Order Code RL34689
Oil Industry Financial Performance and the
Windfall Profits Tax
September 30, 2008
Salvatore Lazzari
Specialist in Energy and Environmental Economics
Resources, Science, and Industry Division
Robert Pirog
Specialist in Energy Economics
Resources, Science, and Industry Division

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Oil Industry Financial Performance and the
Windfall Profits Tax
Summary
Over the past 10 years, surging crude oil and petroleum product prices have
increased oil and gas industry revenues and generated record profits, particularly for
the top five major integrated companies (also known as the “super-majors”): Exxon-
Mobil, Royal Dutch Shell, BP, Chevron, and Conoco/Phillips. These companies,
which reported a predominant share of those profits, generated more than $100
billion in profits on nearly $1.5 trillion of revenues in 2007. From 2003 to 2007,
revenues increased by 51%; net income (profits) increased by 85%. Oil output by the
five majors over this time period declined by more than 2%, from 9.85 to 9.63
million barrels per day. Being largely price-driven, with no increase in output, and
with little new production resulting from increased oil industry investment, many
believe that a portion of the increased oil industry income over this period represents
a windfall and unearned gain, i.e., income not earned by any additional effort on the
part of the firms, but due primarily to record crude oil prices, which are set in the
world oil marketplace.
Numerous bills have been introduced in the Congress over this period to impose
a windfall profits tax (WPT) on oil. Most of the bills were introduced in the 109th and
110th Congresses, after the enactment of the Energy Policy Act of 2005, which
provided oil and gas industry tax incentives, in addition to the industry’s traditional
tax subsidies. An excise-tax based WPT would tax only domestic production, and
like the one in effect from 1980-1988, would increase marginal oil production costs,
which theoretically could reduce domestic oil supply, and raise petroleum imports,
making the United States more dependent on foreign oil, undermining goals of
energy independence and energy security. By contrast, an income-tax based WPT
would be more economically neutral (less distortionary) in the short-run: sizeable
revenues could be raised without reducing domestic oil supplies. Neither the excise-
tax based or income-tax based WPT are expected to have significant price effects:
neither tax would increase the price of crude oil, which means that refined petroleum
product prices, such as pump prices, would likely not tend to increase.
In lieu of these two types of WPT, an administratively simple way of increasing
the tax burden on the oil industry, and therefore recouping some of any excess or
windfall profits, particularly from major integrated producers, would raise the
corporate tax rate by, for instance, repealing or reducing the domestic manufacturing
activities deduction under IRC § 199. This deduction is presently 6% of a firm’s net
income) and is available generally to all domestic manufacturing businesses (service
firms are excluded), including almost all oil firms. Repealing this deduction for the
major integrated oil companies, and freezing it at 6% for the remaining qualifying oil
companies is estimated by the Joint Committee on Taxation to generate about $10
billion over 10 years.

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Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Oil Industry Financial Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
The Super-Major Integrated Oil Companies . . . . . . . . . . . . . . . . . . . . . . . . . 4
Use of Profits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Increased Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Increased Oil Output . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Cash Reserves and Dividend Payouts . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Legislative History of Windfall Profits Tax Proposals . . . . . . . . . . . . . . . . . . . . . 9
Windfall Profits Tax Legislation in the 109th Congress . . . . . . . . . . . . . . . . 11
Excise Tax Type of WPT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Income Tax Type of WPT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Other Types of WPT Proposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Windfall Profit Tax Legislation in the 110th Congress . . . . . . . . . . . . . . . . 12
Excise Tax Type of WPT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Income Tax Type of WPT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Other Types of WPT Proposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Analysis of Economic and Policy Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Defining and Measuring Windfall Gains . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
The Non-neutral Economic Effects of the Excise Tax Type of WPT . . . . . 15
Output Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Oil Imports and Energy Independence . . . . . . . . . . . . . . . . . . . . . . . . . 16
Price Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
The Neutrality of the Corporate Income Tax Type of WPT . . . . . . . . . . . . 17
Output Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Oil Imports and Energy Independence . . . . . . . . . . . . . . . . . . . . . . . . . 17
Price Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Alternative Policy Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Rescinding the § 199 Deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
An Income Type WPT Tax and § 199 Repeal . . . . . . . . . . . . . . . . . . . 19
A Tax on Imported and Domestically Produced Crude Oil . . . . . . . . . 19
An Excise WPT and Gas Tax Suspension . . . . . . . . . . . . . . . . . . . . . . 20
Possible Revenue Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
List of Tables
Table 1. Financial Data for Oil Industry Firms, 2003-2008 . . . . . . . . . . . . . . . . . . 4
Table 2. Revenue of the Top Five Major Integrated Oil Companies,
2003-2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Table 3. Crude Oil Production by the Major Oil Companies . . . . . . . . . . . . . . . . 6
Table 4. Net Income of the Major Oil Companies, 2003-2008 . . . . . . . . . . . . . . . 6
Table 5. Average Profit Rates In the Oil Industry, 2003-2008 . . . . . . . . . . . . . . . 7
Table 6. Tax Payments by the Major Oil Companies, 2005-2007 . . . . . . . . . . . . 14

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Table 7. Estimated Revenue Effects of Repealing the § 199 Deduction for
All Oil and Gas Industry, and for Major Integrated Oil and
Gas Producers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

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Oil Industry Financial Performance and the
Windfall Profits Tax
Introduction
Over the past 10 years, the price of crude oil has been increasing, volatile, and
has recently attained record high levels. The results of those price increases, which
led to high gasoline prices, have been a weakening of the U.S. economy, and
financial hardship for many American families who have also been buffeted by the
housing slowdown, the credit crunch, rising unemployment, and other economic
factors. While much of the American economy has suffered as a result of high oil
prices, those prices generated record profit levels for the oil industry. Five
companies, Exxon-Mobil, Royal Dutch Shell, BP, Chevron, and ConocoPhillips
earned a predominant share of those profits
Record oil and gas industry profits have raised the concern of many public
policy experts and federal policymakers, including many in Congress, who have
questioned whether these profits were justified, or whether they constituted a
“windfall” to the industry: an excessive, unearned, and unfair gain. Important factors
in considering this issue might include the ultimate source, or reason, for the price
increases, and what was the industry’s role in generating them, i.e., whether it was
through the direct result of the industry’s efforts, in terms of employing its resources,
decision-making, or risk-taking, or whether it was the result of fortuitous factors and
events. Also important to the public policy question might be the actual size of the
profits and what the industry did with them. If an industry invests profits into
increased production capacity, the increased supply may ultimately cause prices to
fall and the profits to dissipate. As the analysis in this report shows, the experience
between 2003 and the first half of 2008 is not encouraging. Investments in oil
exploration and development have not managed to keep company output from
declining by some 7% over the five-year period.
Numerous bills have been introduced in the Congress over this period to tax
the oil and gas industry’s record profits. These bills generally take one or more of
four approaches. First, some bills have proposed rescinding, or taking back, the tax
incentives or subsidies enacted under the Energy Policy Act of 2005 (EPACT 05,
P.L. 108-58), which not only expanded preexisting oil and gas industry tax subsidies,
but enacted several new ones.1 To be sure, EPACT05 also reinstated two excise taxes
1 In the 110th Congress H.R. 86, H.R. 498, H.R. 1945, and S. 115 propose to rescind
EPACT’s oil and gas industry tax breaks.

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on petroleum that were larger than the tax subsidies,2 but policymakers asked: 1)
Why should the federal government provide any subsidies at a time when oil and gas
prices and oil and gas industry profits are not only rising, but reaching higher and
higher record levels; and 2) Why should the level of oil and gas industry subsidies
be increased for an already profitable industry at a time when consumers and energy
intensive industries (trucking, airlines, etc.) and the general economy are burdened
by the high crude oil and gasoline prices?
Another policy option proposed in Congress to raise the tax burden on the oil
and gas industry would repeal or cutback the pre-existing oil and gas industry tax
subsidies, i.e., those that predated EPACT05, some of which were also expanded
under EPACT05, and which generally are still in effect. Since the inception of the
federal income tax system in the early 20th Century, the oil and gas industry has
benefitted from sizeable — some estimates exceed $100 billion in real terms —
federal tax subsidies, primarily for upstream activities such as exploration and
development, and extraction and production, as compared to the downstream
activities such as refining and marketing. For example, the domestic oil and gas
industry is able to expense, i.e., write off in the first year (as compared to capitalize),
intangible drilling costs (IDCs), and independent producers qualify for the percentage
depletion allowance, rather than cost depletion. And while these traditional subsidies
have been significantly pared back over the years, and are not now large relative to
the size of the industry, some feel that no subsidies should be available to the
industry at a time of surging record profits.
A third policy option that would raise taxes on oil and gas is to amend or reform
certain income tax code provisions that, although legally and economically not
subsidies — they would not be defined as subsidies in the tax expenditure sense by
the Joint Committee on Taxation — may confer undue or disproportionate (and
unnecessary) tax benefits to the oil and gas industry.3 As an example, some bills
propose to repeal the industry’s use of the “last-in/first-out” (LIFO) system of
inventory accounting under IRC § 472. This method values the goods sold as the
most recent inventory purchase. During a period of rising prices, this method of
inventory accounting increases production costs and reduces taxable income and tax
liabilities.4
2 EPACT05 reduced taxes (provided additional tax subsidies) valued at $2.633 billion over
11 years. It also reinstated two excise taxes: the Oil Spill Liability Trust fund tax, and the
Leaking Underground Storage Tank Trust fund tax, both of which are imposed on oil
refineries. According to the Joint Committee on Taxation, over 11 years, the value of the tax
increase was $2,857 million, $224 million ($2,857-$2,633) more than the tax cuts Also, the
Tax Increase Prevention and Reconciliation Bill of 2006 (P.L. 109-222), enacted on May
17, 2006, reduced one of the industry’s tax subsidies, i.e., it increased taxes on the oil
industry, by about $189 million.
3 There is an important economic distinction between a subsidy and a tax benefit. As is
discussed elsewhere in this report, business firms, including oil and gas companies,
generally receive a variety of tax benefits that are not necessarily targeted subsidies (or tax
expenditures) because they are available generally.
4 See CRS Report RL33578 for more detail.

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CRS-3
A second example is the proposed reform of the foreign tax credit. Many of the
major energy tax bills that the Congress has considered over the last two years
proposed to reform the tax treatment of foreign oil and gas extracting income
(FOGEI) and foreign oil-related income (FORI). The proposed reforms are apparently
focused on reducing instances in which such income is not measured correctly
(overstated), so as to overstate foreign income taxes, and overstate their foreign tax
credits, which tends to reduce the U.S. tax liability (i.e., the tax on U.S. source
income).
Finally, a fourth option — the one that is discussed in this report — is to impose
a windfall or “excess” profits tax i.e., a supplemental or additional tax on the oil
industry, one based on windfall or excess profits in addition to other income or other
taxes that the industry might pay. While some congressional Legislators envision this
as a totally new type of tax on windfall gains, others would model it after the windfall
profits tax on oil that existed from 1980 to 1988, while still others propose a higher
corporate income tax burden, either through raising the corporate rate or eliminating
deductions. Either way, a windfall profit tax would be in addition to the current tax
on corporate and business income that applies to the oil and gas industry, and which
tax profits at rates as high as 35%.5
This report discusses the fourth option: the windfall profit tax. The first section
analyzes the major oil companies profit performance, particularly from 2003 to 2008,
both in terms of earnings and how those earnings have been used. The second section
is a brief legislative history of windfall profit tax proposals and legislation in both the
109th and 110th Congresses. The third section analyzes the idea of a windfall profits
tax, including experiences with the tax of the 1980s, its viability, and potential role
in the tax system and economy.
Oil Industry Financial Performance

During the Fall/Winter of 1998/1999, the spot market price of West Texas
Intermediate (WTI) crude oil hovered between $11 and $12/barrel.6 In July 2003, it
was $30.75 per barrel. Five years later, in July 2008, the spot market price of WTI
was $133.37, an increase of 334% in five years, and more than 1,000% over the 1998
trough. In June 2008, the spot market price reached the all-time high of $147/barrel.7
This nearly 10-year period of generally increasing oil prices began after a poor year
for profitability in the oil industry, 1998, and included another poor year, 2002. The
5 As discussed below on p. 18, the marginal corporate income tax rate is presently less than
35% for most domestic manufacturing activities due to the 6% domestic manufacturing
activities deduction, which typically applies to large corporations such as oil and gas
producers and refiners, and which is equivalent to a marginal corporate income tax rate of
32.9% (35% x 0.94) rather than 35%. In addition, present federal tax law imposes a
minimum tax on corporations (and individuals) to the extent that their minimum tax exceeds
their regular tax liability.
6 The low of $10.82/barrel was reached on December 10, 1998.
7 The $147 is in nominal or current dollars; crude oil prices also reached a record high in
real terms, or inflation adjusted terms.

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CRS-4
increase in prices that began in late 2003 seemed to be largely unanticipated by the
industry. It has since been attributed primarily to 1) a growing world economy,
particularly the ascending economies of China and India, and 2) declining excess
production capacity, particularly within OPEC (Organization of Petroleum Exporting
Countries) producers. As the price of oil rose, company revenues, net incomes, and
income taxes paid also rose, with Exxon-Mobil eventually becoming the most
profitable corporation in the history of American industry.
The oil industry is composed of thousands of companies, ranging from the major
integrated oil companies with operations around the globe, independent producers
(which can be very large), to relatively small oil service and equipment companies.
The rise in oil prices over the past 10 years — particularly over the past five years —
has enhanced the profitability of virtually all sectors of the industry, directly, or
indirectly.8
Table 1 reports three measures of the financial performance of the domestic oil
and gas industry in the United States, using data for the largest oil and gas producing
companies as reported by Oil Daily. Note that while industry revenue (price times
output), increased by 63%, from $1.1 trillion to nearly $1.9 trillion from 2003 to
2007, industry profits (net income) more than doubled, increasing from $72 billion
to more than $150 billion over this time period.
Table 1. Financial Data for Oil Industry Firms, 2003-2008
(billions of dollars)
Income
Statement
2008
Item
2003
2004
2005
2006
2007
First Half
Revenue
1,144.6
1,396.4
1,620.2
1,718.9
1,868.4
1,253.9
Net Income
72.4
100.7
139.8
162.8
155.8
87.6
Source: Profit Profile Supplements, Oil Daily.
Note: The companies included in Table 1 are ExxonMobil, Royal Dutch Shell, BP, Chevron,
ConocoPhillips, Marathon, Hess, Occidental, Murphy, Encana, Apache, Devon, Andarko, XTO, EOG,
Noble, Chesapeake, Pioneer, Newfield, Valero, Sunoco, Tesoro, Western, Frontier, Holly, and Alon
and the companies they merged with, or acquired, since 2003.
The Super-Major Integrated Oil Companies
While the oil and gas industry’s good fortune has been extensive and
widespread, it has also been concentrated among industry’s largest firms. Table 2
uses more recent financial data to show that the performance of the industry is
dominated by the five largest firms (the “super-majors”): ExxonMobil, Royal Dutch
8 There are, of course, exceptions. Stone Energy Corporation, for example, lost money (they
reported negative net income) during 2006. See Standard and Poor’s. Industry Surveys: Oil
and Gas, Production and Marketing. March 20, 2008. P. 48.

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CRS-5
Shell, BP, Chevron, and ConocoPhillips.9 For the first half of 2008, the net income
of these five firms constituted 90% of the total net income of the nine firms
considered to be integrated oil companies operating in the United States. Of the set
of twenty-six firms, which includes integrated oil companies, independent oil and gas
producers, and independent refiners and marketers, the five major firm’s net income
was 82% of the total. As a result of the dominant position of these five firms in the
industry, the data in the remainder of this report are limited to their financial
performance.
Table 2. Revenue of the
Top Five Major Integrated Oil Companies, 2003-2008
(billions of dollars)
2008
First
Company
2003
2004
2005
2006
2007
Half
ExxonMobil
246.7
298.0
371.0
377.6
404.5
254.9
Shell
269.1
265.2
306.7
318.8
355.8
245.7
BP
236.0
294.8
253.6
270.6
291.4
201.1
Chevron
120.0
155.3
198.2
210.1
220.9
148.9
ConocoPhillips
105.0
136.9
183.4
188.5
194.5
129.9
Total
976.8
1,150.2
1,312.9
1,365.6
1,467.1
980.5
Source: Profit Profile Supplements, Oil Daily.
The data in Table 2 show that the revenue of the five major firms increased.
This increase was caused primarily by the increasing prices of oil and petroleum
products. Total revenue is measured as price times the quantity of goods and services
sold. In the case of the five major oil companies over this period, the increase in
revenues was largely price-driven, with quantities produced largely stagnant. For
example, in 2003, ExxonMobil produced 2.59 million barrels per day (b/d) of crude
oil, and in 2007, ExxonMobil produced 2.61 million b/d, an increase of less than
1/10th of 1%. In general, the five major oil firms were unable to produce more crude
oil and petroleum products in response to the higher prices as shown in Table 3.
Note that only one company, BP, produced more crude over this period, and that, for
the five firms as a whole, output declined by 2.2% from 2003-2007, and by 5.8%
through the first half of 2008.
9 ExxonMobil, Chevron, and ConocoPhillips are U.S. based firms. BP is a British firm, and
Royal Dutch Shell is a Dutch and British firm, both with U.S. subsidiaries.

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CRS-6
Table 3. Crude Oil Production by the Major Oil Companies
(million barrels per day)
2008
First
Company
2003
2004
2005
2006
2007
Half
ExxonMobil
2.51
2.57
2.52
2.68
2.61
2.43
Shell
2.39
2.25
2.09
2.03
1.82
1.73
BP
2.12
2.53
2.56
2.47
2.41
2.43
Chevron
1.81
1.71
1.67
1.73
1.76
1.65
ConocoPhillips
1.02
0.90
0.91
1.13
1.03
0.94
Total
9.85
9.96
9.75
10.04
9.63
9.18
Source: Profit Profile Supplements, Oil Daily.
The revenue data for the first half of 2008 reflects the sharp increases in the
price of oil observed during the first six months of the year, with the price of WTI
reaching $147 per barrel in June. During the third quarter of 2008, the price of oil
declined from the June peak, making extrapolation of the first half 2008 to the entire
year uncertain. The likely result is that revenue increases were predominately price-
driven, which, as noted, is important in considering a windfall profit tax.
Table 4. Net Income of the Major Oil Companies, 2003-2008a
(billions of dollars)
2008
First
Company
2003
2004
2005
2006
2007
Half
ExxonMobil
21.5
25.3
36.1
39.5
40.6
22.6
Shell
12.7
18.5
22.9
25.4
27.6
15.7
BP
16.4
16.2
19.3
22.2
17.3
13.4
Chevron
7.2
13.3
14.1
17.1
18.7
11.1
ConocoPhillips
4.7
8.1
13.5
15.5
11.9
9.6
Total
62.5
81.4
105.9
119.7
116.1
72.4
Source: Profit Profile Supplements, Oil Daily.
a. Data reflect consolidated worldwide earnings of these firms. Data segmenting net income on the
basis of geographical earnings are not available.
Table 4 shows the net income of the five major oil companies over the period
2003 to 2008. While revenues increased by 51% from 2003 to 2007, net income
increased by 85%. These percentages suggest that price increases for crude oil and
petroleum products increased at a higher rate than costs and taxes for the five major

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firms. Analogously to the observed increase in revenues, the increase in net income
experienced by the five firms was largely price-driven.
The previous measures of financial performance focus on absolute levels:
absolute levels of revenue, and absolute net income. Perhaps a better measure of
performance is the profit rate, which may also be measured in variety of ways. One
measure of the profit rate is the operating margin, essentially net income divided by
revenue. As a result of the increasing price of oil driving up both total revenues and
net incomes, the return on revenue, or the profit rate, increased slightly for both the
major integrated oil companies as well as for the industry as a whole, as shown in
Table 5. This indicator of industry performance is not out of line with the rate in the
manufacturing industry generally, which in 2007 has a profit rate of 8.9%. However,
a more appropriate measure of the relative profit rate may be the rate of return on
equity (ROE). Using this measure of profit rate, the oil and gas industry’s ROE was,
on average, significantly greater than the ROE for the manufacturing industry
generally. According to the Energy Information Administration (EIA), the oil and gas
industry earned a 27% ROE in 2006, down slightly from 2005, but more than 9%
higher than the average ROE for all manufacturing companies.10
Table 5. Average Profit Rates In the Oil Industry, 2003-2008
(percent)
2008
First
2003
2004
2005
2006
2007
Half
Major Integrated
6.4
7.0
8.0
8.7
7.9
7.4
Companies
All Oil Industry
6.3
7.2
8.6
9.5
8.4
7.0
Source: Profit Profile Supplements, Oil Daily. CRS calculations.
For the entire 2000-2006 period, the oil and gas industry’s ROE averaged 7
percentage points higher than manufacturing’s ROE, while for the 1985-1999 period,
the oil and gas industry’s ROE was only 2 percentage point higher. By this measure,
the industry’s recent high profits, measured both in absolute terms, and relative to
ROE, suggest the presence of excess or windfall profits.
10 The EIA reports these data in its annual reports for the Financial Reporting System (FRS),
which are based on detailed financial and operating data and information submitted each
year to the EIA on Form EIA-28, the Financial Reporting System (FRS). The FRS
Companies derive the bulk of their revenues and income from petroleum operations, which
include natural gas production. A majority of these companies are multinational, with 40%
percent of the majors’ net investment located abroad. EIA supplements the FRS data with
additional information from company annual reports and press releases, disclosures to the
U.S. Securities and Exchange Commission, news reports and articles, and various
complementary energy industry data sets. See Energy Information Administration.
Performance Profiles of Major Energy Producers (Issues December 2007, March 2006,
February 2004, and January 2002).

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The data in Table 1, Table 2, Table 3, and Table 4 characterize an industry that
was unable to respond to the market signal of higher price by increasing output as
predicted by economic theory. As a result, their revenues and net incomes increased
proportionately, possibly supporting the judgement that those profits constituted a
“windfall,” at least in the sense that they were not earned through output expansion
or improvement, risk-taking, or investments leading to cost reductions in production.
However, the data in Table 5 could be taken to suggest that the major oil companies
did not earn more net income respective to the value of their product, than many
other industries, and the value of their product was determined on a world market,
beyond their control. From this point of view oil was attaining its fair market value.
The net income data presented in Table 4 was earned in three sectors of the
industry: upstream operations (the exploration and production of oil and natural gas),
downstream operations (the refining, transportation, distribution, and marketing of
petroleum products, including motor gasoline, diesel, jet fuel, and other petroleum
products), and chemicals and all other “non-oil” activities. Over time, the relative
importance of these sectors may shift in terms of potential to generate net income.
For example, while downstream activities were very strong in 2005 and 2006, they
weakened in 2007 and 2008. In terms of general corporate income taxation, this
cyclical pattern of change is likely to have little effect, since it is over-all corporate
net revenues that form the tax base. In terms of possible windfall profit taxation,
however, this cyclical pattern of change might be important as it is net-income from
crude oil ownership and production that is likely to have a windfall gain, or
“unearned” income component.
Use of Profits11
In economic theory, when firms earn returns in excess of the market rate of
return, they are likely to re-invest in their businesses to expand output and improve
their technologies to meet the challenge of new firms that might choose to enter the
industry as new competitors. In the theory of corporate finance, firms that seek to
maximize shareholder value use profits to invest in business projects that offer a
higher potential rate of return than that currently earned by the firm.
Increased Investment. Capital expenditures for the five major oil companies
were $48.6 billion in 2003, $48.7 billion in 2004, $57.2 billion in 2005, and more
than $80 billion in 2006 and 2007, for a total increase of 77% over the five-year
period. This increase is proportionately less than the increase in net income over the
period. Part of total investment funding is directed to environmental compliance for
both facilities and products, and does not increase capacity to bring petroleum
products to the market.12 It is well known that the five companies have not committed
to the construction of a new refinery in the United States since the 1970s, though
existing refineries have been expanded and upgraded. When the demand for gasoline
11 This section of the report is based on CRS Report RL34044, The Use of Profit by the Five
Major Oil Companies, by Robert Pirog. See CRS Report RL34044 for a more complete
analysis of this topic as well as more complete data.
12 The Energy Information Administration, The Impact of Environmental Compliance Costs
on U.S. Refining Profitability 1995-2001, May 2003.

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CRS-9
exceeds the ability of the U.S. refineries to produce, the gap has been filled with
imported product.
Increased Oil Output. Although the oil industry, and the five major firms
have invested in exploration, development, and production, those investments have
not met with noticeable success. Table 2 shows that the companies have failed to
expand, or even maintain their oil production rates.
Cash Reserves and Dividend Payouts. The major oil companies
accumulated cash reserves from 2003 through 2007. The five firms held $19.4
billion in cash in 2003 and $52.27 billion in 2007, an increase of almost 170%. While
cash holdings declined in 2007, compared to 2006, this was the result of reduced
balances at only one company, Chevron.13 The other four major oil companies
continued to build their cash balances.
From one point of view, cash balance accumulation gives firms flexibility and
positions them to take advantage of opportunities quickly. It is also likely that the
rapid increase in the price of oil and profits from 2003 to 2007 exceeded corporate
plans and strategies on how to use it. However, the theory of corporate finance
suggests that extraordinary cash returns to shareholders are appropriate only when the
management feels that individual shareholders are likely to have access to higher
return investment alternatives than management can identify. Activities that
represented direct returns to stockholders, in the form of increased dividend
payments and stock buy-backs also claimed a share of earned profits.
Legislative History of Windfall Profits Tax Proposals
Almost from the outset of the surge in crude oil and petroleum product prices,
many in Congress became concerned over the level of oil industry profits, and bills
were introduced to raise taxes on the oil and gas industry by imposing some type of
windfall profits tax. These proposals are viewed as a way of generating tax revenue
to fund subsidies for low income persons and offset the burden of recent high
petroleum prices, and programs for energy conservation and alternative and
renewable fuels. Also, they are viewed from the perspective of basic equity or
fairness — the overall distribution of the tax burden could be viewed as being more
fair when taxes on the record, unearned incomes of business enterprises are used to
reduce the tax burden of lower income persons burdened by the higher prices that
contributed to those record earnings.
The concept of a windfall profits tax is not new; a tax on windfall, or excess,
business profits has been one the instruments of fiscal policy, used by both state and
federal governments, whenever business profits either rise too fast or rise to levels
that are either considered too high, above “normal” or fair, or which reflect
“excessive” rates of return. At the federal level, however, such taxes have been used
13 Balance sheet data for the five major oil companies can be obtained at
[http://www.hoovers.com].

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CRS-10
sparingly — being viewed as extraordinary measures, their use limited to wartime or
other periods characterized by economic emergencies and instabilities such as hyper-
inflations. Such was the case with the surtax on business profits imposed as a
temporary measure to control large profits earned during World Wars I and II, and
the Korean War.14
A type of windfall profits tax on domestic crude oil production was in effect
from April 1980 to August 1988. This tax, which was actually an excise tax, not a
profits or income tax, was part of a compromise between the Carter Administration
and the Congress over the decontrol of crude oil prices. It is discussed and analyzed
in detail in CRS Report RL33305.15 Some have proposed reinstating this tax,
although it should be underscored that the current situation giving rise to possible
windfall profits — the current reasons for the high price of petroleum products and
record profits — is different than the conditions and rationale which existed at the
time that tax was imposed.16
Reinstating the oil windfall profits tax was again discussed in 1990, when crude
oil prices doubled in just two months due to the crisis in the Middle East (Iraq
invaded Kuwait on August 2, 1990).17 More recently, a windfall profits tax has also
been discussed as part of the presidential campaign, with Senator Obama reportedly
being a proponent of such a tax (in addition to cutting the industry’s subsidies and
providing a consumer energy credit to compensate for rising prices), and Senator
McCain not discussing this option.18
14 Hakken, John. Excess Profits Tax. The Encyclopedia of Tax Policy. Joseph J. Cordes, and
Jane Gravelle, eds. The Urban Institute Press, 1999. pp. 108-111.
15 U.S. Library of Congress. Congressional Research Service. The Crude Oil Windfall
Profits Tax of the 1980: Implications for Current Energy Policy. CRS Report RL33305, by
Salvatore Lazzari. March 9, 2006.
16 As noted above, the 1980 WPT was imposed as part of compromise to decontrol crude
oil prices — a quid pro quo. From a control regime level of about $6/barrel before the tax,
crude prices were allowed to rise gradually to market levels (as influenced strongly by
OPEC), which at that time were about $24/barrel. By contrast, today there are no price
controls on crude oil and prices are determined in a generally competitive global crude oil
market, one in which the United States is a price taker, and one in which OPEC plays a
relatively smaller (but still important) role. Also, more recently crude oil prices have
increased for significantly different reasons than was the case in the 1970s. Unlike the 1980s
when crude oil prices declined sharply to pre-decontrol levels just after the WPT was
imposed (and for most of the life of the tax), crude oil prices since the trough of 1998/1999
have increased fairly steadily and consistently and have surpassed the levels of 1982 in real
terms.
17 From the beginning of July 1990 to August 1990, domestic oil prices (the spot price of
West Texas Intermediate) nearly doubled increasing from just over $16 per barrel to nearly
$32 per barrel.
18 The Wall Street Journal. The Economy: Competing Visions for Fixing Today — and
Tomorrow. August 25, 2008. P. R5, R8. Obama also supports repealing the IRC § 199
manufacturing deduction, which is also allowed for oil and gas companies, raising nearly
$10 billion in revenues over 10 years, and another provision to limit the ability of oil and
(continued...)

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CRS-11
Windfall Profits Tax Legislation in the 109th Congress
After the enactment of EPACT05 in August 2005, congressional interest in a
windfall or excess profits tax on the oil and gas industry intensified. In fact, most of
the bills to impose some type of windfall profits tax were introduced in the 109th
Congress — there were more than a dozen such bills — after EPACT05 was enacted
into law. Many of these bills proposed to use the revenues from the WPT to offset
the burden of higher gasoline prices for consumers.19 There were two types of
windfall profits tax bills in the 109th Congress: those that would have imposed an
excise tax on windfall profits based on the price of crude oil, and those that would
have imposed an income tax on windfall profits based on either the existing tax law’s
definition of corporate taxable income or excessive rates of return.
Excise Tax Type of WPT. As noted above, the WPT that was in effect from
1980-1988 was not an income tax but an excise tax — it was not a type of tax that
most economists would consider a true tax in “windfall gains or income.” The tax
was imposed on the difference between the market price of oil, which was technically
referred to as the removal price, and a statutory 1979 base price that was adjusted
quarterly for inflation and state severance taxes. Almost every barrel of domestically
produced crude oil — i.e., every barrel of domestic production that was not
specifically tax-exempt — was subject to this excise tax.
The excise tax type of WPT was the type proposed in most of the WPT bills in
the 109th Congress. These bills would have generally imposed an excise tax equal to
50% of the windfall profits not reinvested in 1) oil/gas exploration and drilling, 2)
increased refinery capacity, 3) renewable electricity property, or 4) facilities for
producing alcohol fuels or bio-diesel. These bills would have defined a windfall
profit as the difference between the market price of oil (at the wellhead) and an
inflation-adjusted base price of $40/barrel — in other words, they would have
effectively defined a windfall as the difference between the market oil price and $40.
S. 1631, H.R. 3752, H.R. 4203, H.R. 4248, H.R. 4449, H.R. 4263, S. 1981, and S.
2103 were of this type. S. 1631 (Dorgan) was offered as an amendment to S. 2020,
the Senate’s version of tax reconciliation which went to conference, but was ruled out
of order.
Income Tax Type of WPT. Some of the WPT proposals in the 109th
Congress were of the income tax type, using the existing corporate income tax system
18 (...continued)
gas companies to claim foreign tax credits for their overseas operations could raise another
$4 billion. According to the Bureau of National Affairs, Inc. Daily Tax Report. “Obama
Says Tax Plan Offers More Tax Cuts.” Pp. GG1, Friday, August 29, 2008.
19 Some of the bills would have allocated the receipts to offset the cost of supplemental
spending bills targeted to aid victims of Hurricanes Katrina and Rita. Others would allocate
them to the highway trust fund to compensate for any losses from the proposed
commensurate reduction in motor fuels excise taxes to offset the WPT. Several bills would
have appropriated the proceeds for the Low-Income Home Energy Assistance Program,
which gives grants to poorer households to offset high energy bills and for residential
weatherization.

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CRS-12
to assess the tax, or defining the tax base in terms of taxable income under the
existing corporate income tax.
Typical of the income tax type of WPT were those that would have imposed a
50% tax on the excess of the adjusted taxable income for a taxable year over the
average taxable income during the 2000-2004 period. The 50% tax would have
applied to crude producers and integrated oil companies with sales in 2005 or 2006
above $100 million. The tax would have been temporary and would apply to
petroleum products as well as crude oil. S. 1809 (Schumer) and H.R. 4276 (Larson)
in the House were of this type. Senators Schumer and Reed sponsored S. 1809 as an
amendment to S. 2020 (S.Amdt. 2635 and S.Amdt. 2626). In both cases, the
amendments were ruled out of order.
A variant of the income tax type of WPT is H.R. 3712 (McDermott). This bill
would have taxed any profit from the sale of crude oil, natural gas, or products of
crude oil and natural gas above a 15% rate of return at 100%. Tax revenues would
have been earmarked for a program of gas stamps to help indigent persons offset the
burden of recent high gasoline prices, which would be similar to the current federal
food stamp program.
Other Types of WPT Proposals. Some WPT proposals are not easily
classified. For example, H.R. 2070 (Kucinich), H.R. 3664 (Kanjorski), and H.R.
3544 (DeFazio) would have imposed a graduated tax with the rates — 50%, 75%, or
100% — dependent on the extent to which profits exceed a reasonable level, as
determined by a specially created board or commission. These bills differ, however,
on how the tax’s proceeds would be used.20 Whether these WPT would have been
excise tax based or income tax based, or whether they would have used some other
tax base, is unknown since the bills did not provide a definition of either profits or
a reasonable profit.
Windfall Profit Tax Legislation in the 110th Congress
WPT proposals have been introduced in the 110th Congress, although there are
fewer excise tax based and more income tax based than in the 109th Congress. Also,
many of the income tax based proposals have focused on repealing the IRC § 199
deduction for domestic manufacturing activities, which is effectively equivalent to
an increase in the existing marginal corporate tax rate — and is not really tax on
windfall profits. As discussed in more detail below, the corporate income tax system
could be used as an administratively simple way to increase the tax burden on the oil
and gas industry, and approximate a WPT without the risks of adverse economic and
energy market effects.
20 H.R. 3544 (DeFazio) would impose price controls on gasoline, ban drilling in the Arctic
National Wildlife Refuge, mandate minimum levels of inventory of crude oil and petroleum
products, ban the export of Alaskan oil, and facilitate the draw down of the Strategic
Petroleum Reserve. H.R. 2070 (Kucinich) would fund income tax credits for the purchases
of fuel-efficient passenger vehicles, and to allow grants for mass transit.

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CRS-13
Excise Tax Type of WPT. S. 1238 (Casey) would impose a 50% excise tax
on any major integrated oil company based on the difference between the market
price of oil and $50 (this $50 would be adjusted annually for inflation). This bill is
the only bill to propose an excise type of WPT in the 110th Congress.
Income Tax Type of WPT. On the Senate side two bills introduced by
Senator Clinton, S. 701 and S. 2971, would tax half of the excess profits of major
integrated oil producers, and oil producers with gross revenues above $100 million
per year. Excess profit would be defined as taxable income above 110% of the
average taxable incomes over the 2000-2004 period. Thus, these bills would use the
existing tax law definition of taxable income, which, as discussed below, not only
facilitates tax administration and compliance, but also minimizes economic
distortions and adverse, short-run economic effects. S. 2991 and S. 3044 (Reid) take
a similar approach to the Clinton bills, but would 1) tax excess profits at a lower rate,
25% instead of 50%, and 2) use 2001-2005 (2002-2006 in S. 3044) as the base period
rather than 2000-2004. Also, any increased investment in renewable energy over the
same base period would be credited toward the tax and hence, reduce the windfall
profit tax liability. S. 3044 (Reid) is the Democratic leadership bill; it was introduced
on June 11, 2008.21
Other Types of WPT Proposals. H.R. 5800 (Kanjorski) and H.R. 6000
(Kucinich) would tax excess profits above a “reasonable” amount at rates ranging
from 50% to 100%. A Reasonable Profits Board would be created to determine the
reasonable profit level. The tax base to which this tax would apply appears to be the
income tax, but it is not defined.
Analysis of Economic and Policy Issues
Even with rising crude oil and petroleum product prices, and record oil industry
profits, not all of those profits or returns constitute a windfall or unearned income —
much of that income may be a return to investment and its capital stock, a return on
the firm’s decision-making and risk-taking. And, indeed, the business income taxes
paid to state and local governments, the federal government, and even foreign
countries, which are substantial, reflects their share of these profits in the form of
taxes. Table 6 shows the total taxes reported in their financial statements by the
major integrated oil companies in 2005, 2006, and 2007. These include income,
excise (including motor fuel excise taxes to federal, state, and local governments),
and severance taxes (which are primarily state levies). The record profits earned by
the five major oil companies generated liability for tax payments that increased by
21 S. 3044 would also roll back $17 billion in existing oil and gas industry tax breaks over
10 years for the largest oil companies; revenues would be earmarked to expanding
renewable energy development. In addition to the tax provisions, S. 3044 would prohibit,
and provide penalties for, price gouging by the oil and gas industry, tighten regulation of
speculators in offshore oil, and suspend filling of the Strategic Petroleum Reserve.

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CRS-14
32% from 2005 through 2007 as shown in Table 6. Any windfall profits tax that
might be adopted would add to these tax revenues.22
Table 6. Tax Payments by the Major Oil Companies, 2005-2007
(billions of dollars)
2005
2006
2007
ExxonMobil
23.30
27.90
29.86
Shell
17.99
18.31
18.65
BP
9.29
12.31
21.17
Chevron
11.10
14.84
13.48
ConocoPhillips
9.91
12.78
11.38
Total
71.59
86.14
94.54
Source: Company Income Statements, available at [http://www.hoovers.com].
Such taxes, however, do not belie the existence of windfall gains or unearned
income, and do not necessarily undermine the case for a WPT. A well designed and
structured WPT tax, however, would tax only the true windfall component of oil
industry incomes. Moreover, such a tax would be simple to administer and comply
with, and would avoid or minimize any adverse economic and energy market effects.
As the discussion below suggests, while in theory the concept of a windfall profit
seems simple and intuitive, in practice it can be difficult to measure accurately and
so the actual implementation of a WPT involves a compromise over differing fiscal
policy objectives: 1) administerability — collecting the excess revenues (or windfall
gains) in the least costly manner in terms of tax administration and compliance, 2)
economic efficiency — devising and structuring the tax in a way that minimizes
economic distortions, including adverse output and price effects, and adverse impacts
on petroleum imports, energy independence, and energy security.
The remaining sections of this report discuss some of the more important
economic issues surrounding proposed legislation, and draw relevant policy
implications. The final section discusses alternative policy options.
Defining and Measuring Windfall Gains
The most vexing problem in designing a WPT is how to define a true windfall,
i.e., the tax base. In theory, there is a difference, even if a subtle difference, between
a windfall gain, excess profit, and an unearned gain. A windfall gain applies to
22 According to the U.S. Department of the Interior, the domestic oil industry in the United
States also pays billions in royalties, which are not taxes but factor payments, the return to
landowners on their mineral assets. For FY2007, total federal royalties on oil and gas
(including natural gas liquids) were $9.4 billion. See the Minerals Management Services
website at [http://www.mrm.mms.gov].

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CRS-15
income or wealth that is unexpected, a gain which arrives fortuitously, possibly due
to factors outside of the control of the institution in question. This can be
distinguished from excess profits, which might be considered to be more subjective,
and are based on defining an acceptable profit, and attributing everything above that
level as excessive. This difference might be illustrated with a hypothetical example:
a firm might be so efficient that its above-average profitability (or returns) might be
considered excessive, but not a windfall. However, if its production waste, which
formerly was costly to dispose of, became valuable, that gain might be considered a
windfall.
Finally, one might differentiate both a windfall profit and an excess profit from
an economic rent, a technical term for the return to a fixed factor of production or
resource. For such resources that are in fixed supply, economic analysis suggests that
earned profits are not necessary for the services of that factor to be available to the
market.
The record profits reported by the oil and gas industry have characteristics of
both windfall gains, excess profits, and even economic rents, although they are more
in the nature of “quasi-rents” than pure economic rents because some industry
investment, effort, and risk is required for production: oil supply is not perfectly
inelastic. Thus, for purposes of taxing this income — from the perspective of merely
raising revenues — it matters little whether the tax is an excise tax or income tax
type, or whether it is based on industry rates of returns compared to rates of return
in other industries (manufacturing, for example), or in the general economy. Since
the profits are price-driven, and since there is little or no output or investment effect,
either the excise tax or income tax or rate of return type could be used to collect the
windfall.
Rather, the critical difference in the type of WPT tax to implement is in the
firm’s economic response to the tax, and in the cost of administration and compliance
costs. The next two sections of this report examine the output and price effects of the
two different types of WPT. It also examines the effects on the demand for oil
imports, and therefore energy independence, and energy security. Finally, this section
examines a variety of other tax options for increasing the tax burden on the oil and
gas industry, options that have been offered as alternatives to the WPT. In general the
conclusions of this analysis are that an excise tax is non-neutral and could have
adverse economic effects, particularly on the level of dependence on foreign oil,
while the income tax approach is relatively neutral in the short run, thus minimizing
economic distortions and other adverse economic effects.
The Non-neutral Economic Effects of
the Excise Tax Type of WPT
As discussed in more detail below, an excise tax on domestically produced
crude oil may only approximate a windfall profit tax, and may have certain adverse
energy market and economic effects. In other words, depending on how a WPT were
structured, an excise tax type of WPT — for instance, by reinstating the WPT of the
1980s — might make the United States more dependent upon foreign oil, which in
turn might have implications for energy security.

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CRS-16
Output Effects. Economic theory suggests that a WPT in the form of an
excise tax — e.g., H.R. 3752 and S. 1631 in the 109th Congress; S. 1238 in the 110th
Congress — could reduce domestic oil production.
In economic terms, oil producers would likely view the tax as an increase in the
marginal, or incremental, cost of domestic oil production — the marginal cost of
producing every barrel of taxable crude oil would be higher by the amount of the
excise tax. An increase in the marginal cost of production might be viewed as an
incentive to produce less oil. However, this effect is likely to be mitigated in the U.S.
oil market by other factors. The theoretical analysis assumes that the difference
between price and marginal cost is relatively small, implying that the imposition of
a tax would reduce profits to, or below, the competitive level. In the current oil
market, oil prices are typically far above the marginal cost of production, implying
that even after paying a tax, profitability could remain high, continuing to provide an
incentive for production. The economic analysis also assumes that some cheaper
alternative source of oil is available to substitute for taxed domestic production.
Firms are unlikely to pay the market price for oil in the international oil market
instead of using domestic production. If they did this, they would lose the difference
between the price and cost of domestic oil, substituting foreign oil, for which price
is effectively equivalent to marginal cost. Finally, marginal production adjustments
are unlikely to be made to existing oil wells. Once an oil well goes into production,
the maximum sustainable flow rate is likely to simultaneously be the maximum
economic flow rate, allowing for oil field management to be based on physical
factors related to output.
Oil Imports and Energy Independence. If the domestic supply of oil were
reduced in response to an excise tax on domestically produced oil, the demand for
imported oil and petroleum products would likely increase, unless some other policy
would concomitantly reduce the demand for petroleum to offset a tax-induced
reduced supply. This is because oil imports to the United States are a residual,
adjusting to reflect the difference between aggregate demand for oil and aggregate
domestic oil supply.
Price Effects. One of the concerns — and one of the arguments made by
opponents of a WPT — is that such a tax would raise prices: a WPT on crude oil
would raise the price of crude oil, which would then be passed on to consumers in
the form of higher petroleum product prices — higher prices of gasoline, diesel, jet
fuel, and other products. If true, then this might defeat one of the purposes of
imposing such a tax: to relieve consumers (both personal and business consumers
such as truck drivers) from the burden that recent high gasoline and diesel price have
had on them.
As noted, an excise tax only on oil produced domestically in the United States
would increase marginal or incremental production costs, and, in theory, a profit
maximizing firm would respond to this type of tax by reducing output and attempting
to raise prices to offset the higher marginal production costs. However, in the case
of domestic crude oil, the higher marginal cost cannot be shifted forward as a higher

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CRS-17
oil price, because oil is priced in the international (world) oil market).23 Oil producers
would not be able to shift the tax forward as a higher oil selling price because the
first purchaser (generally, the refiner) would merely substitute imported crude, which
would be tax-exempt. Instead, this type of WPT would reduce the net selling price
paid to producers. As noted earlier, the first purchaser would subtract the tax from
the price paid to the producer (supplier) — the producer’s net selling price of each
barrel of oil would be less by the amount of the WPT.
The Neutrality of the Corporate Income Tax Type of WPT
Output Effects. From an economic perspective, the income tax based WPT
— such as those that use the existing corporate tax system to define excess or
windfall taxable income — would be relatively neutral in the short run — it would
have no (or few) output, or price effects and other economic effects. The reason for
this is that a firm maximizes profit at the point at which market prices are equal to
marginal production costs, and neither are affected in the short run by an increase in
the corporate tax burden — the profit maximizing level of output and price are
unaffected by the tax. Thus, to the extent that a surtax on the corporate income of
crude oil producers on their upstream operations could approximate such a tax, this
would not raise crude oil prices and would not tend to increase petroleum imports in
the short run.
In the long run, however, all taxes (or almost all taxes) distort resource
allocation, and even a corporate profit tax (either of the pure type or the surtax on the
existing rates) would raise average long-term production costs, reduce the rate of
return and reduce the flow of capital into the industry relative to other industries, and
move resources away from the corporate form of business organization. All these
effects could adversely affect domestic production, possibly resulting in increased
petroleum imports.
Oil Imports and Energy Independence. Because the income tax type of
WPT does not create incentives to reduce domestic production in the short run, there
is no increase in the demand for imports under such a tax in the short run, although
it could if the tax were still in effect in the long run.
Price Effects. From an economic perspective, that is to say, in theory,
increasing marginal tax rates on corporate income would have no (or few) price
effects. The reason is as before: a firm maximizes profit at the point at which market
prices are equal to marginal production costs, and neither are affected by an increase
in marginal tax rates — the profit maximizing level of price is unaffected by such a
tax.
Alternative Policy Options
As mentioned above, should Congress decide to tax oil industry surpluses, there
would be several alternative policy options to increase taxes on the domestic oil and
gas industry, including eliminating the industry’s several targeted tax subsidies,
23 There may be some small price effects if the export supply curve is not perfectly elastic.

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CRS-18
reducing tax benefits provided through the general or non-targeted provisions of the
tax code, or even eliminating the tax incentives enacted under EPACT05. These
options are discussed in a separate CRS report.24 Rather, the remaining sections of
this report address alternatives that are really variations on the two WPT options
discussed before.
Rescinding the § 199 Deduction. One option that has been proposed
frequently in congressional bills is the repeal of, or reduction in, the IRC § 199
deduction for domestic manufacturing activities. This option does not actually
attempt to measure or tax windfall profits, but uses the existing corporate income tax
system to effectively increase the marginal corporate tax rate on domestic oil and gas
producers, targeting primarily the major integrated oil companies.25
Enacted in 2004 as an export tax incentive, this provision allows a deduction,
as a business expense, for a specified percentage of the qualified production activity’s
income (or profit) subject to a limit of 50% of the wages paid that are allocatable to
the domestic production during the taxable year. The deduction was 3% of income
for 2006, is currently 6%, and is scheduled to increase to 9% when fully phased in
by 2010. For the domestic oil and gas industry, which qualifies for this deduction
(i.e., it is not excluded from claiming it) the deduction applies to oil and gas or any
primary product thereof, provided that such product was “manufactured, produced,
or extracted in whole or in significant part in the United States.” Note that extraction
is considered to be manufacturing for purposes of this deduction, which means that
domestic firms in the business of extracting oil and gas from underground reservoirs
or deposits qualify for the deduction. This deduction was enacted under the American
Jobs Creation Act of 2004 (P.L. 108-357, also known as the “JOBS” bill). It was
originally a substitute for repeal of the export tax benefits under the extra-territorial
income tax exclusion, which was ruled to be in violation of trade laws.26
Repealing, or cutting back this deduction would be effectively equivalent to an
increase in the marginal income tax rate, and as noted earlier a change in the
corporate tax burden in the short run is relatively neutral. For example, at the top
marginal corporate tax rate of 35%, which typically applies to large corporations such
as major oil and gas producers and refiners, the current deduction of 6% is equivalent
to a marginal corporate income tax rate of 32.9% (35% x 0.94) rather than 35%.27
The proposed elimination of this deduction would be, thus, equivalent to an increase
24 See CRS Report RL33763, Oil and Gas Taxes and Subsidies: Current Status and
Analysis, by Salvatore Lazzari.
25 Repealing this deduction has been part of almost every major energy tax bill in the
Congress over the last two years. Section 199 repeal is also part of the so-called “Gang of
16” draft energy bill (no number yet) which would also open up much of the Outer
Continental Shelf to oil and gas production, and restrict speculation in the oil commodities
(futures) markets.
26 CRS Report RL32652, The 2004 Corporate Tax and FSC/ETI Bill: The American Jobs
Creation Act of 2004, by David L. Brumbaugh.
27 Corporations are currently taxed at 15% of the first $50,000 of taxable income, 25% of
the taxable income from $50,001 to $75,000, 34% of the taxable income from $75,001 to
$10 million, and 35% of taxable income above $10 million.

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CRS-19
in the marginal tax rate from 32.9% to 35% for those major oil companies to which
this would apply. All other large corporations would continue to face a top marginal
tax rate of 32.9%, with the exception of non-manufacturing enterprises (services, for
example), which do not qualify for the § 199 deduction. Thus, as noted, this option
does not attempt to measure and tax the oil industry’s windfall profits; it is just a way
of using the existing corporate income tax system to increase the tax burden on the
oil industry, and recoup some of the windfall or excess profits in the form of
corporate income taxes.28
As before, eliminating the deduction — that is to say, raising the corporate tax
rate — would increase total (or average) business costs and therefore reduce
profitability among the major oil and gas producers. As long as marginal production
costs are unaffected, there would be no price effects in the short run. Similarly, the
demand for imports is likely to remain the same in the short-run. Thus, this type of
corporate income tax increase would arguably be an administratively simple and
economically effective way to capture at least some of the oil industry’s windfalls in
the short run. However, at a current deduction of 6%, and a marginal corporate tax
rate of 35%, only a small portion of the industry’s likely windfalls would likely to be
captured under this option.
The market price of crude oil and natural gas, or even of refined petroleum
products, such as gasoline, would not be expected to increase very much, if at all, by
such a change in the short run. In general, also, the income tax increases are not
expected to have real output effects in the short run, although they could cause
resources to flow to other industries in the long run as long as these other industries
are allowed the manufacturing deduction, which is equivalent to a lower marginal tax
rate.
An Income Type WPT Tax and § 199 Repeal. Some WPT proposals
combine the WPT, with a repeal or reduction in the § 199 manufacturing activities
deduction. This effectively uses two instruments to raise the corporate tax rate on
domestic oil and gas producers, which, as noted before, would be relatively neutral
in terms of its price, output, and import effects. One bill that takes this approach is
S. 3044, which would rescind the IRC § 199 deduction for major integrated oil
companies, and assess a 25% tax on the difference between profits in any one year
and 110% of the average of profits over the 2002-2006 period.29 This bill follows
many of the earlier bills in that it attempts to recoup for the federal taxpayer some of
the windfall or “excess” profits reported by the oil and gas industry as a result of
unprecedented high petroleum prices.
A Tax on Imported and Domestically Produced Crude Oil. If, instead,
an excise tax were to be imposed broadly on both imported as well as domestically
produced oil (as proposed in the early 1980s by the Reagan Administration), this tax
28 The proposed repeal or cutback in the § 199 deduction could also be a way of funding
other provisions in the bills.
29 S. 3044 also restricts the ability of major oil and gas companies to claim tax credits for
taxes and other payments to foreign governments against the U.S. tax on foreign source
income, which also is a way of increasing the corporate tax burden.

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would produce upward price effects — the price of crude oil in the United States
would tend to be higher than under the WPT on domestic oil alone. This is because
the tax would be imposed on imports, which are the marginal source of oil supplies
and therefore the benchmark for crude oil prices. The effect on domestic production
and the level of imports — dependence on foreign imports — would depend on the
size of the tax and the price elasticities of domestic supply and import demand.
An Excise WPT and Gas Tax Suspension. An excise tax holiday —
suspension of the 18.4¢/gallon tax on gasoline — combined with an equal revenue
WPT on oil would be completely counterbalanced or offsetting. Eliminating the
gasoline tax might cause refiners to reduce prices over time by the amount of the tax,
depending on the state of the energy market at the time of suspension, (or somewhat
less depending on tax incidence, which depends on the ratio of price elasticities of
the demand and supply schedules), but the excise-tax based WPT on all crude oil
(i.e., one imposed on both imports and domestic production) would be shifted as a
higher price of crude oil bought by refiners, thus offsetting the decline in product
prices.30
Possible Revenue Effects
A WPT on crude oil could generate sizeable revenues depending on the tax rate
and the tax base, i.e., whether it was excise tax based or income tax based, and
depending on crude oil prices at the time the tax were imposed. This section of the
report does not provide revenue estimates, because CRS neither has the data nor the
estimating models to do so.
The excise tax based WPT probably has the greatest revenue potential merely
because of the high recent level of crude oil prices, and because the tax base is not
adjusted for operating costs (operating costs are not deducted from the tax base) as
in the case of the income-tax based WPT. To illustrate, S. 1238 (Casey) would tax
any major integrated producer on the difference between market price and $50/barrel
at a 50% rate. If oil prices remain over $100 per barrel, this tax could generate
substantial revenues.
The income tax type of WPT generally has a smaller revenue potential, again
because, 1) taxable income is used as the tax base, which is generally much smaller
than book income (which is the net income measure reported in Table 4). Also, the
income tax based proposal typically uses the average of taxable income over a lagged
five-year period. Thus, in a period of generally rising prices, the base tends to
progressively decline.
Finally, there are revenue estimates related to repeal of the IRC § 199 deduction.
These have been estimated several time in recent years by the Joint Committee on
30 Eliminating the gasoline tax would deny the Highway Trust Fund of its principal source
of revenue unless some adjustment were made. See CRS Report RL30497, Suspending the
Gas Tax: Analysis of S. 2285, by Salvatore Lazzari. and CRS Report RL34475,
Transportation Fuel Taxes: Impacts of a Repeal or Moratorium, by John W. Fischer and
Robert Pirog.

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Taxation for several different congressional proposals. The figures reported in Table
7 are the most recent available, and show that over 10 years, nearly $10 billion in
additional revenue could be collected from repealing the § 199 deduction for major
integrated oil producers. It should be noted that the figures in Table 7 would likely
change if they were re-estimated using more current assumption about crude oil
prices, the state of the oil industry, the condition of the macro-economy, and other
economic variables.
Table 7. Estimated Revenue Effects of Repealing
the § 199 Deduction for All Oil and Gas Industry, and for
Major Integrated Oil and Gas Producers
(billions of dollars)
2008-
2008-
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2012
2017
Revenue
0.262
0.605
0.776
0.950
1.022
1.098
1.180
1.269
1.364
1.466
3.615
9.992
Effect
Source: U.S. Congress. Joint Committee on Taxation. Estimated Budget Effects of the Revenue
Provisions Contained in Titles I. And XV. Of H.R. 6, The Clean Renewable Energy and Conservation
Tax Act of 2007, as Passed by the House of Representatives on December 6, 2007. JCX-112-07,
December 12, 2007.

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