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Fossil Fuel Taxation in the President's 2013 Budget

The president’s fiscal year 2013 budget proposes changes to the taxation of fossil fuels in the United States by increasing tax rates, reinstating expired taxes, and eliminating production deductions. The stated rationale for these changes is to remove tax preferences that encourage more investment in fossil fuel production than would occur under a neutral tax system. This paper evaluates whether the proposal accomplishes this goal. We do so by looking at the neutrality of the individual changes proposed, the overall tax treatment of fossil fuel production, and the effect the proposal will have on fossil fuel production. We first identify the changes proposed in the budget and compare them to both current law and a neutral tax system. We find that some of the proposed changes increase the neutrality of the system while others decrease it. We then move to look at the overall tax treatment of fossil fuel production in order to determine if the tax code gives preferential treatment to fossil fuel production. Surveying past literature on the effective tax rate on capital shows a wide variety of estimated tax rates for the sector. We calculate our own measures of the effective tax rate for the sector using three different specifications. Under all three of our measures, the effective tax rate for fossil fuel production is higher than the average for other sectors. Finally, we predict the effect of the proposal on fossil fuel production using a general equilibrium model of the US economy. We find that the proposal would increase the price of fossil fuels by 1.8 to 2.7 percent, decrease demand for fossil fuels by 0.7 to 1.7 percent, and that the excess burden of the additional revenue is 60 percent of revenues higher than if the tax increase was spread over all sectors. The price of the proposal’s reduction in carbon dioxide emissions is estimated to be at least $69 per metric ton.