Don’t let corporate tax reform camouflage a sneak attack

Gary Clyde Hufbauer Reginald Jones Senior Fellow, Peterson Institute for International Economics
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For all the rhetoric surrounding big oil, American companies are dwarfed by their state-run competitors in places like Venezuela, Saudi Arabia, Iran, Mexico, Russia, and more. The largest American company, in fact, is only the twelfth largest company globally in terms of worldwide production.

State-run energy firms – like those in China and Russia — benefit from the full support of their governments, with favorable financing, outright subsidies and low taxes. They are encouraged to cast a wide net in search of recoverable resources, tying up as much energy as possible.

U.S. energy companies face completely different circumstances. As a perennial target for tax increases, U.S. companies are viewed as a political punching bag and a source for short term revenue. This treatment is encouraged by our antiquated system of international taxation. Aside from the United States, every advanced country practices the territorial system of international taxation: a company’s earnings abroad are subject to the corporate income tax of the host state, but with minor exceptions not the income tax of its home country.

By contrast, under the “worldwide” system practiced by the United States, overseas earnings are subject to both the host state’s corporate income tax and the US corporate income tax. However, the United States allows a credit, meaning a dollar-for-dollar offset, for foreign income taxes paid by the company.

Under longstanding practice in the U.S. system, royalties paid to foreign governments for the right to extract oil and gas from public lands are a deductible expense.  But, as mentioned, the corporate income taxes paid to the foreign government are allowed as a credit, or offset, against the US corporate tax liability.

One of the administration’s stealth proposals is to artificially re-characterize part of the income tax liability as a royalty, thereby turning those payments into a deduction rather than a credit. The bottom line of this proposed change would be sharply higher tax burdens on U.S. energy companies seeking to compete overseas.

This would create an immediate competitive disadvantage as they engage in the global energy race. Without getting credit for taxes paid to foreign governments an American company, such as ConocoPhillips, would be hard-pressed to win the rights to develop a valuable tract in foreign waters. Why? ConocoPhillips would face an additional tax liability that its competitors – companies like Sinopec or Citgo – would never see.

So, who wins if this change sneaks into U.S. law as a revenue-raiser within the wider umbrella of corporate tax reform?

It’s certainly not U.S. energy security, as the proposal would make it more difficult for American companies to develop the world’s fossil resources. And it’s probably not the Treasury, as the net impact of this proposal over a decade would be depressed activity abroad by U.S. energy companies. And it’s not skilled oil field workers who now find highly paid employment around the globe.

But there are two clear winners under this proposal: state-run companies and foreign nations seeking to enhance their own energy security.

The United States should not seek the distinction of being the only advanced nation that uses tax policy to make its companies less competitive.

Gary Clyde Hufbauer is the Reginald Jones Senior Fellow at the Peterson Institute for International Economics. In the 1970s, he was director of the International Tax Staff at the US Treasury. The views expressed are his own.