Reagan's Free-Market Energy Tax Policy
The Reagan era, the period from 1981-1989, witnessed the first attempt to create a more free-market energy tax policy by deregulating the energy markets, and by both reducing taxes and eliminating tax subsidies, both for conservation, alternative fuels, and for conventional fuels. The idea was to have a more neutral, and less distortionary policy, which would make energy markets and the general economy more efficient.
President Reagan's free-market views were well known prior to his election. During the 1980 Presidential campaign, he frequently proposed repeal of the WPT, the deregulation of energy prices, and the minimization of government intervention, including reduced spending and taxes. The Reagan Administration opposed using the tax law to promote either oil and gas development, energy conservation, or the supply of alternative fuels. It believed that the responsibility for commercializing conservation and alternative energy technologies rested with the private sector and that high oil prices would be ample encouragement for the development of alternative energy resources. This view was facilitated by the regime of high oil prices in 1981 and 1982. High oil prices in themselves create conservation incentives, stimulated oil and gas production, and render tax breaks for alternative resource ineffective, and wasteful, as a policy tool.
The Administration's energy tax policy was professed more formally in several energy and tax policy studies, including its 1981 National Energy Policy Plan and the 1983 update to this plan; it culminated in a 1984 Treasury study on general tax reform, which also proposed fundamental reforms of federal energy tax policy. In terms of actual legislation, many of the Reagan Administration's objectives were realized, although as discussed below there were unintended effects. In 1982, the business energy tax credits on most types of non-renewable technologies - those enacted under the ETA of 1978 - were allowed to expire as scheduled; other business credits and the residential energy tax credits were allowed to expire at the end of 1985, also as scheduled. Only the tax credits for business solar, geothermal, ocean thermal and biomass technologies were extended. And as mentioned above, today the 15% tax credit for business investment in solar and geothermal technologies is all that remains of these tax credits. A final accomplishment was the repeal of the WPT, but not until 1988, the end of the Reagan term.
The Administration's other energy tax policy proposals, however, were not adopted. The primary tax benefits for the oil/gas investments were not eliminated, although they were pared back as part of the Tax Reform Act (TRA) of 1986. For instance, expensing of IDCs was retained, but there was another cutback for integrated oil producers, who could only expense 70% of such costs and who were required to amortize (deduct evenly over time) the remaining 30%. In addition, expensing was no longer available for IDCs incurred in foreign countries. The TRA also specified that IDCs incurred abroad had to be either amortized over 10 years or added to the basis for cost depletion. With respect to percentage depletion, the TRA provided that percentage depletion would not apply to lease bonuses, advance royalties, or any other payments made without regard to actual production from the property. This amendment applied to geothermal as well as oil and gas properties. Another section of TRA denied capital gains treatment on certain dispositions of interest in oil and gas property; this also applies to geothermal property.
Finally, the TRA of 1986 replaced the old minimum taxes with a new alternative minimum tax that placed limits on the tax benefits to oil/gas producers from the expensing of IDCs and the percentage depletion allowance. However, in an effort to mitigate any burdensome effects of this new tax, the expensing deduction was not included in full as a tax preference item in the new minimum tax, which is an alternative tax regime to the standard income tax. (Taxpayers must compute both the standard income tax and the alternative minimum tax imposed on a variety of tax preferences or subsidies, and pay the larger of the two.) Rather, only the excess of the deduction above 65% of net income was to be treated as a preference item. In most cases, investments in oil and gas properties were exempted from the passive loss limitation rules that were intended to curb tax shelter investments. Thus, a working interest in an oil and gas property was not treated as a passive activity. This implied that losses and credits derived from such an activity could be used as a tax shelter to offset the taxpayer's other income without limitations under the passive loss rules.
Perhaps the key characteristic of the Reagan Administration energy tax policy, however, was the extent to which its objectives of neutrality and efficiency were countered by the Administration's other tax policies. While the objective was to create a free-market energy policy, the unintended effects of the significant liberalization of the depreciation system and reduction in marginal tax rates - both the result of the Economic Recovery Tax Act of 1981 (ERTA, P.L. 97-34) - combined with the regular investment tax credit and the business energy investment tax credits, resulted in negative effective tax rates for investments in many alternative energy investments such as solar and synthetic fuels. Also, the retention of percentage depletion and expensing of IDC's (even at the reduced rates) rendered oil and gas investments still favored relative to investments in general. Other energy tax policy developments during the Reagan era were as follows:
In 1984 the Deficit Reduction Act (P.L. 98-369) prevented the last stage of a phased-in reduction in the WPT for newly discovered oil, and corrected a technical error made in the percentage depletion provision of the Tax Reform Act of 1975. Also, the 1984 tax law extended several of the tax incentives for alcohol fuels: (1) the tax exemption for alcohol fuels mixtures was raised from 5¢ to 6¢; (2) the law retained the prior 9¢-per-gallon exemption for neat alcohol fuels, i.e., those that are at least 85% alcohol, derived from alternative substances, but it provided for a new exemption of 4.5¢ per gallon for alcohol fuels derived from natural gas; (3) the alcohol "blenders" credit was raised from 50 to 60¢ per gallon; and (4) the duty on alcohol imported for use as a fuel was increased from 50 to 60¢ per gallon.
In 1986 two environmental excise taxes were enacted on oil. The first was an increase in the 0.79¢ per barrel oil tax created under the original Superfund law of 1980, which expired on September 30, 1985. The Superfund Amendments and Reauthorization Act of 1986 (P.L. 99-499), increased the tax rate to an 8.2¢-per-barrel excise tax on domestic oil received by refineries; the rate on imported crude oil and petroleum products was 11.7¢ per barrel, to be paid by the importer. (This differential tax rate was ruled to violate the General Agreements on Tariffs and Trade (GATT), and 1989 legislation (the Steel Trade Liberalization Program Implementation Act (P.L. 101-221) corrected this problem by providing for a uniform rate of 9.7¢ per barrel.). The second environmental excise tax was a 1.3¢ per barrel tax on oil imposed as part of the Omnibus Budget Reconciliation Act of 1986 (P.L. 99-510). This tax was also to be imposed on crude oil received by refineries, as well as on imported and exported crude oil and petroleum products. The revenues from this tax were to be allocated to the Oil Spill Liability Trust Fund, created to finance the costs of cleaning up chemical disposal sites and hazardous waste spills. But, in fact, no revenues were ever collected from this tax, because the authorizing legislation -- as required by the 1986 law -- was not enacted until 1989.
In addition, the TRA of 1986 reduced the excise tax exemption for "neat" alcohol fuels, from 9¢ per gallon to 6¢ per gallon. It also permitted alcohol imported from certain Caribbean countries to enter free of the 60¢-per-gallon duty. The TRA also repealed the tax-exempt financing provision for alcohol-producing facilities and for certain steam-generating facilities.
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