9, 2002. The latter is a $42 billion, ten-year tax cut that retroactively extends several
energy tax provisions:
! §45 Tax Credit for Electricity Produced From Wind, Biomass, and
Poultry Waste. The 1.5¢ per kilowatt hour (in real, 1992 dollars) tax credit
for electricity produced from wind technologies, "closed-loop" biomass, and
poultry waste (as described above), is available for 10 years after the
generating facility is placed in service, for which the previous deadline was
January 1, 2002. The tax cut bill extended this placed-in-service deadline to
December 31, 2003.
! Tax Credit for Electric Vehicles. The onset of the phase-out of the $4,000
tax credit for the purchase of electric vehicles began on January 1, 2002.
The tax cut bill deferred the onset of the phase-out date by two years.
! Deduction for Clean-Fuel Vehicles and Certain Refueling Property. The
deduction for clean fuel vehicles, which ranges from $2,000 to $50,000, is
to be phased out over 3 years beginning on January 1, 2002. This was
deferred by two years to January 1, 2004.
! Dyed Fuels Mandate. Beginning on January 1, 2002, registered terminals
were required to store both dyed diesel fuel and dyed kerosene as a
prerequisite for being allowed to sell undyed diesel and kerosene. The tax
cut bill repeals this mandate effective on January 1, 2002.
! Percentage Depletion Allowance. The 100% net income limitation for the
percentage depletion allowance on marginal wells had been suspended since
December 31, 1997, but this expired on January 1, 2002, thus reinstating the
limitation. The tax cut bill reinstates the suspension, thus repealing the
limitation through December 31, 2003.
While no tax bill was passed that reduced taxes on oil and gas, the 106th Congress did
enact a package of $500 million in loan guarantees for small independent oil and gas
producers, which became law (P.L. 106-51), in August 1999.
Tax Provisions in the Comprehensive Energy Policy Legislation
At the convening of the 107th Congress, policymakers witnessed not only the usual
gamut of energy market problems just described, there was also an electricity crisis in
California, and spiking natural gas prices, which increased steadily during 2000 and reached
$9 per thousand cubic meet (mcf) at the outset of the 107th Congress. (At one point on the
spot market prices reached about $30 per mcf, the energy equivalent of $175/barrel of oil).
Recurrent energy problems had developed into an “energy crisis.”
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The Republican leadership resuscitated its energy plan of the 106th Congress,
particularly measures focusing on tax relief to the oil and gas industry, and proposed a more
general or comprehensive policy including major energy tax measures that would address
fundamental energy problems of supply and demand. The ideas and measures in this plan
were incorporated into Senator Murkowski’s comprehensive energy policy legislation, S.
389, and other Senate bills, and into H.R. 4 in the House.
On February 26, 2001, Senator Murkowski introduced S. 389, the comprehensive
energy bill that includes significant expansion of tax incentives for energy supply, energy
efficiency, and alternative fuels. (The tax incentives are title IX of S. 389, which comprises
over half of the bill; the non-tax provisions were introduced on the same date as S. 388). On
March 22, 2001, Senator Bingaman introduced the Democratic version of comprehensive
energy policy legislation, also comprising two bills, which have separate titles: S. 596, the
Energy Security Tax and Policy Act of 2001 (essentially the tax component of the
comprehensive legislation) and S. 597, the Comprehensive and Balanced Energy Policy Act
of 2001 (the non-tax component of the legislation). This bill is based largely on Senator
Bingaman’s bill in the 106th Congress ( S. 2904). Many of the tax measures in S. 389 and S.
596 are similar. However, S. 396 is weighted more toward production and supply than is S.
596, which is, on balance, slightly more weighted toward energy efficiency and alternative
fuels. (For a comparison of these two bills, see CRS Report RL30953, Energy Tax
Incentives: A Comparison of the National Energy Security Act of 2001 (S. 389) and the
Democratic Alternative (S. 596).)
On December 5, the Democratic leadership in the Senate introduced S. 1766, a newer
version of comprehensive energy legislation, without tax provisions, which appeared to be
a revised version of Senator Bingaman’s bill, S. 597. S. 1766 was replaced by a substitute
bill, S. 517, which was largely the same as the original bill but which included dramatic
increases in fuel economy standards.
As to the energy tax provisions of the bills, the Senate Finance Committee (SFC) held
three hearings on the major Senate energy tax proposals during the first session of the 107th
Congress; the Senate leadership had stated that the energy situation was one of the key issues
to be taken up after the August 2001 recess. But declining federal budget surpluses, the
waning of the electricity crisis in California, declining petroleum and natural gas prices, the
terrorist situation, and economic recovery issues put this legislation on hold. On February
13, 2002, however, the SFC approved the Energy Tax Incentives Act of 2002, which was
an amendment (Amendment #2917) to S. 517 on the floor. S. 517 was formally renamed the
Securing America’s Future Energy Act when the Senate approved the measure on April 25
as an amendment in the nature of a substitute to the House counterpart, H.R. 4.
In the House, the major energy tax measure is the Energy Tax Policy Act of 2001, a
package of $33.5 billion of energy tax incentives (over 10 years) for energy supply and
conservation introduced on July 17, 2001. H. R. 2511 was marked up by the House
Committee on Ways and Means on Wednesday, July 18, 2001.The marked up bill was a
substitute amendment offered by Ways and Means Committee Chairman William Thomas.
The bill was approved 24-17 and has been incorporated in the Republican leadership’s
comprehensive energy legislation, H.R. 4, which was approved by the House on August 2,
2001.
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The energy tax provisions of H.R. 4 are generally very similar to those in the two initial
Senate bills discussed above (S. 389 and S. 596), although the mix of provisions differs. As
between the two versions of H.R. 4 now in conference committee, the House bill proposes
larger energy tax cuts (net of some energy tax increases), and is broader in scope than the
Senate bill. The House version of H.R. 4 reduces energy taxes by about $33 billion over 10
years, as compared with the Senate version, which reduces energy taxes by about $15 billion
over 10 years.
Both bills provide tax incentives for both energy conservation – i.e., incentives that
reduce the demand for energy – and the supply of conventional fossil fuels, particularly oil
and gas (including nonconventional gas). But, overall, the House version appears to be
weighted more than the Senate version toward stimulating the supply of conventional fuels,
including capital investment incentives to stimulate production and transportation of oil and
gas, as well as production and transmission of electricity. This seems to be predicated on the
view that many of the nation’s recent energy problems are due to supply and capacity
shortages in the face of rapidly increasing demand, caused by rapid economic growth and
relatively low energy prices. The conservation incentives in the House bill are weighted more
toward promoting alternative fuels rather than energy efficiency.
The Senate-passed bill either eliminates or significantly reduces most of the incentives
for fossil fuels production and supply and for nuclear power that are included in the House
version of H.R. 4. There are also some reductions in tax incentives for energy efficiency. The
tax incentives for alternative and renewable fuels are increased over the House-passed H.R.
4. About half of the tax cuts in the Senate bill accrue to fossil fuel and nuclear power, and
the other half accrue to energy efficiency and to renewable and other alternative fuels.
Bush Administration Proposals
The Bush Administration, which a comprehensive plan to address the energy crisis in
May 2001, was initially against a significant expansion of energy tax incentives (whether for
supply, efficiency, or alternative fuels). It has, however, recommended a limited number of
energy tax measures, some of which appeared in the Administration’s FY2002 budget
proposal and others incorporated in its National Energy Policy Development Group
(NEPDG) report. (See CRS Report RL31096. Bush Energy Policy: Overview of Major
Proposals and Legislation.) Some of these energy tax measures in the Administration’s
FY2002 budget and the NEPDG report also appear in the FY2003 budget, and the
Presidents’ global climate change initiative.
Tax Issues Relating to Electricity Restructuring
The proposed restructuring of the electricity supply industry envisions a transition from
a regulated and vertically integrated monopoly to a deregulated and more competitive
industry, primarily in the generation sector, with all the projected benefits: lower costs and
prices, technological innovation, and greater economic efficiency (including dynamic
economic efficiency) both within the industry itself and economy-wide. But some of the
provisions of the federal tax code, as they relate to electric utilities, evolved within the
monopoly/regulatory structure or regime and thus may be inconsistent with a more
competitive restructured industry. Comprehensive as well as stand-alone restructuring
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legislation was introduced in the 106th Congress, but no comprehensive electricity
restructuring legislation has been enacted at the federal level.
Open Access and Tax Exempt Bonds. Current federal tax provisions, as they
relate to the use of tax-exempt bonds by state and local government utilities (public power)
effectively preclude them from participating in open-access restructuring because of the tax
code’s private-use rules; i.e., the bonds cannot be used for any private purpose. The private
use restrictions are intended to ensure that the benefits from the tax-exempt financing accrue
to the general public for the welfare of all rather than to individual private entities. Opening
up a public power entity’s transmission lines to privately owned utilities can jeopardize the
tax-exempt status of its outstanding bonds – it could make the bonds retroactively taxable.
If public power utilities comply with Order 888 of the Federal Energy Regulatory
Commission (FERC) by providing other utilities comparable access to their transmission
facilities; if they join independent regional system operators; if they let other power
marketers use their distribution facilities; and if they sell excess power outside their
traditional markets; all these could jeopardize the tax-exempt status of any outstanding
bonds.
Tax Treatment of the Sale of Transmission and Distribution Lines. In
general, most analysts argue that competitive electricity markets cannot work well unless the
transmission systems, which are owned primarily by investor owned utilities (IOUs), are
subject to independent ownership and management. For this reason, federal rules are
encouraging, and certain states are mandating, IOUs to sell or divest themselves of assets
used in the transmission and distribution of electricity to independent system operators.
However, under current tax rules, such sales or conversions could, under typical
circumstances, trigger a taxable gain, which could inhibit the sale or spin-off of the assets.
Several tax bills (for example, H.R. 1459 and S. 2967) propose that these sales or spin-offs
be treated as involuntary conversions, which are not taxable events provided that the funds
are used to invest in similar property within two years.
Contributions in Aid of Construction. Payments received from land developers
(and builders) or prospective customers in reimbursement of the costs of constructing
facilities and power lines needed to connect these customers to the grid and extend electricity
service to them have to be reported as income to the utility subject to tax. The fees that
utilities charge customers for connecting their homes or businesses to the distribution lines
are also treated as taxable income. The utility is allowed to depreciate these types of
investment expenditures, which are treated as contributions in aid of construction.
Under IRC§118, contributions in aid of construction are not treated as contributions to
capital. Prior to 1986, such contributions in aid of construction were tax exempt as
contributions to a corporation’s capital, although no depreciation was allowed on the capital.
The Tax Reform Act of 1986 (P.L. 99-514) made such contributions taxable. For example,
if an IOU generally requires prospective customers to pay for the cost of extending the
existing wires to the customer’s premises, the IOU is required to include such payments in
income, although it can depreciate the additional wires. The tax on contributions in aid of
construction applies to IOUs. It does not apply to public power entities, which, as
government enterprises, are not taxable entities. IOUs would like to amend the tax laws and
make contributions in aid of construction tax exempt, thus reverting to pre-1986 tax
treatment. This proposal does not hinge on the restructuring of the electric industry. It is
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rather part of a compromise which includes continuation of the tax breaks for investors who
purchased tax-exempt bonds for public power entities.
Nuclear Decommissioning. Owners of nuclear power plants are required to
establish independent trust funds, and to make contributions to those funds, to ensure that
funds are available to decommission those plants when they are retired. Under present law,
money set aside for the future decommissioning of nuclear power plants receives special tax
treatment. Basically, the contributions into the fund are tax deductible in the year they are
made, rather than in the year in which the actual decommissioning takes place as economic
and accounting principles dictate. Any income earned by the fund, say from investments, is
taxed at a flat rate of 20%.
The rules spelling out the tax treatment of nuclear decommissioning costs were enacted
during a time when all nuclear power plants were operated by regulated public utilities, and
when any transfers of plant assets occurred between such regulated entities. One such rule
states that the amount deductible cannot exceed the amount of nuclear decommissioning
costs collected from ratepayers under the cost-of-service regulation. Thus, a public service
commission must authorize that the costs be approved into the rate base. Under rate
deregulation in a more competitive industry, there would be no cost-of-service amount for
the nuclear generating plant owners, hence zero deduction for contributions into the nuclear
decommissioning fund.
Also, restructuring, with its separate ownership of generating, transmission, and
distribution and retailing, is likely to lead to the sale or disposition of nuclear generating
plants to parties that are not regulated public utilities as the law requires for tax-exempt
transactions. Under present tax rules, the transfer of decommissioning fund assets as part of
the sale of a nuclear power plant is not a taxable transaction as long as both the seller and the
buyer are regulated public utilities. This raises questions as to the tax treatment of the nuclear
decommissioning funds in a sale to a non-utility, which is somewhat ambiguous under
current tax laws. Under certain conditions, the purchaser may be required to recognize the
gain as taxable income.
Size of the Tax Burdens on Public Power Relative to Investor Owned
Utilities (IOUs). Public power utilities are not only exempt from federal taxes (as
compared with investor owned utilities, which must report and pay tax on their income), but
the interest on the bonds used to finance their capital investments is also exempt from federal
taxation. Restructuring could lock in the competitive advantage of public power (and
cooperatives) rendered by the current tax code provisions.
Tax Exempt Status of Electric Cooperatives. Electric cooperatives are exempt
from federal taxes as long as 85% or more of their annual income comes from members.
Non-member, unrelated business income is fully taxable. Under restructuring, the fees that
cooperatives would receive for retail wheeling of electricity, combined with other member
income, could exceed 15%, which may jeopardize the cooperatives’ tax-exempt status.
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LEGISLATION
H.R. 2511 (McCrery)
The Energy Tax Policy Act of 2001. Amends the Internal Revenue Code of 1986 to
provide tax incentives to encourage energy conservation, energy reliability, and energy
production. Introduced on July 17, 2001. Marked up on Wednesday, July 18, 2001, by the
House Committee on Ways and Means. The marked up bill was a substitute amendment
offered by Ways and Means Committee Chairman William Thomas. The bill was approved
24-17 and has been included as part of H.R. 4, passed by the House August 2, 2001.
Currently in conference.
Securing America’s Future Energy Act (Amendment in the Nature of a Substitute
to H.R. 4)
The tax provisions are basically those approved by the Senate Finance Committee (SFC)
as the Energy Tax Incentives Act of 2002. Amends the Internal Revenue Code of 1986 to
provide about $15 billion (over 10 years) of tax incentives for energy conservation and fossil
fuels production. Marked up by the SFC on Wednesday, February 13, 2002. The bill, which
was approved by voice vote, was a somewhat expanded version of the bill introduced by
Senator Baucus on February 11. Added to S. 517 on the floor as Amendment #2917. The
tax provisions embodied in Division H of the Senate energy bill are a modified version of
Amendment 2917. S. 517 as amended was substituted for the text of H.R. 4 and passed by
the Senate April 25, 2002. Currently in conference.
S. 596 (Bingaman)/H.R. 2108
The Energy Security Tax and Policy Act of 2001. Amends the Internal Revenue Code
by providing tax credits and deductions for: (1) energy efficient property used in business;
(2) residential energy systems; (3) electricity facilities and production; (4) commercial
applications of advanced clean coal technologies; (5) heating fuels and storage; and (6) oil
and gas production and petroleum products. Senator Bingaman introduced two bills
representing what was then the Democratic version of comprehensive energy policy
legislation: S. 596 (essentially the tax component of the comprehensive legislation) and S.
597, the Comprehensive and Balanced Energy Policy Act of 2001 (the non-tax component
of the legislation). Introduced on March 22, 2001; referred to the Senate Finance Committee.
S. 389 (Murkowski)
The National Energy Security Act of 2001. A bill to protect the energy and security of
the United States and decrease America's dependency on foreign oil sources to 50% by the
year 2011 by enhancing the use of renewable energy resources, conserving energy resources,
improving energy efficiencies, and increasing domestic energy supplies. Introduced on
February 26, 2001; referred to the Senate Finance Committee.
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Table 1. Current Energy Tax Provisions and Revenue Effects (FY2001, in $ mil.)
Category
Provision
Major Limitations
Revenue Effect
CONVENTIONAL FOSSIL FUELS SUPPLY (bpd = barrels per day; < indicates less than)
% depletion–oil/gas
15% of sales (higher
for indep.,up to 1,000 or
- $300
for marginal wells)
equiv. bpd
Expensing of
100% deductible in
corporations expense only
- 600
IDC’s–oil/gas & other
first year
70% of IDC’s
fuels
Enhanced Oil Recovery
15% of the costs
only for specific tertiary
- 200
Credit
methods
% depletion–coal and
10% for coal
must be < 50% of taxable
- < 50
other fuels
income
coal excise tax (fy2000)
$1.10/ton (0.55 for
not to exceed 4.4% of sales
527
surface mines)
price
ALTERNATIVE AND RENEWABLE FUELS
§29, production tax
$6.25/bar. (or
biogas, coal synfuels,
- 1,500
credit
$1.00/mcf)
coalbed methane, etc.
5.3¢ exemption for
exemption from motor
for biomass ethanol only
- 880
gasohol
fuels taxes
§45 credit for renewable
1.7¢/kWh.
wind, closed loop biomass,
- 100
electricity
and poultry waste
exclusion of interest on
interest income exempt
for hydroelectric or
-100
S&L bonds
from tax
biomass facilities used to
produce electricity
tax credits for alcohol
53¢/gal+ 10¢/gal for
only for biomass ethanol
- < 50
fuels
small producer credit
(e.g., corn)
deduction for clean-fuel
$2,000 for cars;
CNG, LNG, LPG,
- < 50
vehicles
$50,000 for
hydrogen, neat alcohols,
trucks;$100,000
and electricity; phases out
deduction for refueling
over 2002-2004
facilities
tax credit for electric
10%, up to $4,000
phase-out from 2002-2004
- < 50
vehicles
credit for solar &
10% investment tax
utilities excluded
- < 50
geothermal tech.
credit for businesses
ENERGY CONSERVATION
fuels taxes (fy2000)
18.4¢/gal of gas
4.4¢-24.4¢ for other fuels
33,500
mass trans. subsidies
exclusion of $65/month
up to $175/month for
- 3,600
parking benefits
gas-guzzler tax (fy2000)
$1,000-$7,700/car
to limos and vehicles
71
weighing 6,000 lbs. or less
exclusion for utility
subsidies not taxable as
any energy conservation
- < 50
conservation subsidies
income
measure
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