The Trump tax bill: An object lesson on the need for policymaker engagement

In early 2009, the oil and gas industry’s trade associations, and oil and gas lobby, received a strong wake-up call, when new President Barack Obama first proposed to eliminate each and every tax treatment contained in the IRS code that is specific to oil and gas. Intangible drilling costs, percentage depletion, tax treatments for marginal wells, geological and geophysical costs, all those and several other treatments would, if Mr. Obama had his way, soon disappear.   

Same refrain

As the Jimmy Carter administration had done 30 years before, the Obama administration had identified the oil and gas industry as a convenient target, and produced a steady drumbeat of misinformation. This deliberately erroneous material was designed to convince members of Congress and the general public that any provision in the tax code that was specific to the industry was, in fact, a subsidy and a giveaway that needed to be eliminated.

In quick response to Obama’s initial targeting, the industry’s state and national trade associations, and company lobbyists and tax experts, initiated a campaign focused on educating members of Congress about key industry tax provisions, and how critical some of them—like the intangible drilling cost deduction—are to the ability of companies to raise the capital necessary to remain in business.  It was clear that some form of a tax reform bill would be coming, and the industry wanted to be sure that it had a critical mass of support among both Republicans and Democrats to support the continuation of these crucial tax treatments.

The industry perseveres

It took nine years of debating, arguing, drafting, negotiating, re-drafting and bargaining through five different Congresses and all or part of two presidencies, but that tax reform bill finally came (Fig. 1), and was signed into law, during December. At the moment when President Donald Trump put his signature to the bill, all of that work by the industry’s associations, executives, experts and lobbyists had finally paid off. The Tax Cuts and Jobs Act of 2017 retains the most crucial of the industry’s tax treatments, and adds new tax provisions that will be highly conducive to expansion of oil and gas exploration in the coming years.

Fig. 1. Senate Majority Leader Mitch McConnell (R – Ky.), left, and House Speaker Paul Ryan (R – Wis.), right, shepherded the tax bill to its final version, and its signing by President Trump. Photos: Official Senate and House images.

Drafting of the bill began after the GOP assumed a majority in the House after the 2010 mid-term elections, and had been a work in progress ever since.  President Obama gave a lot of lip service to wanting to do corporate tax reform, but he never really had any intention of working to make it happen. Yet, Republicans and many Democrats in Congress recognized the need for radical reform, due to the extremely high U.S. corporate tax rate.

That 35% rate made the U.S. uncompetitive for attracting manufacturing infrastructure and jobs. This was fine with Mr. Obama under the contentious carbon dioxide/climate change rationale that dominated his administration. He and his people were true believers in the theory that the U.S. needed to slow economic growth to protect the climate, and thus had no real intention of reducing
tax rates.

Hillary Clinton, the Democratic presidential nominee in 2016, subscribes to that rationale.  Thus, the 2016 presidential election’s result, when Donald Trump was elected, was the only reason why this bill finally got done. Had Donald Trump lost, the seemingly interminable stalemate between a GOP Congress and a Democratic presidency would still exist today.

The effects of the new law on the economy are being felt already, including employee bonuses; wage hikes; and massive new investments in the U.S. economy being announced by Apple and other large corporations. This is a direct cause-and-effect that the Obama administration tried, for eight years, to convince the public would never happen.

Meanwhile, where oil and gas is concerned, there are numerous positive impacts contained in the new law.  Here follows a detailing of many of those impacts.

TAX LAW: KEY PROVISIONS IMPACTING OIL AND GAS 

• Lower tax rates. For individuals involved in the business, as well as corporations, the marginal tax rates in all tax brackets are lowered. Even with the bill’s limitations on deductions for interest and state taxes, and eliminations of certain other personal deductions, the lower tax rates are going to result in net tax reductions for almost everyone.
• The ability to deduct intangible drilling costs is retained (Fig. 2) . Retention of this century-old treatment was a focus of the industry’s educational efforts, and is vital for independent producers.  
• The deduction for Percentage Depletion is retained. The retention of this provision—also on the books for more than a century—is vital for smaller independents and royalty owners.
• Another key provision for corporations is the ability to deduct most other capital costs, in the year in which they are incurred. This is key for the upstream, midstream and downstream segments of this capital-intensive business. This provision will begin a phase-out in FY 2023, but the period for which it is effective will likely spur dramatic growth of new infrastructure, all along the oil and gas value chain.
• The Corporate Alternative Minimum Tax is repealed. This provision has served mainly to penalize marginally profitable corporations for decades. This repeal is a real positive development for rapidly expanding midstream companies, as well as many upstream producers.
• The Personal Alternative Minimum Tax is retained but scaled back. This is another positive development for privately-held businesses and royalty owners. It is too bad that this inherently un-American concept wasn’t repealed for individuals, as it was for corporations. We can thank the arcane Congressional Budget Office “scoring” rubrick for that discrepancy.
• “Carried Interest” provision is retained. The bill leaves in place the so-called “Carried Interest” provision for managers of private equity funds. This will help to preserve the industry’s access to a key source of capital that has funded so many projects and start-ups in recent years.
• A one-time lower rate for repatriation of overseas profits is established. International companies that have held profits overseas, due to high U.S. tax rates, will be able to repatriate those funds for use in the U.S., at a one-time rate of 15.5%. This is expected to create a flood of new capital into the U.S. in all major industries, as estimates on the magnitude of profits held overseas by U.S. companies exceed $2.5 trillion.
• The net operating loss (NOL) deduction is slightly limited. The new law limits the NOL deduction for a given year to 80% of taxable income. It was previously 90% of taxable income.
• New limitation on net business interest expense. The law limits the deduction of net business interest expense to 30% of a company’s adjusted taxable income, plus floor plan financing interest. This will negatively impact businesses with heavy debt burdens, but the expectation is that the lower tax rate, and ability to expense most capital costs, will more than offset this impact.

OTHER INDUSTRY IMPACTS

When looking at the impacts of this tax bill on the oil and gas industry, it is important to also look at how it is likely to impact other economic sectors that provide demand for the industry’s various products.

Fig. 2. A key component of the tax bill affecting independent producers was retention of the century-old intangible drilling cost deduction. Photo: Anadrako Petroleum Corporation.

There is no question, for example, that the capital cost deduction and foreign profits repatriation provisions of this bill—not to mention the radically lower rate of taxation—will result in a new, huge influx of manufacturing plant and equipment back into the United States. These assets have, for the last 40 years, gone overseas.  

Plastics, fertilizers, chemicals—these and so many other capital-intensive industries rely on natural gas and other petroleum products for their feedstocks. The low natural gas price already has been attracting massive new investments by these industries in the U.S. The tax bill will only serve to accelerate such investments.

So, in addition to stimulating the supply side of the domestic oil and gas industry, the Tax Cuts and Jobs Act also will have a stimulative effect on demand for the industry’s products.  This increased demand will be especially helpful for natural gas, whose price has been depressed for many years now. The more demand, the better.

It is important to remember that this positive outcome for the oil and gas industry did not just happen by accident. It is the result of almost a decade of planning and hard work by hundreds of people in the industry’s trade associations and lobby, and industry executives and other personnel, who took the time to engage with policymakers on this subject in Washington, D.C., and in their home districts. The outcome of this tax bill, and the process by which the industry arrived at it, is a real object lesson for those who question why the industry needs to engage with policymakers on a regular basis.