Candidates disagree on oil companies' tax rate

— -- ExxonMobil xom earned after-tax profits of $41 billion and paid $14.5 billion in worldwide income taxes in 2007 — the highest in corporate history in both categories. The world's largest oil company is on track to smash both records in 2008, despite a recent decline in oil prices.

Should it pay higher taxes?

Democratic presidential nominee Barack Obama wants to impose a "windfall profits tax" on oil companies and use the money to provide tax rebates of $500 for most individuals and $1,000 for most married couples. Republican nominee John McCain opposes the idea.

McCain wants a dramatic cut in the top corporate income tax rate — to 25% from 35% — that would save ExxonMobil and other oil companies several billion dollars a year. Obama opposes this.

Both candidates, however, want to close some "loopholes" that let Exxon and other oil companies save several billion dollars a year in taxes.

The disagreements reflect broader differences between Republicans and Democrats on energy policy. McCain generally supports lower taxes to encourage domestic exploration and promote energy independence.

Obama backs higher taxes on the oil industry to help provide tax breaks for individuals and to promote renewable energy. He says high prices ($78.63 per barrel Tuesday, down from an intraday high of $147.27 on July 11, but up from $40 in 2004) are incentive enough to produce.

Oil industry tax breaks aren't huge considering the size of the industry, says Jeffrey Hooke, an investment banker in Bethesda, Md., who has studied the incentives. But Hooke says the tax breaks should be abolished because the industry is too profitable to need tax favors.

"They spend their profits mostly on dividends and buying back their own stock, not exploration," Hooke says.

ExxonMobil spokesman Alan Jeffers disagrees: "If you increase taxes, you reduce the … money we have available to invest in exploration."

Taxes already substantial

Whether oil companies should pay higher taxes is clouded by an unusual twist: The companies are already heavily taxed compared with other U.S. industries. But they are lightly taxed compared with what they pay abroad.

ExxonMobil would have paid an extra $1.3 billion in income taxes in 2007 if the U.S. tax rate matched those of foreign countries. However, the company would have paid $1 billion less if it had been taxed at the average 22% rate that other U.S. manufacturers pay.

Tax rates differ because foreign countries explicitly target oil production as a revenue source. As prices have risen, foreign governments have imposed additional taxes. China and Venezuela have imposed windfall profits taxes in recent years. Russia added new export duties in 2006 — only to cut them slightly in August to spur production.

The U.S. Energy Information Administration (EIA) estimates that foreign tax increases cost oil companies an extra $10 billion in 2006, the most recent year for which data are available.

Some states, including Alaska, also have raised their own oil taxes to capture more revenue amid recent record oil prices. The federal government's decision not to do this is at the heart of the debate.

"Oil extraction is incredibly lucrative," says Tyson Slocum, energy policy director at the Public Citizen advocacy group. "It's crazy to give tax incentives. The incentive is $100-a-barrel oil."

Economist Mark Perry of the University of Michigan at Flint, however, says forcing some industries to pay higher taxes is bad policy. He notes the prices of soybeans and corn have soared even more than crude oil.

"Nobody suggests a windfall profits tax on corn, soybeans or wheat," Perry says. "You shouldn't target industries based on when prices go up or down."

Congress eliminated one oil industry tax break in September when it approved the $700 billion financial rescue bill. The oil industry had been scheduled to get a tax cut in 2009 when the standard deduction for corporate income taxes was raised from 6% to 9% of income for manufacturers. Congress stripped the bigger deduction from the oil industry but left it unchanged for others.

"It's frustrating that oil and gas companies get singled out for different treatment than other industries," says Mark Kibbe, director of federal relations for the American Petroleum Institute.

Focus on loopholes

Obama helped create some of the tax loopholes he now opposes when he voted for the Energy Policy Act of 2005, a 1,725-page compromise that dealt with tax breaks, alternative energy, extended daylight savings time and ethanol. McCain voted against the law.

The tax breaks for the oil industry involve technical accounting issues. For example, the oil industry deducts the cost of exploration and development immediately, rather than over the life of the investment, as tax policy typically requires. This cost the government $510 million this fiscal year, the Office of Management and Budget reports.

The U.S. Treasury lost another $1 billion this year because Congress lets oil companies assume that oil fields are being depleted at a high fixed rate rather than the true rate of depletion.

The tax breaks, designed to spur U.S. production, may be working. Domestic oil production will rise 1.8% in 2008, the first increase in more than a decade, the EIA predicts.

Even with the tax breaks, the federal government is collecting more taxes from oil companies. The EIA reports that oil companies paid $31 billion to the federal government in 2006, up from $12 billion in 2004.