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In conclusion, the current patchwork of energy tax subsidies set out in detail in my written testimony plays havoc with rational energy policy, wasting both economic and natural resources. Further, it distorts the true environmental costs of resources, resulting in unnecessary environmental impact. If the Tax Code is to continue to be used to set energy policy, then at the very least it should be done on the basis of a careful examination of the broad range of issues relating to energy use and production.
Tax incentives should not run counter to principles of least cost energy planning and the efficient allocation of scarce resources. Only then will we not waste taxpayers' dollars through unwise tax expenditures. But let me repeat, the best tax policy would be to remove all tax subsidies to the energy sector.
Thank you very much.
STATEMENT OF RUTH CAPLAN, ACTING DIRECTOR, ENVIRONMENTAL ACTION
Mr. Chairman and members of the committee, on behalf of the environmental community, I would like to express our appreciation to the Committee for scheduling a pa nel to examine environmental concerns in relation to the feder al tax code Our request to testify reflects a growing recognition within the environmental community of the critical role which the tax code plays in shaping the way in which our nat ur al resources used. Unfortuna tely, when we examine the current federal income tax code, we find that the tax code is not neutral in its environmental repercussions In fact, the present code creates a broad range of adv er se environmental impact &
This recognition has been spurred by the Environment and Economy Project, which has examined the federal tax code from an environmental perspective. The or ga nizations testifying on this panel today are also represented on the steering committee of the project. The analysis of the tax code by the project is included as Attachments A and B to my testimony. Other environmental or ga nizations, including the Sierra club, the wilderness Society, Natur al Resources Defense Council and the National Recreation and Park Association, which are not able to be represented here today, share our concern about the tax code and plan to submit statement s for the recordo
The existing tax coda is encrusted with layers of barnacles in the fora of tax preferences, deductions and exemptions which distort the allocation of e co nomic and natural resources. These provisions subsidize and encourage accelerated and more intensive exploitation of our nat ur al reso ur ce s--our farmland, our forests, our minerals and our ecologically sensitive na tur al areas As long as investment decisions are made on the basis of tax advantages, our economic system will suffer from inefficient allocation of reso ur ces and more of our resources will be required to produce a given quantity of goods and services This dynamic can be clearly Ulustrated in the energy sector, the main subject of my testimony.
The Treasury plan (Treasury I) would go a long way toward remov ing these preferences and restoring efficiency as a basis for making economic de ci sions Unfortunately, Treasury II has rest or ed many current provisions and in the process has selectively benefited some economic ende av or s over others, continuing incentives to exploit our natural resour ces unnecessarily.
AN OV BRVIKU OP EN BRGY TAX POLICY AND THB RIV IRONMENT Federal tax policy has an enormous impact on the way energy resources are developed and used in the United States. The federal government loses more than $27 billion in revenue annually through tax benefits for the devel ope ent and production of energy reso ur ces, according to a recent study by the Environmental Action Foundation (EAP). All but a small fraction of the 1 dentifiable tax expenditures for energy development are for non-renewable reso ur ces such as oil, gas, coal and uranium, as well as for conventional electricity production facilities Table 1 lists these tax expenditures
The current federal income tax code encourages wast ef w use of limited energy reso ur ces and promotes the use of energy technologies which have adv er se environmental impact & It encourages energy investment de ci si ons which are made l ar gely on the basis of expected tax benefits rather than economic efficiency. By fav oring development of non-renewable energy resources, it discourages more emironmentally benign ways of meeting our energy needs such as renewable energy so ur ces and energy efficiency improvements In our view, existing federal tax policy is a major ca use of our nation's wasteful and environmentally un so und energy development practices
GENERAL CORPORATE TAX BENEFITS POR ENERGY
Sev er al investment incentives made available to all businesses by the federal tax code are of particular importance to the capital-intens ve energy industries. These include the accelerated cost recovery system (A CRS), the investment tax credit (ITC), and the use of tax-exempt industrial development bonds,
Accelerated Cost Recovery Sy ster. The Accelerated Cost Recovery System (ACRS) benefits e na ble energy firms to post po ne paying more than $10 billion of their tax liability annually. Electric utilities def er about $5 billion annually through ACRS benefits 011 and gas interests defer an estimated $6 to $10 billion annually, according to estimates by EAF (see table).
A CRS has been roundly criticized by the Treasury De par tment because it "creates an artificial incentive for one form of investment over another...and encourages non productive, tax-motivated investment activity. Further, Treasury I argues, "A CRS disproportionately be nef its capital-intensive industries and methods of production." (Tax Reform for Fairness. Simplicity and Economic Growth, V. 2, pp 154, 156.)
Investnent Tax Credito Nearly all investments in new energy facilities qual ify for the 10 per cent ITC, including power plants, oil refineries and coal mining machinery. The ITC provides at least $5 billion annually in subsidies for energy investments, mostly to oil com pa nies and utilities (see table).
This tax subsidy favor s costly energy investments such as nual ear plants and oil refineries over less capital-intensive technologies. The ITC can reduce the cost of building a new nuclear plant by as much as half a billion dollars.
The ITC has become an enormous capital subs i dy for the energy industries, encouraging investments which might not be made but for this tax benefit. Economist Don Fullerton of the University of Virginia has argued in testimony this spring before the House Subcommittee on Economic Stabilization that the original justification for the investment credit has di sa ppeared and that businesses' nown efficient allocation decisions are distorted by this subs i dy. We agree and are pleased to see that all the major tax reform pro po sal s would eliminate this subsidy.
Pollution Control Bonds. The energy sect or has made heavy use of industrial development bonds (I DBS) due to a provision pa s sed in 1968 which allows private businesses to use IDBs to finance pollution control facilities Be cause they offer a low-cost source of capital, pollution control bonds have become an impor tant vehicle for financing new energy investments, particularly electric power plants
Use of pollution control bonds for energy facilities has increased dr ama ti cally in recent years. During the first nine months of 1984, 86 per cent of all pollution control bonds issued were used to finance energy facilities, and 84 per cent were for power plant & Pollution control bonds for energy facilities out standing at the end of 1984 cost the the federal Treasury approximately $1 billion last year. New pollution control bonds issued for energy facilities in 1984 al one will cost the Treasury $6 billion over the next 30 years. (The net present val ue of this revenue loss is $2.5 billion, assum ing a 10-percent discount rate)
Instead of protecting the environment, pollution control bonds act ually encourage investments in polluting technologies. The se tax-exempt bonds are used mainly to build new facilities rather than to clean up existing one Moreover, they are available only for pollution controls which are already required by the U.S. Environmental Protection Agency. Pollution control boods may also encourage capital-intensive approaches to pollution control when other approaches are more cost-effective
SPECIAL ENERGY TAX BENEFITS
Bxpensing Under the current tax code, the costs of financing a new longterm asset are gener ally not deductible currently but must be capital ized and then deducted or amor tized over a period of years. Energy investments, how ever, derive substantial tax benefits from exceptions which are made to this rule
Expensins ef construction-period Intereste For certain per so nal property, including energy facilities, present law allows a current tax deduction for interest on funds borrowed to finance construction Expensing of construction-period interest allows an energy firm to receive a large tax de duction up front, long before its new investment is producing income This represents an interest-free loan from the Treasury for long-term construction projects such as power plants and off shore oil rigs.
Electric utilities alone saved $4.1 billion on their 1983 tax returns by expensing construction period interest, according to cal cua tions by EAF. The extent of savings by the other energy industries is not known, but 18 probably quite substantial.
Expensing of Intangible Drilling Costs. Few provisions have received as much attention in the press as the expensing of intangible drilling costs, (IDCs). Under the law, a taxpay er can take an immediate write-off of 80 per cent or more of their IDCs, rather than having to capital ize the cost of productive wells and write-off un productive wells over time as a business 1088 The environmental consequences from the excess drilling encouraged by this provision is discussed in testimony presented by Dr. Jan Bey ea of tbe Na tional Audubon Society.
Expensing of Exploration Costs. As with oil and gas, most exploration and dev el o pment costs for hard mineral energy resources such as coal and ur ani um can be expense d currently, instead of being capital iz ed. The total benefit is much smaller for coal than for oil and gas drilling ($110 million in 1983 compared to more than $2 billion for oil and gas)
Percentage Depletion. Under this 1926 provision depletion is based on the size of the reserve, not on the cost of production As a result, the total de pletion claimed for tax pur po ses may be many times the original in estment.
Deductions for Mind ng Real anation Costa Mining com pa ni es are permitted to take current de ductions for future reclamation cost s, even if they do not set a si de funds for that pur po se. Energy mining com pa ni es are thus allowed a bo ut $400 million annually in advance deductions for reclama tion cost s, though there is no assurance the land wul be real aimed
Deductions for reclamation cost s are justified only when such cost s are act ually incurred or when funds are set a side for that pur po ge.
In an analogous situation, a 1984 law allows utilities which operate nuclear reactors to take current deductions for future de commissioni ng expenses, only if funds are a ct ually set a side for this purpose
Capital Gains Treatment of Coal Royalties Income earned on roy al ties from coal production is eligible for capital gains treatment. This provision saves coal interests $110 million annually, according to Treasury.
Lirited Partnerships. Nearly one million individuals had limited partnership investments in oil and gas in 1982, according to Treasury. This represents a bo ut one-third of all limited partnership investors This tax loophol e encourages investments in oil and gas; and because such investments need not be profitable, it may encourage frivolous drilling activity. The exact level of tax expenditures due to limited partnerships in the energy sect or is difficut to determine and is not included in Table 1.
Benefits for Syathetic Puela Sy nf uels investments can benefit from more than ten different subsidies in the current tax code Capital subsidies such as the ITC and A CRS provide an important boost to all sy nf uels projects. In addition, any sy nf uels products which are derived from coal benefit from all of the tax subsidies available for cal development.
Sy nf uels can al so benefit from as many as five additional subsidies, according to a congressional Research Service report. Any sy nf uels project which had an affirmative commitment in 1982 qual fies for a special business energy tax credito Certain sy nf uels projects may al so qualify for fina ncing with tax-exempt industrial development bonds Producers receive a special tax credit for every barrel equival ent of synthetic fuel they produce. Sy nf uels product s are also exempt from federal excise tax on fuel s, and income from sy of wels is exempt from the windfall prof its tax These tax expenditures are in addition to substanti al federal bud get outlays for sy nf uels through the Synthetic Fuels Corporation
Despite the large number of tax benefits available for sy nf uels development, the cost to the Treasury is still relatively small be cause few such projects have been undertaken Nev er th el ess, 11 left in place, tax subsidies could make sy nf uels development appear profitable, res ul ting in substantial environmental and economic costs to our society.
TAX BENEFITS POR DERGY EFFICIENCY AND RENEWABLE ENERGY SOURCES
The business and residential energy tax credits for renewables and conservation adopted by Congress in 1978, were an attempt to give these newly developing energy sources a chance to compete with the already establish ed and heavily subsidized non-renewables with a few exceptions, all of these benefits are now scheduled to expire at the end of 1985. By contrast, the