Even if comprehensive tax reform is unlikely to be enacted during the 113th Congress, the tax reform policy discussion has begun in earnest. Earlier this month, House Ways and Means Committee Chairman Rep. Dave Camp (R-Mich.) released his proposal for comprehensive tax reform. Chairman Camp’s plan follows a set of proposals (here and here) issued in December 2013 by former Senate Finance Committee Chairman Sen. Max Baucus (D-Mont.). Both proposals reform the tax code in a manner that would significantly impact the American energy system—with some surprising early agreements— though neither plan is likely to advance past discussion drafts.
How big are energy tax expenditures?
The federal tax code, in addition to its broad implications for the U.S. economy, significantly affects the economics of the energy sector. According to the Congressional Research Service, tax expenditures for energy accounted for roughly $22 billion in 2013 and are estimated to average roughly $16 billion per year through 2017 if present trends continue. These energy-related tax expenditures fall generally into three categories:
- Credits and deductions: the modification of tax liability, either indirectly through reducing taxable income (i.e., deductions) or directly reducing tax payments (i.e., credits);
- Cost-recovery mechanisms: the rules for allocating the business expense associated with an asset over the asset’s life; such depreciation (for tangible assets) or amortization (for intangible assets) expenses are then deducted from revenue to calculate a business’ taxable income; and
- Alternative business structures: the rules for eligibility and taxation associated with different types of business entities—particularly whether a business entity is subject to corporate income taxation or whether its income is “passed-through” to business owners and subject to individual income taxation.
The federal tax code has provisions specific to energy dating from as far back as 1916. Most existing energy tax expenditures have been enacted since 1986, when Congress last passed comprehensive tax reform legislation. All energy sources are directly affected by some part of the tax code, either by provisions specific to a resource, such as the renewable energy production tax credit and the percentage depletion allowance for oil and gas, or by general measures, such as corporate income tax rates and depreciation rules.
Why do we even have tax policies specific to energy?
In theory, taxes and subsidies are intended either to correct an energy market failure or to achieve a greater national objective. Energy market failures, such as externalities and informational asymmetries, result in an economically inefficient allocation of market resources. In practice, U.S. energy tax policy is a product of fiscal objectives and the interests of policymakers, experts and interest groups. As a result, enacted tax policy embodies compromises between economic and political goals at a particular point in time. As time passes, the policies embodying previous compromises may reach (or prove unable to reach) their goals and can become increasingly dissonant with new economic realities and political goals. For this and other reasons, in 2013 BPC’s Strategic Energy Policy Initiative called for Congress to critically review all existing tax expenditures associated with energy.
The proposals released by Chairman Camp and former Sen. Baucus take on this charge, with both including a number of notable changes to the tax code that would affect all parts of the energy sector. While they differ in ways too numerous to recount here, they appear to agree at several points.
Growing reluctance for technology-specific energy tax credits
As BPC’s Economic Policy Project summarized previously, Chairman Camp’s comprehensive tax reform proposal generally lowers individual and business tax rates while removing or limiting deductions, credits, and techniques for recognizing income in low-tax jurisdictions to broaden the base of taxable activities. In line with that objective, Camp’s plan eliminates nearly all energy tax credits, as well as retroactively reducing the value of some credits.
The Baucus tax reform proposal also eliminates a range of energy tax credits, but retains a simplified pair of credits—for electricity generation and for fuel production—that vary based on greenhouse gas emissions intensity. Camp’s proposal does not mention explicit environmental policy goals.
Although the two tax proposals diverge on whether to make use of energy tax credits to reach policy aims, they show a surprising amount of bipartisan agreement on eliminating a large set of energy tax credits that include energy efficiency equipment, alternative vehicles, enhanced oil recovery, carbon capture and advanced energy manufacturing, among other provisions. While this can largely be attributed to the shared goal stated by both Camp and Baucus to simplify the tax code and broaden the tax base (advocated by BPC’s Domenici-Rivlin Debt Reduction Task Force), it may also signal growing consensus against tax credits for narrowly-defined energy technologies.
Agreement to reduce annual depreciation deductions for energy capital assets
Another area of potential bipartisan agreement is in changes to the treatment of depreciation and amortization expenses for tax purposes. A series of provisions in the tax code, often referred to collectively as “accelerated depreciation,” allow businesses to recognize depreciation and amortization expenses much earlier on their tax returns than they can on public financial statements. Both Camp’s and Baucus’s plans would replace modified accelerated cost recovery system (MACRS) depreciation rules, in force since 1986, with approaches closer to how depreciation is reported in financial statements. MACRS covers many asset types and includes specific provisions for electricity generating assets, fuel production facilities and energy infrastructure.
Camp’s proposal would replace MACRS with rules similar to the alternative depreciation system (ADS) currently in use for certain property types. Under the Camp proposal, all tangible property would be assigned to a particular asset class, and each class would be assigned a depreciation life (to be developed by the Treasury Department). All depreciation deductions would then be calculated on a straight-line basis over their assigned asset class life—that is, as equal increments annually. (In contrast, MACRS currently allows depreciation schedules for physical assets that are frontloaded to early years—and are thus “accelerated.”) Camp’s proposal also allows further depreciation deductions to account for inflation, using chained consumer price index (CPI). Existing special depreciation provisions, such as bonus depreciation, would be repealed, and other cost-recovery provisions in the tax code associated would be similarly adjusted to better match treatment on financial statements.
The Baucus proposal also would repeal MACRS and establish a new set of asset classes. In contrast to the Camp proposal, the Baucus proposal assigns most asset classes an annual depreciation rate, rather than asset lifetimes over which to calculate straight-line depreciation.
While the particulars of the plans differ, both the Camp and Baucus proposals agree on reforming depreciation rules to more accurately reflect the economic life of assets—which will generally reduce annual deductions and raise federal tax collections. This is particularly important for the capital-intensive energy sector, where the investment decisions for electricity generating assets, fuel production facilities and energy infrastructure are impacted by the extent to which depreciation deductions affect tax liabilities. Early bipartisan agreement suggests that changes to the tax treatment of energy capital assets are likely to be less generous in any future tax reform bill.