(This document is still under construction. Pardon our dust...) Dirty Little Secrets

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This report was made possible by the generous support of the W. Alton Jones Foundation, the Joyce Foundation, the Nathan Cummings Foundation, the Wallace Genetic Foundation.

Thanks to Environmental Media Services for generously providing media support.

Thanks also to Cathy Carlson, Dana Clarke, Courtney Cuff, Jack Doyle, Nicole Anderson Ellis,

John Fitzgerald, Ferd Hoefner, Dena Leibman, Joanne Lesher, Jim Lyon, Bob McIntyre,

John O'Hare, Jeff Olson, Gene Peters, Perry Plumart, Dianne Saenz.

Special thanks to Andrew Hoerner, who provided daily guidance and assistance.

by Dawn Erlandson, Jessica Few, and Gawain Kripke

1995 Friends of the Earth

ISBN 0- 913890- 92- 8

April 1995

Additional copies of this report are available from

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For general information about this report, contact:

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Printed on 100% recycled paper, 50% post- consumer content

Friends of the Earth- U.S. is a tax- exempt environmental advocacy organization founded in 1969 and headquartered in Washington, DC. Dirty Little Secrets is a report of Friends of the Earth's Economics for the Earth program, which promotes economic reform to protect the planet and its people. FoE- U.S. also features programs on international, ozone, and groundwater issues. FoE- U.S. is a member of Friends of the Earth International, a network of affiliates in 52 countries.


Table of Contents


5-Year Savings

Topic ..............................................(savings in millions of dollars)


Overview

Close Up Polluter Loopholes

The Tax Code Plays Favorites 3

Polluter Welfare: "Get out of the wagon and help pull" 4

Throwing Stones 5

The Challenge Ahead 6

Mining:

Gold Diggers: Percentage Depletion Allowance 7 ..................... $2,800

Money for Mining: Expensing Exploration & Development 8 ..................... $675

Play Now, Pay Later: Reclamation Deduction 9 ..................... $200

Oil & Gas:

Pumping the Tax Code: Percentage Depletion Allowance 10 ..................... $2,000

Bad to the Last Drop: Enhanced Oil Recovery 11 ..................... $500

Drilling for Dollars: Intangible Drilling Costs 12 ..................... $2,500

Lucky Loser: Passive Loss 13 ..................... $665

Syn Sins: Nonconventional Fuel Production Credit 14 ..................... $5,800

Timber:

Logging Loopholes: Special Tax Treatment of Timber 15 ..................... $2,600

Ozone-Depletion:

Loophole in the Sky: Tax Ozone-Killing Chemicals 16 ..................... $1,600

Agribusiness:

Cooking the Books: Cash Accounting 17 ..................... $1,300

Pigs in a Poke: Dairy and Livestock Expensing 18 ..................... $700

Polluting Industries:

Up in Smoke: Tax Exempt Bonds for Incinerators 19 ..................... $900

Cloaking Profits: Publicly-Traded Limited Partnerships 20 ..................... n/a

Spoils of Spills: Pollution Deduction 21 ..................... n/a

Sources 22

TOTAL SAVINGS $22,200


Overview

This report is dedicated to the millions of Americans who diligently pay their taxes and hope the government will spend them wisely. No one enjoys paying taxes. But Americans have a right to expect that taxes are spread equitably, that the same rules apply to everyone, and that everyone has to pay for the services tax dollars provide.

Close inspection, however, reveals that some taxpayers are paying less than their fair share. Through powerful lobbying, polluters have carved out special treatment in the tax code. What they do is not illegal, but it is unfair. It is also a disaster for the environment and human health.

In Washington, politicians are clamoring for a balanced budget and "an end to welfare as we know it." The face of welfare has been that of the poor, but Secretary of Labor Robert Reich has offered another face: that of rich corporations. He has challenged Washington to "ask Corporate America to get off welfare and play by the rules as well."

Friends of the Earth has accepted the challenge. In January, we published The Green Scissors Report with other environmental and taxpayer groups. The report called for the elimination of 34 federal programs that harm the environment and cost the taxpayers $33 billion. Dirty Little Secrets addresses the other side of government spending -- tax expenditures.

"Tax expenditures" are a form of government spending. They are special exclusions, deductions, credits and other tax breaks that result in lost government revenue. Many of these tax breaks serve worthwhile public purposes, but the breaks cited in this report undermine the public good. Not only is the government subsidizing environmental degradation, but average citizens must make up for the lost revenue by paying higher taxes or suffering under the burden of increased national debt. In effect, they function as a reverse Robin Hood, taking from average working people and giving to rich, polluting businesses.

Every year, these polluting tax subsidies cost taxpayers close to $4.5 billion each year. What could the government do with $4.5 billion a year? If these subsidies were eliminated, the resulting revenue would equal all federal income taxes paid by close to 13 million low-income taxpayers, about 1 in 9 taxpayers. The revenue gained from cutting these subsidies could also roughly offset all federal income taxes paid by the citizens of Kansas. Or Oklahoma. Or Iowa. Or New Mexico and West Virginia. Or Arkansas and Montana.

Too long the domain of corporate lobbyists and tax lawyers, tax policy must be made more equitable and reclaimed by the people.


Close Up Polluter Loopholes

This report calls for the elimination of tax subsidies that:

* conflict directly with federal health and environmental policies. It makes no sense to subsidize pollution that the federal government and the private sector spend billions of dollars a year to clean up.

* subsidize practices that harm the environment and human health. For example, the federal government currently taxes the production of most chemicals that destroy the stratospheric ozone layer like chloroflourocarbons (CFCs) and halons. However, two types of ozone-depleting chemicals are slipping through. Methyl bromide and HCFCs are not taxed despite international agreements and EPA action to eliminate them. These chemicals contribute to an increase in the sun's harmful rays that can cause skin cancer and threaten the health of sensitive ecosystems such as coral reefs.

* favor declining, polluting industries over growing, clean industries. These tax subsidies hurt competition. They lock-in dinosaur technologies, such as coal-fired electricity, and make it harder for new, cleaner, more efficient technologies such as solar or wind energy, to take hold and compete. Also, subsidizing the logging and extraction of virgin minerals makes recycling and pollution prevention less competitive.

* distort market decisions about investments. Tax subsidies undercut the normal market pressures for firms to become more efficient. They weaken America's overall economic prospects by placing every unsubsidized sector and firm at a disadvantage. Tax subsidies substitute political micromanagement for normal market forces that govern the allocation of capital. They encourage more rapid depletion of our scarce natural resources.

* exacerbate the federal budget deficit. These tax breaks drain the treasury of revenue year after year. They operate like entitlements, unchecked with no spending limits.

* benefit the few at the expense of the many. To pay for these tax loopholes, the rest of us, both individual and corporate taxpayers, have to pay higher taxes. Furthermore, the beneficiaries of these special tax favors are rarely low- and middle-income working people but usually wealthy investors.

The Tax Code Plays Favorites

The industries most responsible for polluting our environment and depleting our natural resources are the beneficiaries of special tax treatment. In stark contrast, tax benefits are rare for clean industries, or even for better practices within polluting industries. Studies have found that extractive and polluting industries such as coal mining, petroleum and natural gas, and hardrock mining industries have lower effective tax rates than other industries. The effective tax rate is the tax rate on actual profits.

Incredibly, this coddling of polluters in the tax structure exists alongside a comprehensive set of federal laws that seek to maintain clean air, water, and soil and preserve species of plants and animals. It appears that one hand of government does not know, or has chosen to ignore, what the other hand is doing.

This report is not comprehensive.[1] More research would almost certainly find additional provisions that are unfair and hurt the environment. That said, simply eliminating these subsidies would be a major step toward greater tax equity and improved environmental protection.

The industries that benefit from special tax breaks for polluting activities are:

* Chemicals -- Polluters can write off almost all the costs of cleaning up hazardous substances, including lawyers fees. Companies that spill oil and dump toxic wastes receive this tax subsidy even when the actions are intentional or the result of gross negligence.

* Mining -- The industry enjoys outright tax subsidies for mining toxic substances such as lead, mercury, and asbestos. These subsidies can exceed the value of the owner's investment in the mine.

* Oil & Gas -- The oil and gas industry enjoys the best targeted tax treatment available to any industry. For example, investors can write off "passive" losses from oil and gas investments but not from investments in other industries.

* Agribusiness -- The tax code provides tax breaks to huge, chemical-intensive agriculture without helping small farmers nor promoting sustainable agricultural practices.

* Timber -- Special tax benefits for the industry drive up profits but do nothing to promote sustainable forestry. For example, special rules permit timber companies to deduct capital costs immediately while other businesses cannot deduct such costs.

Polluter Welfare: "Get out of the wagon and help pull"

At a time when there are no guarantees of government support for the poor, the young, or the infirm, one might ask whether there should be guarantees of government support for businesses, particularly those that degrade our natural environment and threaten our health.

While federal appropriations provide plenty of "pork" for polluters, at least these expenditures are subject to annual review. Typically, they cost millions of dollars. Polluter "pork" in the tax code, on the other hand, is not subject to annual review. Once a tax loophole is in law, it is more likely to become embedded in the tax code than repealed, thus costing hundreds of millions and even billions of dollars.

In the debate over welfare for the poor, some have made distinctions between the "deserving" and the "undeserving." If there are to be government handouts to business, it is clear that established businesses that pollute the environment do not belong in the category of "deserving."

It is time to end these extensive tax breaks that have produced a culture of dependency. Generations of businesses have grown up dependent upon the public dole rather than upon their own initiative. It is time these businesses took responsibility for their success. Senator Phil Gramm has said during the welfare reform debate that it's time to ask able-bodied men

and women who are riding in the welfare wagon to get out of the wagon and help the rest of us pull. We believe this sentiment applies to polluters, too.

Throwing Stones

Defenders of these tax breaks will make any number of arguments to defend their special favors. They will say:

This tax relief is needed to maintain the viability of "strategic industries" that are essential to American national security.

The oil industry justifies its tax breaks this way. Unfortunately, America is reliant on foreign sources of oil to meet roughly half of its current appetite for oil. Given the limited oil reserves in the United States and the pattern of increasing consumption, to believe that we will ever again be self-sufficient is to believe in fairy tales. If reducing American dependence on foreign oil is the true goal, it is more prudent to curb demand, through higher fuel efficiency and fewer miles traveled by car, than to increase supply.

Repealing these tax breaks will cost jobs.

Many of the industries receiving tax breaks are actually very poor job-producers. They are relatively capital-intensive and produce fewer jobs per dollar of investment than other unsubsidized industries. For example, oil and gas extraction produces 7.02 jobs per million dollars invested, coal mining produces 12.88 jobs, and other mining produces 13.51 jobs. By comparison, health services produce 23.15 jobs per million spent, construction produces 20.97 jobs, and transportation and communications produce 16.37 jobs.

Our business is uniquely risky, and so these tax breaks are needed to attract investment.

Investing in oil and gas exploration is risky; however, tax policy should not promote pollution over stewardship. In reality, the major effect of these special industry entitlements is to divert capital to politically well-connected businesses at the expense of their less politically influential competitors. For example, staff size of the American Petroleum Institute, the big oil trade association, is about 470 people while the staff size of the Solar Energy Industries Association is 30 persons.

There are tax breaks that help the environment, too.

Targeted tax breaks to assist clean, infant technologies to gain a foothold and grow bear some merit. They are transition assistance, not permanent subsidies. In addition, they may be necessary to meet the goals of national environmental legislation as well as international environmental commitments. Removing the subsidies for the polluting competition is important as well and lessens the need for "clean" tax subsidies. Clean technologies, unlike the dirty ones they replace, provide environmental and technology benefits that flow to the public and not the firms that receive the tax break. Studies show that previous tax breaks for renewable energy, for example, were necessary for the development of renewable energy technologies that now are quickly becoming competitive with coal-fired electrical generation.

Eliminating these tax breaks is tantamount to raising taxes.

Tax subsidy reforms are not tax increases. As Senator Bill Bradley noted, "spending is spending whether it comes in the form of a government check, or in the form of a special exception from the tax rates that apply to everyone else. Tax spending does not, as some pretend, simply allow people to keep more of what they have earned. It gives them a special exception from the rules that oblige everyone to share in the responsibility of our [government]". Nothing is free, including a tax break. Someone has to pay for it.

The Challenge Ahead

In 1996, the federal government will spend approximately $450 billion through special tax breaks. In comparison, total collected revenues amount to about $1.3 trillion. This means that for every dollar the federal government collects, it gives back about 35 cents through loopholes and special tax breaks. This report does not suggest that all of these tax breaks should be revoked. We do believe, however, that in their zeal to cut the federal budget, the Administration and Congress -- especially members of the powerful House and Senate tax committees -- have not adequately examined the Internal Revenue Code.

Tax policy is a rarefied, obscure realm. Much of tax policy is very complicated, not to mention boring. Yet it is too potent to be ignored. Seemingly trivial provisions or phrases can mean billions of dollars in revenues. Over the years, tax bills have been a playground for powerful special interests. Over the last few decades, a $13 billion industry of tax lawyers and accountants has emerged to promote and exploit the loopholes and inequities of the tax code as well as enforce the law, according to the Tax Foundation.

With all these forces conspiring to protect polluters, cutting polluter subsidies out of the tax code will be a daunting challenge indeed. The hope lies with the American people. Only if citizens become savvy and speak out about how our tax system contributes to planetary degradation will we wrest control of the tax code from the lobbyists, tax lawyers, and dependent businesses.

We cannot release this report without putting it in context of what is happening on Capitol Hill. The House of Representatives completed its Contract with America by passing the "crown jewel," a massive tax cut. If enacted into law, the House Republican tax plan would undo many of the tax reforms passed in 1986. These reforms eliminated tax shelters while bringing down tax rates. The House Republican bill would bring back the days of massive tax shelters and no-tax corporations. The bill calls for large cuts in capital gains taxes, elimination of the corporate Alternative Minimum Tax, and accelerated write offs for investment in capital equipment. These changes, by and large, would particularly benefit resource and capital intensive industries such as oil and gas and timber.

Gold Diggers: Percentage Depletion Allowance

PROPOSAL: Eliminate the percentage depletion allowance for mining operations. This would save $2.8 billion over five years according to the Congressional Joint Committee on Taxation.

BACKGROUND: The percentage depletion allowance, first codified early in this century, is based on the idea that as minerals are extracted, the mine is worth less. The percentage depletion allowance permits mining companies to deduct a certain percentage from their gross income to reflect the mine's reduced value over time. However, instead of allowing deductions that reflect the actual loss of value, the percentage depletion allowance allows mining companies to deduct a fixed percentage of gross income. The percentages range from 22 percent allowance to a 5 percent allowance, depending on the mineral. For example, clay, sand and gravel receive 10 percent while uranium, sulphur, and lead get 22 percent. This fixed deduction often bears no resemblance to the actual lost value or to the amount of investment. In fact, the money that mining companies recoup through this tax subsidy generally exceeds the total investment in the property. In other words, the public provides more investment than the owner.

TAXPAYER ARGUMENT: The billions of dollars the percentage depletion allowance costs directly benefits the mining industry and burdens taxpayers and the environment. Average taxpayers must pay taxes on things such as college fellowships and telephone ownership to pay for tax breaks to bolster the profits of mining interests. Such a large subsidy also distorts the market for minerals and other extracted resources, providing financial incentives for mining and drilling regardless of the real economic value of the resource. The result is overinvestment and poor allocation of resources.

ENVIRONMENTAL ARGUMENT: The percentage depletion allowance makes a mockery of the notion of conservation. The subsidy encourages wanton mining regardless of the true economic value of the resource. The result is more tailings piles, scarred earth, toxic byproducts, and disturbed habitats.

Ironically, the more toxic the mineral, the greater the percentage depletion allowance subsidy is. Mercury, zinc, uranium, cadmium and asbestos are among the minerals that receive the highest percentage depletion allowance while less toxic substances have lower rates.

In many instances, this tax break creates absurd contradictions in government policy. For instance, federal public health and environmental agencies are struggling to come to grips with a vast children's health crisis caused by lead poisoning. Nearly nine percent of U.S. preschoolers, 1.7 million, have lead poisoning. Federal agencies spend nearly two hundred million taxpayer dollars each year to prevent lead poisoning, test young children, and research solutions. At the same time, the percentage depletion allowance subsidizes the mining of lead with a 22 percent depletion allowance.

Money for Mining: Expensing Exploration & Development

PROPOSAL: Eliminate expensing, or immediate write off, for mining exploration and development costs and special capital gains treatment for coal and iron ore. This proposal would save about $675 million over five years according to the Congressional Joint Committee on Taxation and Office of Management and Budget.

BACKGROUND: Section 617 of the Internal Revenue Code (IRC) allows certain costs associated with the exploration and development of mineral resources to be deducted in the year the costs are incurred, rather than over the productive life of the mine. Under normal tax rules that apply to other businesses, such "capital" costs are investments in property like buildings or mines that last more than one year and are written off over time as the property wears out, or is depleted in the case of a mine. Immediate deduction, or expensing, allows companies to write off costs of machinery and equipment faster than they actually wear out. The result is that tax bills early in the life of the property, or mine, are lower and consequently save the mining company money.

Exploration and development costs include site location, determination of quality and amount of mineral resource, and construction of shafts and tunnels. Covered minerals include coal, uranium, and hard rock minerals such as lead, gold, copper, and asbestos. Congress enacted immediate write off of mine development costs in 1951 and exploration costs in 1966. In 1982, such expensing for corporations was limited to 85 percent of costs.

The other tax break for for mining companies is Section 631 of the IRC which treats the sale of coal and iron ore as a capital gain. Capital gains are profits reflecting increased values of stocks, bonds, investment real estate, and other "capital," or lasting assets. Under normal tax rules, the sale of coal and iron ore should be treated as ordinary income (e.g. wages, interest), not capital gains income. It is preferable to have one's income treated as capital gains rather than ordinary income because the tax rate on capital gains is lower than the tax rate on ordinary income for well-to-do taxpayers. This special capital gains treatment for coal was granted in 1951.

TAXPAYER ARGUMENT: When combined with other tax subsidies, effective tax rates in the mineral industry are reduced to rates below those of other industries. These tax breaks stimulate increased investment in mining at the expense of other business investments. At the same time, the taxpayer underwrites the risk of exploration rather than the mining company. It is patently unfair to burden average working Americans with higher taxes in order to cut tax bills for mining companies.

ENVIRONMENTAL ARGUMENT: A scarred landscape and polluted water attest to the environmental degradation caused by mining. Over the past 25 years, coal mining has disturbed almost 2 million acres of land, only half of which has been reclaimed to minimum environmental standards. The legacy of hardrock mining has littered 32 states with more than 557,650 abandoned sites. The exploitation of the land caused by mining activities has altered the topography of sites to the extent that they will never be able to be restored to their previous conditions and uses. Strip mining has resulted in landslides, which have scarred more than 3,000 miles of land. Mining related activities have introduced dangerous levels of lead, mercury, iron, and sediment to our water supplies. If there are to be tax breaks for materials, they should be for recycled materials, not extraction of scarce, raw materials.

Play Now, Pay Later: Reclamation Deduction

PROPOSAL: Require that mining companies establish a separate trust fund that is adequately funded and escrowed in order for mine reclamation and closing costs to be deducted immediately. Otherwise, repeal the special rules that allow costs for reclamation to be deducted before they have actually been paid. This provision costs the treasury $200 million over five years.

BACKGROUND: Section 486 of the Internal Revenue Code permits reclamation and closing costs to be deducted immediately when mining begins even though the eventual closing of the mine and reclamation of the mine site will not occur for some time. Without this special provision, general tax rules would require the companies to wait until the mine site is closed, restored, and the costs associated with these activities are paid before the companies can deduct these costs.

This provision was adopted as part of the Deficit Reduction Act of 1984. The stated intent of the provision was to encourage reclamation, but there is no requirement that actual payment into a reclamation and mine closing trust fund actually occur in order to get the tax break, nor even that the reclamation and closing actually occur. Reclamation of coal mining sites is required by the Surface Mining Control and Reclamation Act (SMCRA) of 1977, but is not well enforced. There is no similar reclamation requirement for hardrock mineral sites.

TAXPAYER ARGUMENT: The tax treatment of closing and reclamation costs is flawed for several reasons. The law does not require that a separate trust fund be set up or that funds actually be available when it is time to close and reclaim (clean up) the mine. This exposes funds for mine closing and reclamation to the risk of default as well as claims by creditors in the case of bankruptcy of the mining operator. Simply put, there is no guarantee that there will be money available for clean up or mine closing. In the end, taxpayers may well get stuck paying for closing and reclamation of the mines even though the mining company had already claimed a deduction for mine closing and reclamation.

ENVIRONMENTAL ARGUMENT: The tax code delegates to local authorities the power to control the nature of the reclamation or closing activity, but enforcement has been lax. Since 1977, there have been more than 6,000 coal mines closed but not reclaimed. There are more than 550,000 abandoned hardrock mines. A current deduction without a requirement for a separate trust fund raises the possibility of non-compliance and a deduction for activities that are never performed. Until proper standards exist regarding environmental impacts of mining, no tax subsidy should be available to the industry. According to the U.S. Bureau of Mines, 12,000 miles of rivers have been polluted by mining activities and waste. In California, wastes from one closed mine delivers an average daily dose of 4,800 pounds of iron, 1,466 pounds of zinc, 423 pounds of copper, and 10 pounds of cadmium into the Keswick Reservoir on the Sacramento River, which serves as the source of drinking water for Redding.

Pumping the Tax Code: Percentage Depletion Allowance

PROPOSAL: Eliminate the percentage depletion allowance for independent oil and gas companies. This will save about $2 billion over 5 years according to the Congressional Joint Committee on Taxation.

BACKGROUND: Independent oil companies -- those oil companies that are not substantially involved in retailing or refining activities -- can use a special "percentage depletion" method to write off oil and gas investments. The percentage depletion allowance allows these oil and gas companies to deduct a flat 15 percent of their gross income, or sales revenue, to reflect the declining value of the wells as they are drained. This flat deduction bears little resemblance to the actual loss in value over time and the independent oil and gas companies often end up deducting more than the value of the investment.

Percentage depletion allowances were established by Congress early in this century. In recent years, Congress has gradually pared back the subsidy. Nonetheless, the percentage depletion allowance is still an enormous benefit which serves little purpose other than subsidizing production from certain oil and gas companies.

The 15 percent deduction actually gets bigger for some smaller "marginal production" oil companies. According to current tax law, if the price of oil drops below $20 per barrel, the company can increase its deduction -- one percent for every dollar less than $20 per barrel.

TAXPAYER ARGUMENT: The percentage depletion allowance amounts to a simple production subsidy for the oil and gas industry. The special subsidy benefits certain oil and gas producers to the disadvantage of competitors. The deduction can amount to 100 percent of an operation's net income. In other words, for some companies all profits may be due to government tax subsidies.

The percentage depletion allowance distorts the market by attracting investment that could be used more productively elsewhere in the economy. Because the percentage depletion applies only to independent producers, the subsidy encourages the draining of scarce domestic energy resources. In combination with other subsidies for the oil and gas industry, the percentage depletion allowance subsidy often exceeds 100 percent of the actual value of the energy produced.

The general effect of this subsidy is to promote oil production and energy waste rather than efficiency or conservation. Increased profits for polluters are not the best use of taxpayers' money, especially when the tax breaks encourage overproduction of scarce resources at the expense of clean alternatives.

Tax law has been very generous to the oil and gas industry. It has propped up the industry in the face of stiff competition from cheap, imported oil.

ENVIRONMENTAL ARGUMENT: Oil and gas tax policy has focused on production while doing little to increase energy efficiency throughout the oil and gas system or conservation of petroleum in the transportation sector. The percentage depletion allowance not only drains the treasury but also taxes the environment. It encourages producers to prematurely tap marginally economic oil and gas fields, resulting in the exhaustion of energy reserves and the destruction of environmentally sensitive areas such as estuaries, bays, and wetlands. In addition, the oil and gas industry enjoys special exemptions under our environmental laws including Superfund, the Clean Air and Clean Water Acts, the Safe Drinking Water Act, and the Emergency Planning and Community Right-To-Know Act.

Bad to the Last Drop: Enhanced Oil Recovery

PROPOSAL: Repeal the 15 percent credit for "enhanced oil recovery" and disallow expensing, or immediate write off, of so-called tertiary injectants until proper environmental regulations for the industry are adopted and the current waste and inefficiency in the oil and gas industry are dramatically curbed. These special tax breaks cost the treasury $500 million over 5 years according to the Congressional Joint Committee on Taxation.

BACKGROUND: Section 43 of the Internal Revenue Code provides for a 15-percent income tax credit for the costs of recovering domestic oil by a qualified "enhanced-oil-recovery" method. Qualifying methods involve injecting fluids, gases, and other chemicals into the oil reservoir, and use heat to extract oil that is too viscous to be extracted by conventional techniques. Costs covered by the tax credit include the costs of equipment, labor, supplies, repairs, and injectants. The tax credit was adopted in 1990.

In addition, Section 193 allows for expensing, or immediate write off, of so-called tertiary injectants used in enhanced oil recovery. According to standard tax principles, tertiary injectant expenditures should be written off over the income-producing life of the oil and gas property. Such "capital" costs are investments in property like buildings or oil wells that last more than one year and should be written off over time as the property wears out, or is depleted in the case of an oil well. Immediate deduction, or expensing, allows companies to write off costs of machinery and equipment faster than they actually wear out. The result is that tax bills early in the life of the property, or oil well, are lower and consequently save the oil company money. This provision became law in 1980.

These provisions were adopted in order to reduce the costs of producing oil from abandoned reservoirs and to increase the domestic supply of oil. The combined effects of the enhanced oil recovery credit and immediate deduction of tertiary injectants result in a net subsidy due to a negative tax rate.

TAXPAYER ARGUMENT: Oil production in the United States peaked in 1970 and has been declining about 4 percent every year since then. Having depleted our most accessible oil reserves, the U.S. is increasingly a high marginal-cost producer. Reliant on foreign sources for about half of our country's oil needs, it is unlikely that the U.S. can reverse the long-term slide in domestic production and growing dependence on imports, given current trends. Even if subsidies such as the enhanced oil recovery provision do manage to relieve short-term dependency by increasing domestic production, less oil will be available in the longer-term. All of this begs the question of why taxpayers should subsidize production at $30 per barrel when it costs only $18 to buy a barrel of oil on the global market. If and when the price of oil increases due to real or politically-induced scarcity, production from these wells will become economical without subsidy.

ENVIRONMENTAL ARGUMENT: In general, it is environmentally desirable to extract all the oil in a well to avoid waste and seepage. That said, much greater energy savings could be gained by eliminating current waste in the oil and gas industry. Today, the oil and gas industry tolerates a degree of energy waste and pollution that is hard to believe: an energy loss -- through spills, emissions, evaporative loss, venting and flaring, waste generation, inefficient processing, pipeline and storage tank leaks -- that is equivalent to 1,000 Exxon Valdez oil spills every year, according to Friends of the Earth's Crude Awakening.

Enhanced oil recovery methods themselves often are bad for the environment. They force oil and sometimes chemical injectants into surrounding surface and groundwater, which can lead to contamination of drinking water, soil, crops, and wetlands. Additionally, reliance on oil imports could be totally eliminated by energy efficiency improvements and aggressive conservation. This would negate the need for enhanced oil recovery in the near future.

Drilling for Dollars: Intangible Drilling Costs

PROPOSAL: Repeal the tax provisions permitting oil and gas producers to immediately deduct "intangible" drilling and development costs (IDCs). Instead, require IDCs to be deducted over time. This reform would raise approximately $2.5 billion over 5 years according to the Congressional Joint Committee on Taxation.

BACKGROUND: Section 263 of the Internal Revenue Code permits integrated oil companies such as Exxon and Chevron to immediately deduct 70 percent of intangible drilling costs (IDCs). IDCs are the costs of wages, fuel, repairs, hauling, supplies, and site preparation. The other 30 percent must be deducted over five years. Under normal tax rules that apply to other businesses, such "capital" costs are investments in property like buildings or oil wells that last more than one year and should be written off over time as the property wears out, or oil is depleted. Immediate deduction, or expensing, allows companies to write off costs of machinery and equipment faster than they actually wear out, or the oil is depleted. The result is that tax bills early in the life of the investment are lower and consequently save the oil and gas company money.

Smaller, independent oil and gas producers, who are not involved in retailing or refining activities, can immediately deduct all of their IDCs. In addition, independent producers enjoy special treatment of IDCs under the Alternative Minimum Tax (AMT). The AMT is an alternative tax system that was created to ensure that profitable businesses do not avoid taxation because of extensive write-offs. However, in the case of independent oil and gas producers, the AMT is less effective because write-offs are permitted.

IDCs typically account for 75-90 percent of the costs associated with developing an oil and gas well. When combined with other tax subsidies, the ability to deduct IDCs effectively reduces tax rates on oil and gas producers significantly below tax rates on other industries. Unlike the percentage depletion allowance, this tax break is largely claimed by corporate producers rather than smaller, independent producers.

IDCs were first determined to be immediately deductible in 1916. Since then, various courts have tried to rule that IDCs should be deducted over time, but Congress and precedent have overturned the rulings. Congress justified the special treatment of IDCs in order to stimulate exploratory drilling, which could increase domestic oil reserves and enhance energy security.

TAXPAYER ARGUMENT: According to the Congressional Joint Committee on Taxation, this special treatment of oil and gas expenses effectively lowers income taxes for oil and gas companies to zero, a huge benefit. This tax break erodes fairness in the tax system. While wealthy oil companies save, other taxpayers, including middle class Americans, pay the bill for the subsidy. In addition, this tax break, along with others that promote exploitation of domestic reserves, unnecessarily charges taxpayers in order to "pump up" oil industry profits.

ENVIRONMENTAL ARGUMENT: The oil and gas industry enjoys many special tax breaks, which creates perverse incentives for irresponsible treatment of scarce natural resources and environmentally sensitive areas such as wetlands, estuaries, and bays.

The intended purpose of special tax treatment for IDCs is to encourage domestic oil and gas production in order to curb foreign oil imports. The environmentally sound way to reduce our reliance on foreign oil imports would be to reduce our demand for oil rather than increase our supply. Incentives for increased automobile fuel efficiency and greater use of mass transit and ridesharing are two key steps to lessen our demand for oil.

Lucky Loser: Passive Loss

PROPOSAL: Eliminate the "passive loss" tax shelter for investors in oil and gas. This change would save $665 million over 5 years according to the Office of Management and Budget.

BACKGROUND: The 1986 Tax Reform Act greatly limited the ability of taxpayers to use losses, deductions, and credits from so-called "passive" business investments to offset other income such as salary or portfolio income (e.g. interest, royalties, dividends, annuities, and gains from the sale of investment property). Prior to these changes, taxpayers with substantial sources of income from salaries or portfolio income could eliminate or sharply reduce tax liability by investing in tax shelters. One of the most infamous results of tax sheltering involved commercial real estate. Investors built office buildings for tax purposes even though there was no economic demand for the buildings.

Today, investors have to "materially participate" in a trade or business in order to offset salary and portfolio income with passive losses. A taxpayer "materially participates" in an activity only if he or she is involved in the operations of the activity on a regular, continuous, and substantial basis.

These rules, however, do not apply to oil and gas investments. Passive losses are still allowed to be used to offset other income in the case of investors who have a "working interest" in oil and gas. "Working interest" is defined by the existence of an unlimited and unprotected financial risk proportionate to the oil and gas investment and is a weaker test than "material participation." Congress decided that the financial risk associated with oil and gas investments outweighed the need to clamp down on tax sheltering. At the time, this boon to the oil and gas industry was intended to alleviate the impact of worldwide competition and low prices.

TAXPAYER ARGUMENT: This tax loophole makes oil and gas investments more attractive than other investment opportunities, thus diverting investment capital from more productive activities and distorting sound economic decisions. Oil and gas investors can be less cautious in their investments because losses actually have tax advantages.

With plenty of cheaper oil available to consumers, it does not make sense to prop up expensive domestic production with costly subsidies and special treatment that benefit rich investors at the expense of average working Americans.

ENVIRONMENTAL ARGUMENT: This oil and gas tax shelter attracts investors that might otherwise invest in cleaner, growing industries. In addition, the tax break encourages the overproduction of oil and gas, which has many attendant damaging environmental consequences affecting air, land, water, and soil quality. Streams and rivers have been fouled and beaches coated with oil. Waterfowl and other wildlife have died from spills at sea, and millions of birds have been killed onshore after diving into unnetted waste pits and ponds. Oil products seep through the ground in hundreds of communities across the country, threatening drinking water supplies and depressing property values.

Oil and gas are polluting, non-renewable resources. Tax policy would do better to provide incentives to conserve oil and gas rather than stimulate additional production.

Syn Sins: Nonconventional Fuel Production Credit

PROPOSAL: Repeal the "nonconventional fuel" production credit, except for the capture of coalbed methane from active coal mining and landfills and for clean biomass technologies using agricultural waste and wood. This provision costs the treasury roughly $5.8 billion over 5 years according to the Congressional Joint Committee on Taxation.

BACKGROUND: Section 29 of the Internal Revenue Code provides for a production tax credit of $5.75 per barrel of oil-equivalent for certain types of liquid and gaseous fuels produced from alternative energy sources. These fuels include oil produced from shale or tar sands, synthetic fuels produced from coal, and gas produced from geopressurized brine, Devonian shale, tight formations, biomass, and methane from coalbeds. The credit applies to facilities "placed in service" between 1979 and 1993 and may be claimed through 2002. The credit is available for gas produced from biomass and synthetic fuels produced from coal or lignite until 2007 if the facility is placed in service by 1996. Although set to expire, the "placed-in-service" rule has been extended three times since first enacted.

The credit was originally passed in 1980 as part of the Crude Oil Windfall Profit Tax Act. Its purpose was to provide incentives to increase development of alternative domestic energy resources due to concern over oil import dependence and national security that resulted from the 1979-80 Iran-Iraq war.

TAXPAYER ARGUMENT: In theory, the credit was supposed to lower the costs of producing nonconventional substitutes for imported petroleum. Instead, the credit has distorted fuel markets without displacing imports. With oil prices low and costs of nonconventional fuel production high, the credit has proven ineffective. Total production of nonconventional fuels has not increased since the credit was enacted, according to the Joint Committee on Taxation. So, in effect, the credit has been a windfall for a few producers and a waste of taxpayers' money.

The credit has, however, favored the development of one domestic fuel over another. Due to the generosity of the credit, which at times has equaled the price of natural gas, as well as declining production costs, coalbed methane production has boomed. This increased production has occurred at the expense of conventional natural gas production.

ENVIRONMENTAL ARGUMENT: A remnant of the $88 billion "synfuel" program under the Carter Administration, the Section 29 credit has had unintended environmental consequences. Unfortunately, coalbed methane developers in states such as Colorado, New Mexico, Wyoming, and Alabama have been overlaying a new grid of wells on top of older fields of abandoned oil and gas wells that have not been properly plugged. When new methane wells are drilled, the gas not only moves up the new wells but also can move into underground aquifers and escape through older oil and gas wells and even water wells. The result has been contaminated drinking water and irrigation systems, and even explosions. As a whole, the credit simply adds to the volume of tax-subsidized fossil fuels and the pollution that results from burning them.

This report recommends retaining the credit for certain narrow applications. One is for coal beds that are emitting methane into the atmosphere. When coal beds are opened for mining, methane escapes. Methane is a powerful greenhouse gas that contributes to climate change. A "Section 29" well can trap the methane so that it does not escape into the atmosphere. For this narrow purpose, the credit is useful environmentally and should be retained. A similar situation exists at landfills that emit methane as the rubbish decomposes.

Logging Loopholes: Special Tax Treatment of Timber

PROPOSAL: Require sustainable forest management plans to be adopted before timber companies and investors can receive special treatment. Alternatively, repeal the timber industry's ability to deduct its costs immediately. Instead, require the capitalization of multi-period timber growing costs. In addition, repeal special capital gains treatment for timber sales. These provisions cost the treasury about $2.6 billion over five years according to the Congressional Joint Committee on Taxation.

BACKGROUND: Timberland owners and the forest products industry enjoy special tax benefits, including capital gains treatment of timber income and expensing, or immediate write off, of capital costs.

Timber income has been treated as capital gains since 1944 and thus has been taxed less than other kinds of income. Capital gains are profits reflecting increased values of stocks, bonds, investment real estate, and other "capital," or lasting assets. Under normal tax rules, the sale of timber should be treated as ordinary income (e.g. wages, interest), not capital gains income. This provision benefits richer individual taxpayers who prefer to have income treated as capital gains rather than ordinary income because the tax rate on capital gains is lower than the ordinary income tax rate for well-to-do taxpayers.

"Expensing" of costs to maintain a timber stand has been available since the early 1900s. These costs include silvicultural practices after seedling establishment, disease and pest control, fire protection, insurance, property taxes, and management. Under normal tax rules that apply to other businesses, such "capital" costs are investments in property like buildings or land that last more than one year and are be written off over time as the property wears out or timber is harvested. Immediate deduction, or expensing, allows companies to write off costs of machinery and equipment faster than they actually wear out, or before the timber is harvested. The result is that tax bills early in the life of the investment are lower and consequently save the timber company money. In 1986, President Reagan proposed eliminating the bulk of these special benefits, but the Congress rejected the idea.

To receive either of these tax benefits does not require sustainable forestry practices, including replanting a diversity of native species after harvest or allowing natural reforestation. A more sustainable approach would tie receipt of these tax breaks to adoption of a sustainable forestry management plan. At minimum this plan should adhere to the standards of the National Forest Management Act (see 36 cfr 219.19), which calls for the viability of all native tree types and native wildlife and limits clearcutting. Ideally, selective cutting should be adopted.

TAXPAYER ARGUMENT: Unlike other businesses, timber producers are able to deduct costs before the product, in this case, timber, is sold. This gives timber producers an interest-free loan from the government and effectively reduces their tax rate on investments to zero. When combined with capital gains treatment, timber receives a negative tax rate or a net benefit. This lowers the tax burden on timber in general. It distorts the market by diverting investment into timbering that might have otherwise gone to other businesses. In addition, the bulk of these tax benefits flow to corporations and wealthy investors.

ENVIRONMENTAL ARGUMENT: Forests serve multiple purposes. They provide habitat for wildlife, medicines, recreational benefits for hikers, fishers, and hunters, as well as timber products. Unfortunately, the current tax breaks treat forests like farms rather than ecosystems, which must contain a diversity of plant and animal life to survive. In addition, these breaks make timber production more profitable for investors and forest products cheaper, which hurts recycling efforts. Better than tax incentives for timber production would be incentives that encouraged recycling, and environmentally friendly pulp and paper alternatives.

Loophole in the Sky: Tax Ozone-Killing Chemicals

PROPOSAL: Include methyl bromide and HCFCs in the list of taxed ozone-depleting chemicals. This is consistent with earlier efforts to tax new chemicals and is worth $1.6 billion over 5 years according to the Congressional Budget Office.

BACKGROUND: In 1989, Congress enacted a tax on ozone-depleting chemicals to provide an economic incentive to reduce production and use of these destructive substances. The tax complements international and domestic measures to reduce and phase out these chemicals.

Ozone-depleting chemicals include chloroflourocarbons (CFCs), methyl chlorform, carbon tetrachloride, halons, methyl bromide, and HCFCs (CFC substitutes). These chemicals are found in various consumer products and used in agricultural and industrial processes. Release of these chemicals into the atmosphere causes damage to the stratospheric ozone layer which shields the Earth and its inhabitants from the sun's damaging ultraviolet radiation.

In 1985, scientists confirmed the existence of a "hole" in the ozone layer over Antarctica. Since its discovery, the ozone hole has grown to cover an area of approximately nine million square miles, roughly the size of the North American Continent. This ecological crisis spurred more than 120 countries to negotiate and approve the Montreal Protocol on Substances that Deplete the Ozone Layer in 1987. While the Protocol called for the phase-out of many ozone-depleting chemicals, some chemicals such as HCFCs and methyl bromide were not included in the original agreement. In 1992, however, parties to the Protocol amended the original agreement to include HCFCs and methyl bromide. The Protocol requires industrialized countries to cap methyl bromide production at 1991 levels and to phase out all HCFC production by 2030. Due to the delay in listing methyl bromide and HCFCs under the Montreal Protocol, however, these chemicals were not included when Congress passed the tax on ozone-depleting chemicals. Since then, however, political pressure on Congress has kept methyl bromide and HCFCs off the tax list.

TAXPAYER ARGUMENT: No policy rationale exists for the inconsistency of taxing some ozone-depleting chemicals while leaving others untaxed. This disparate treatment is simply the result of timing and politics. Methyl bromide is the only Clean Air Act Class I ozone-depleting chemical that is not taxed. While HCFCs are listed as Class II chemicals, they are more potent than other chemicals that are already taxed (i.e. methyl chloroform).

Taxing these chemicals makes good economic sense. The existing tax has very successfully accelerated the phase-out of harmful chemicals while at the same time spurred development of ozone-safe alternatives. Too often our tax code punishes desirable behaviors and businesses while rewarding ecological destruction. The tax on ozone-depleting chemicals does the right thing, and it works.

ENVIRONMENTAL ARGUMENT: Methyl bromide and HCFCs are a direct threat to human health and ecosystem integrity. Their destructive impact on the stratospheric ozone layer has been conclusively established. Ozone layer destruction causes increased ultraviolet radiation which can lead to higher rates of skin cancer and eye diseases such as cataracts. Increased ultraviolet radiation also can suppress the immune system and weaken its response to a host of diseases. In addition, the radiation may decrease crop yields, stunt animal reproduction, and cause fast degradation of materials such as plastics, wood, and rubber.

Methyl bromide is extremely noxious and is acutely toxic. It can cause fatal damage to the central nervous system and severe damage to the lungs, kidneys, eyes and skin. Workers that handle methyl bromide run the greatest risk of toxic exposure and injury.

HCFCs serve as transition chemicals between the more damaging CFCs and safer alternatives. However, ozone-safe substitutes are available for nearly every use of HCFCs.

Cooking the Books: Cash Accounting

PROPOSAL: Disallow the use of "cash accounting" method for agricultural businesses with gross sales of more than $1 million. This proposal would save about $1.3 billion over five years according to the Congressional Joint Committee on Taxation.

BACKGROUND: The cash accounting method does not require a farmer to accurately match expenses to income when paying income taxes. The rules date back to the early part of this century when the IRS determined that many farmers were not sophisticated enough to use more complex bookkeeping procedures that are required for most businesses. Since 1919, however, farms have gotten much larger and most farms are run more like businesses. Today, large agricultural operations are able to take advantage of cash accounting under current law and they are able to significantly reduce their taxes by manipulating expenses, inventory, and income.

Cash accounting is one of a number special tax breaks and loopholes that once lured nonfarmer investors into agricultural tax shelters and speculation. This speculation drove up land prices and caused havoc in the farm economy. According to a 1982 U.S. Department of Agriculture report entitled The Effects of Tax Policy on American Agriculture, "the tax preference may overstimulate production and lead to lower product prices, or may cause the values of limited inputs, such as land, to be bid up." In general, these tax breaks, and the game-playing they invite make it difficult for smaller-scale farming to compete and survive. In the tax reform of 1986 and subsequently, many of the worst tax shelters in agriculture were eliminated. However, some, like cash accounting, survived. Since cash accounting tends to benefit richer farmers it plays a role in the increased concentration of farmland ownership with high-income farmers and businesses.

TAXPAYER ARGUMENT: The ability to defer taxes and immediately deduct costs creates an enormous tax benefit for large farm operations and invites inappropriate mismatching of income and expenses. The fact that farmers with up to $25 million in gross sales can use cash accounting methods means that many large farm operations benefit from a provision intended primarily for smaller, family farms. Agriculture Department studies show that the cash accounting makes farming more profitable to farmers in higher tax brackets while making it harder for farmers with low incomes to compete. According to the 1982 USDA study, "in a tax-favored industry such as farming, success depends not only on entrepreneurial skill and luck; it also depends on the successful management of the tax system and assets and liabilities. The rules of the game demand not only agricultural expertise but also tax expertise and a number of other skills."

ENVIRONMENTAL ARGUMENT: Experts in agriculture policy argue that the mismatching of expenses and income actually subsidizes the purchase of agrichemicals such as fertilizers and pesticides. U.S. agriculture has become reliant on chemicals. Today, crop production systems in most areas of the country rely on at least one pesticide and often several to control weeds, insect pests, and plant disease. Added to the pesticides is a huge volume of synthetic fertilizers. In 1987, for example, U.S. farmers were applying some 10 million metric tons of nitrogen to the land, with the vast majority of it synthetic. Pesticides, which by their very nature are poisons, have been dispersed widely throughout our food supply and environment. The EPA estimates that every year farmworkers suffer more than 27,000 acute illnesses due to pesticide exposure. Pesticides and nitrates have become pervasive contaminants of water supplies, with EPA estimating that at least one of every ten public water wells in the country contains at least one pesticide. Millions of American children, whose diets are high in particular fruits and vegetables, receive -- by age 5 -- up to 35 percent of what is considered an entire lifetime's "safe" dose of cancer-causing pesticides.

Pigs in a Poke: Dairy and Livestock Expensing

PROPOSAL: Disallow immediate deduction for costs related to raising livestock and dairy. This would raise about $700 million over five years according to the Congressional Joint Committee on Taxation.

BACKGROUND: Under current law livestock breeders and dairy producers enjoy special rules which provide favorable tax treatment for their business. When their livestock and cattle are sold, the profits are counted as capital gains income which is taxed at the rate of 28 percent even if the taxpayer is in a higher tax bracket. However, the costs of purchasing, breeding, and raising the livestock are not treated as capital investments, but rather as ordinary expenses. This is the best of both worlds for livestock and dairy producers. Costs are deducted immediately and income is taxed at a relatively low capital gains rate rather than as regular income. This inconsistency is highly favorable for dairy livestock producers and has helped to make cattle and other livestock operations profitable tax shelter ventures.

TAXPAYER ARGUMENT: Livestock producers get a special deal in their business. They can immediately deduct the costs associated with raising the diary and breeding livestock. Yet when they sell, the income is treated as a capital gain and taxed at a 28 percent rate for high-income taxpayers instead of the higher rate at which it should be taxed. Other businesses must treat the income from sales of product as regular income. Most other farmers must treat their sales income as regular income.

This tax break attracts farm investments into animal breeding that might otherwise be directed toward growing crops. It also serves to benefit livestock and dairy breeders at the expense of other taxpayers.

ENVIRONMENTAL ARGUMENT: This tax break subsidizes agricultural activities, which are becoming increasingly controversial in their impact on environmental quality and rural communities. In many rural communities, industrial hog farming and large dairy operations are meeting growing resistance due to significant waste problems (they are smelly and cause water pollution) and because they tend to crowd out smaller scale, diversified farms.

In addition, this tax break distorts farming and animal husbandry decisionmaking. The tax code requires that livestock be sold as breeding stock and not for slaughter in order to receive special tax treatment. Farming and husbandry decisions should be driven by the biology and resources, not tax policy.

Up in Smoke: Tax Exempt Bonds for Incinerators

PROPOSAL: Subject tax-exempt bonds sold to finance incinerators (solid waste facilities that produce electric energy) to the private-activity bond annual volume cap. This would raise about $900 million over five years according to the Office of Management and Budget.

BACKGROUND: Current law provides a tax exemption for interest income on state and local bonds used to finance construction of certain energy facilities. These bonds are classified as "private activity bonds," instead of government bonds, due to the fact that a substantial portion of their benefits is reaped by individuals or businesses rather than the general public. Most private-activity bonds, including hydroelectric facility bonds, are subject to certain limits set by each state. However, bonds issued for government-owned solid waste disposal facilities are not subject to these limits.

In general, the 1986 Tax Reform Act repealed the tax-exempt status of most bonds used to finance projects with substantial private involvement due to the fact that they served as tax shelters for wealthy investors and oftentimes subsidized projects with little overriding public benefit, such as golf courses. Tax-exempt bonds for incinerators and a few other private-activity bonds escaped reform.

TAXPAYER ARGUMENT: Tax-exempt bonds in general distort investment decisions. Because the interest from the bonds is tax free, wealthy investors buy them to shelter income rather than buying taxable corporate bonds or stocks. While tax-exempt bonds continue to help state and local government finance important public projects, construction of environmentally harmful projects for private profit do not merit such special tax treatment. Further, this kind of tax break violates the "polluter pays" principle. Those who create the solid waste should pay for its disposal rather than the taxpayer.

ENVIRONMENTAL ARGUMENT: Although called "renewable" energy facilities by the 1980 tax bill, incinerators as currently used are not environmentally friendly. They emit harmful levels of highly toxic substances into the air such as cadmium, lead, and dioxins. The EPA has not yet issued regulations regarding safe emission levels for incinerators. Providing tax benefits for construction of incinerators before incinerators have met environmental standards is ludicrous.

Cloaking Profits: Publicly-Traded Limited Partnerships

PROPOSAL: Eliminate the corporate tax exemption provided for the development of natural resources through publicly traded limited partnerships. There is no estimate available for how much this reform would save.

BACKGROUND: Certain "publicly traded limited partnerships" enjoy tax benefits not available to many other similar business entities. On the one hand, these partnerships enjoy the advantages of being treated like corporations in that investors can trade their interests in public markets and investors have limited financial liability. On the other hand, they do not pay corporate income tax, essentially skipping a level of taxation. In 1987, the Congress changed the law to treat publicly traded partnerships like corporations for tax purposes. However, major loopholes were left after the reform. Partnerships primarily involved in natural resource development were exempted. Thus, publicly traded partnerships involved in mining, geothermal energy, fertilizer, and timber enterprises can continue to avoid a corporate-level tax while retaining the advantages of being traded like a corporation.

TAXPAYER ARGUMENT: This exemption means that certain businesses can avoid paying taxes that other similarly situated businesses must pay. Such subsidies distort the market and tend to attract artificially high levels of investment in business activities eligible for the publicly traded limited partnership exemption. According to a 1994 investigative report of the House Natural Resources Committee, this tax loophole can radically reduce tax revenues from companies. For instance, one timber company was reportedly able to reduce its tax liability from about 59 percent to about 3 percent. In fact, some companies engaged in natural resource development have restructured as partnerships to avoid corporate-level tax.

This tax break is nothing but a massive giveaway of taxpayer dollars to rich investors and the polluting businesses they support.

ENVIRONMENTAL ARGUMENT: This tax loophole creates an unfair advantage for investment in the extraction and depletion of natural resources and provides yet one more encouragement for business enterprises to deplete the nation's natural resources. The subsidy makes natural resource development cheaper and devalues the natural resource. A better system would let the market determine the rate and manner of extraction of a finite supply of resources.

Spoils of Spills: Pollution Deduction

PROPOSAL: Disallow corporate income tax deductions for future costs associated with illegally released pollution. Cleanup of existing pollution or contamination should be exempted. No estimate is available for how much this proposal could save taxpayers.

BACKGROUND: Under current law, polluters who cause environmental harm can fully deduct all the costs related to illegally released pollution including cleanup costs, legal costs, court settlements, even the cost of the polluting substance itself. Even gross violations of law can qualify for normal business deductions. For instance, when Exxon's Valdez oil tanker spilled 11 million gallons of oil into Prince William Sound, nearly all the costs related to the disaster were deductible. This included all the costs of litigation, legal settlements, cleanup, studies, public relations, etc. Exxon settled a criminal case in court with the United States and the State of Alaska for about $1 billion. However, except for a paltry $25 million criminal fine, the entire settlement was tax deductible for Exxon. The value of this deduction is approximately one-third of the settlement, or $300 million.

This situation arises because under tax law, a business may deduct nearly all the expenses incurred as a matter of conducting business. The law allows deduction of "ordinary and necessary" business expenses and the IRS has been very liberal in its interpretation of this clause.

While the vast majority of business expenses are deductible, Congress has disallowed a deduction for some egregious or ethically complicated activities. For instance, illegal bribes, kickbacks, and fines are not deductible. Damage payments for anti-trust violations are not deductible. Lobbying expenses and political campaign contributions are not deductible. Paying CEOs more than $1 million is not deductible to corporations. But the costs associated with breaking environmental laws, including punitive damages, are deductible.

TAXPAYER ARGUMENT: Companies that deduct the costs of oil spills and chemical discharges avoid paying taxes and save money while damaging the earth. For many corporations, environmental disaster is just a cost of doing business. An average of about 16,000 oil spills every year stretches the definition of "accident." In reality, many polluters would rather take their chances with pollution, litigation, and cleanup than prevent the disasters in the first place. That's not a calculus the taxpayers should subsidize.

This perverse tax treatment of costs associated with illegally released pollution means that taxpayers finance a portion of these costs due to the polluter's tax write offs. In addition, taxpayers usually have to pay to help the polluter clean up, as they did in the case of the Exxon Valdez oil spill. Finally, the citizens who live near the pollution site bear enormous costs associated with loss of a natural resource, whether it is clean water or clean air.

ENVIRONMENTAL ARGUMENT: Eliminating the business deduction for illegally released pollution would reduce the incentive to cut corners or to knowingly risk dangerous accidents. Currently, the tax code allows costs such as cleanup for negligent oil spills, intentional dumping of toxic pollutants, and litigation on the illegal filling of wetlands to be immediately deducted. However, the costs to avoid these problems with investment in pollution prevention are not immediately deductible. For instance, an oil distributor whose pipeline bursts and spills oil into a river can immediately deduct the costs of repairing the pipeline and cleaning up the spill. However, if the company wanted to double-wall the pipeline or make other improvements to prevent leaks, those costs would likely have to be deducted over many years. In other words, deductions for failure are immediately deductible while the deductions for prevention must come over several years, which costs the taxpayer more money. Eliminating the deductibility of environmental harm due to gross negligence or illegal pollution would begin to turn the balance of incentives in the right direction.

Sources

Congressional Budget Office. Reducing the Deficit: Spending and Revenue Options. February, 1995.

Congressional Research Service. Tax Expenditures: Compendium of Background Material on Individual Provisions. December 1994.

Charles Davenport, Michael Boehlje, David Martin. The Effects of Tax Policy on American Agriculture. U.S. Department of Agriculture, Economic Research Service. February 1982.

Jack Doyle. Crude Awakening: The Oil Mess in America: Wasting Energy, Jobs and the Environment. Friends of the Earth. 1994.

Howard Geller, John DeCicco, and Skip Laitner. "Energy Efficiency and Job Creation". American Council for and Energy Efficient Economy and Economic Research Associates. October 1992.

Andrew Hoerner "Tax Treatment of Environmental Cleanup Costs: An Environmental View" in The Natural Resources Tax Review. Tax Analysts. August 1994.

Calvin H. Johnson. "Seventeen Culls from Capital Gains" in The Capital Gains Controversy: A Tax Analysts Reader. Tax Analysts.

Joint Committee on Taxation. General Explanation of the Tax Reform Act of 1986. May 1987.

Internal Revenue Service. Statistics of Income Bulletin. Fall 1994.

Tom Knudson. "Mining's Grim Ecology: Water Resources Poisoned for Generations" in Clementine, Spring/Summer 1990. Mineral Policy Center.

Douglas N. Koplow. Federal Energy Subsidies: Energy, Environmental, and Fiscal Impacts. The Alliance to Save Energy. 1993.

Salvatore Lazzari. "CRS Report for Congress: The Federal Royalty and Tax Treatment of the Hard Rock Minerals Industry: An Economic Analysis". Congressional Research Service, The Library of Congress. October 15, 1990.

Office of Management and Budget. Analytical Perspectives: Budget of the United States Government. Fiscal Year 1996.

Federal Income Tax Code and Regulations. Ed. Martin B. Dickinson. Chicago: Commerce Clearing House, Inc., 1992.

Taxation for Environmental Protection: A Multinational Legal Study. Ed. Sanford E. Gaines and Richard A. Westin. New York: Quorum Books, 1991.

Taking from the Taxpayer: Public Subsidies for Natural Resource Development. Majority Staff Report of the the Subcommittee on Oversight and Investigations, House Committee on Natural Resources, U.S. House of Representatives. August 1994.

Dirty Little Secrets shows citizens how the tax code. . .

depletes our natural resources

helps polluters save money

drains the federal treasury

hurts jobs

Dirty Little Secrets is dedicated to the millions of Americans who diligently pay their taxes and hope the government will spend them intelligently. No one enjoys paying taxes. But Americans have an expectation that taxes are spread equitably, that the same rules apply to everyone, and that everyone has to pay for the services tax dollars provide.

Close inspection, however, reveals that some taxpayers are paying less than their fair share. Through powerful lobbying, polluters have carved out special treatment in the tax code. What they do is not illegal, but it is unfair. It is also a disaster for the environment.

Dirty Little Secrets exposes 15 exemptions, deductions, credits and other tax breaks given to polluting industries. The report finds that every year these polluting tax subsidies cost taxpayers more than $4 billion, money that could go toward reducing individual citizens' taxes or reducing the federal deficit.