Oil troubles the water it floats on this year from the Pacific surf to the Potomac, and even water where it isn’t, along the deep blue coast of Maine, is sullen against it. The 27.5 percent oil depletion allowance is in actual danger for the first time since it was passed forty-three years ago.
In Washington, Wilbur Mills, chairman of the House tax-writing committee, has told his colleagues that “oil sticks out alone—it’s just a target that way,” and depletion must be cut if there is to be any tax reform at all. John Byrnes, the ranking Republican on the committee and “a tested friend of oil.” insisted on knowing why Atlantic Richfield, having just drilled two wells into what its partner Humble says is probably the largest oil field ever found in North America, banked its last half billion dollars’ profit without paying a cent of federal income tax.
“Is there any justification at all,” Senator Edward Kennedy of Massachusetts asked in the spring, “for the present tax treatment of depletion, intangible drilling costs, and foreign royalties, all of which result in countless billions of dollars of lost taxes to the U.S. Treasury?” The last of the Kennedy brothers asking such a question characterizes the situation. The year-in, year-out liberals have been joined by more powerful men in seeking a substantially different approach to one of the country’s most political industries. The debate about depletion has spread to oil’s basic conditions and arrangements—overinvestment and oversupply, concentration in large companies, governmentenforced limitations on production and imports, U.S. prices rising while world prices are falling, even the meaning of the slogan “national security” as a defense for oil’s special privileges. The point is getting around that the government, as the Senate Democrats’ antitrust economist, John Blair, puts it, has been “implementing a cartel" for the oil companies by using the import program and the thirtyfive-year-old state production control system to limit the supply of oil. Current investigations into the curious oil import “ticket cpiota” system may lead to revelations and repercussions even more serious for the industry than tax reforms.
The emotional basis of the situation is a certain national disgust with all things Texan, including, therefore, oil. The events that made oil an “issue” were President Johnson’s 10 percent surtax to fund the unpopular Vietnam War, the leaking oil well off Santa Barbara that befouled California beaches and marinas, and the oil companies’ price increases soon thereafter. The catalyzing event was a statement by the Secretary of the Treasury in the last days of the Johnson period in Washington, Joseph Barr.
“I will hazard a guess,” he told Congress’ Joint Economic Committee, “that there is going to be a taxpayer revolt over the income taxes in this country unless we move in this area” of tax reform. “The revolt is going to come,” he said, not from the poor, who, he said, do not pay very much in taxes, but from the middle class, “who pay every nickel in taxes at the going rate. They do not have the loopholes and the gimmicks to resort to.” The tax system is voluntary, he said, and will not work unless people support it. They want to feel they are not paying more than their share, and they believe everyone should do his part. “This does not happen,” Barr said, “when you are running a corporation and you look at the international oil companies and see they pay little or no taxes. They pay huge taxes including royalties to other governments, but not to this government.”
The context of this warning was, after all, the revolt of students, blacks, and many adults against the war, our domestic social failures and the increasing militarization of the society, and the distraught national reaction against and awareness of the power of protest. No one needed to explain the possibilities of a tax revolt to politicians, many of whom no doubt damned Barr in their cocktails, and oil’s battalions of publicists and cosmeticians must have felt that left-wing Lucifer himself was orchestrating the conspiracy of events.
The alert spread swiftly into four neighborhoods, the House Ways and Means Committee, the Senate Subcommittee on Antitrust and Monopoly, the Senate Finance Committee, and the offices of the oil industry. Oil-state congressmen began feeling the pressure to get cracking in the industry’s defense.
Oil has five or six special tax benefits, of which depletion is only the biggest one. Even President Nixon, whose promise in Texas on the depletion allowance—“As President, I will maintain it”—could hardly be stronger, is letting his people at the Treasury Department make plans for other reforms in oil taxation. Carefully explaining the foreign tax credit as it works to oil’s special advantage, Edwin Cohen, the Assistant Secretary of the Treasury for tax affairs, says, “The President has not indicated to us that the oil tax system is not to be changed.”
“There’s got to be a substantial change in taxation of income developed by extractive industries, which include oil and gas,” Chairman Mills said in the midst of his committee’s work on the tax bill. He said he himself favored a cut in 27.5 percent depletion, and by more than a token two or three points, and a scaling down of the rates for other minerals. Oil producers have been selling rights to their future income in order to change the timing of their earnings to reduce their taxes, and this, Mills said, will be “cut out entirely.” There was also some feeling, he said, against allowing depletion on foreign oil production.
Sensing that something was going to give, oil’s defenders began looking around for anything but oil. Late one afternoon Senator Russell Long of Louisiana, the chairman of the Finance Committee, emerged from a lecture by the Democrats leading tax-reform expert, Stanley Surrey, once an assistant Secretary of the Treasury, to the Senate Democratic Policy Committee, and exclaimed, “The biggest single defect causing people’s not paying any tax is capital gains. Then there’s the way they tax real estate. Another one is so-called charitable deductions. I got out a list of all the people who made all the money and paid no taxes, and I didn’t find out any of them did it because of the depletion allowance. Depletion might have been a part of it. . . . Capital gains—that’s the big one!”
Under so many strains, the tanker of “oil industry unity” sprang some leaks. In Texas one learned that certain discussions were going on behind closed doors between the House taxers and the independent oil producers, who do not get as much out of depletion, even proportionally, as the majors. From a spokesman for a major importer one could deduce that 27.5 percent was not quite as necessary to him and his associates as their foreign tax credit arrangements. Then the president of the Texas oil independents, Netum Steed, made public a letter lie wrote to Nixon stating that if oil taxation had to he a subject of tax reform, “some reduction in the 271/2% depletion factor might well be sustained without irreparable injury,” provided a change was made to give smaller producers more depletion than they get now. An executive of an oil association said of men he works with from the major oil companies, “They’re scared.” The Mills committee showed why, when it recommended cutting depletion to 20 percent. The New Englanders were united against the Southwesterners in a grim struggle for very large prizes, with public indignation working for the Yankees—and the power of oil, as usual, easing in from Texas.
The theory of the oil depletion allowance depends on the assertion that an oil venture’s capital is not the same thing as its capital investment. Oil, it is explained, is an irreplaceable “wasting asset,” a limited quantity of an elusive substance that is being depleted. Therefore, we are told, when oil is discovered in the ground, it becomes capital that should he valued on the basis of its selling price. Once capital investment has thus been eased over into the more adaptable idea of capital, the conclusion is drawn that the income tax, being a tax on income, should not apply to that portion of the income from the oil which is a return of capital.
By this one turn in economic doctrine, an oilman’s capital is cut loose from his actual investment. “No account is taken ... of the actual cost,” explains political scientist Robert Engler. The purpose of the allowance, said Business Week back in 1961, is “to permit . „ . tax-free recovery of the value of the deposit.”
But why should the allowance be, as Paul Douglas of Illinois said when he was a senator, “271/2% of gross income up to 50% of net income, world without end, amen”? By the doctrine, the resulting annual deduction “represents the reduction in the quantity” of the oil. It is “the loss in value in the process of working a wasting asset.” In the elegant formulation of Humble Oil’s economist for many years, Dr. Richard Gonzalez, “The depletion of reserves by production creates a reduction in capital values.” The allowance teas granted, explained former Jersey Standard president M. J. Rathbone, “on the basis that when a prospector found an oilfield and produced that oilfield, he was in effect going out of business.” The calamity increases, the more oil you sell. As you make your profit, you are losing about half of it, even though you keep all of it.
Despite this rather special misfortune, when the time comes to tell the stockholders how much money has been made, oil companies figure it out in the ordinary way. By investment they mean their actual costs. Profit is income in excess of those costs. The effect of percentage depletion in the financial accounts is a reduction in taxes and a higher net profit.
The thought that oil is capital rather than more like a groceryman’s stock on the shelf is an article of faith in the oil industry, but is subject to argument. Louis Eisenstein likes the conservative idea that “the capital of a business consists of the actual investment in the enterprise.” Or again, “Is it not clear.” asked Solicitor General (then Harvard Law School dean) Erwin Griswold, “that income derived from oil production is business income?” Griswold thought this was clear.
Until 1918, oilmen, when figuring their income tax, deducted their costs like other businessmen. That year, however, alter the war was over, ponderous. cynical Boies Penrose, the political boss of Pennsylvania and probably the most powerful Republican in the country at that time, spoke a few strange lines on the floor of the United States Senate, and ever since then oil producers have had about half their income tax-free, year after year.
The Wisconsin Progressive Robert La Follette knew what was happening that day in the Senate and cried out in the wilderness he knew so intimately, but the three Republican Presidents of the twenties, Harding, Coolidge, and Hoover, stood mute on depletion while their Secretary of the Treasury, Andrew Mellon of Gulf Oil, profited from it.
Depletion had its beginning in the original income tax law of 1913, which provided for a depletion deduction up to 5 percent of gross income, limited overall to the original cost of the property or its market value in 1913. The market value option was the pinprick in the law that has been expanded in the course of fifty years into what Douglas calls “a truckhole.
Under the 1916 tax law, to get any depletion an oilman had to show that his actual production was declining, and he could not get back overall more than his actual costs (except on acquisitions before the income tax had gone into effect) . Early in 1918 the Bureau of Internal Revenue was issuing instructions on how to compute the actual investment in oil and gas wells.
Later that same war year, a committee of prominent oilmen was formed to obtain tax relief for the industry and warned that the high war taxes would discourage the oil wildcatters who were discovering new fields. The chairman of the committee, who helped lobby through its program, was later rewarded by the industry with 820,000, a trifle, everything considered.
The small companies, said the oil committee’s spokesman to the Senate hearing, were discouraged by the high wartime tax rates. And then he mentioned another matter that could be dealt with “in almost a moment ... a reasonable allowance for depletion without statutory restriction. Oklahoma’s Senator Thomas Gore, who was later to become an oil lobbyist himself, first mentioned the new theory, saying that the major part of produced oil represents not profit, but capital. A lobbyist for the big companies testified before the Senate Finance Committee that the oilman “sells his capital assets from the day he begins producing,”and it is not fair to treat his business like banking, manufacturing. “and other going industries.”
Senator Penrose, the ranking Republican on the committee, was a man of legendary appetites. Someone with an obscene sense of history recorded that one evening Penrose consumed for his dinner a dozen oysters, chicken gumbo, a terrapin stew, two chicks, six kinds of vegetables, a quart of coffee, and several cognacs. On another occasion his repast consisted of nine cocktails, five highballs, twenty-six reed birds in a chafing dish, wild rice, and a bowl of gravy. He weighed 350 pounds.
All sources seem to agree that Penrose sedulously served the large corporate interests. He received their political gifts—on one proved occasion, .825,000 from John Archbold of Standard Oil—and passed out funds to functionaries, but never kept a rakeoff for himself. The last of the old-style bosses in Pennsylvania, born to wealth, he was no hypocrite or small-timer. His principal cause was the protective tariff. He told an associate that he had decided early to “control legislation that meant something to men with real money and let them foot the bills.” By 1918, the Pennsylvania business baron to whom he looked for cues and support was Andrew Mellon, a leading member of the banking family that had become dominant in Alcoa and Gulf Oil. Two years later it would be Boies Penrose who would say to Senator Harding, “Warren, how would you like to be President?", and then it would be Boies Penrose who would say to Mellon, “I want you to be Secretary of the Treasury.”
On December 17, 1918, Penrose presented the Senate the Finance Committee’s proposal to stop limiting depletion to the capital actually invested and to base the deduction thereafter, for wells not bought in “proven fields,” on the value of the discovered oil. His argument occupies just twenty-one lines in the Congressional Record. When, for example, a ton of coal is sold, he said, part of the excess of the price over cost must be treated as a “repayment of what was invested.”But then in one short phrase—Penrose told the Senate that the proposal based depletion for wells and mines on market value “instead of cost.”
Arguing for the House tax bill, which adhered to what is now called cost, depletion, La Follette warned that under the Penrose plan a mine or oil well might cost $100,000, but on the basis of its enhanced value because of a discovery, the cost might be deducted ten times. He understood, and he opposed. He got only seven votes, including those of William Borah and George Norris.
The chairman of the House tax committee, Claude Kitchin of North Carolina, told the full House that he was opposed to the several provisions for mines and wells as “pieces of special favoritism.” He was the House Majority Leader, but he had been pilloried and his influence reduced because of his opposition to Wilson on our going into the war, and one can see in the look of his words on the page that he did not expect to be heeded. He was not, and thus it was that half a century ago depletion was broken free and clear of any limitation to a producer’s actual investment.
In our period, Treasure studies show that average oil and gas depletion deductions are ten times what the actual cost depletion would be. In 1948 and 1949, oil and gas producers were deducting more than nineteen times their cost each year. On a group of products, including iron, copper, and silver, depletion deductions in 1960 were ninety-one times cost depletion each year. C. Wright Mills has written, “The important point of privilege has less to do with the percentage allowed than with the continuation of the device long after the property is fully depreciated.” The late Senator Robert Taft of Ohio said that when a man has gotten back his entire costs, “it does not stop,”and another leading Republican critic of depletion, Senator John Williams of Delaware, makes this point even more clearly: “There is no limit.”
The Mellons’ Gulf Oil and other oil companies began collecting the extra profit the 1918 amendment gave them. Mellon, a spare, handsome, and aristocratic man, stayed on in the Treason job throughout the twenties. He appears never to have spoken publicly about depletion, but he became entailed in a public “battle of the millionaires” with Senator James Couzens of Detroit, who succeeded La Follette as depletion’s nemesis in the Senate. Couzens, who had been in effect Henry Ford’s original partner in the Ford Motor Company, charged that Gulf Oil and other corporations had been unduly begifted by tax rebates involving, in part, depletion, in the one year 1919, according to an inquiry Couzens conducted, Gulf’s depletion allowance had been 449 percent of its net income.
As administered, discovery-value depletion had not been limited to newly discovered wells. The 1918 law was only three years old when a Treasury tax official who had been working in the minerals section attacked discovery depletion as “an enormous privilege,”“really a gift in the form of taxfree income.”He explained how, tinder an artificial definition of what a “proven field" was, thousands of wells were qualifying, making this “unquestionably one of the greatest loopholes of escape from taxation to be found in the entire statute.”With the deduction often exceeding the entire income from a well, Congress in 1921 limited it to 100 percent of profit, but again in 1924 a Missouri congressman warned of “a great leak" in the tax law because of the way a proven field had been defined, letting every well drilled in six square miles get “discovery" depletion. The deduction was limited to 50 percent of profit that year, but just about every well was still getting it. Of 13,671 claimants studied by the Couzens investigation, only 35 had been the discoverers of new oil pools; only 3.5 percent of the depletion was going to wildcatters, in Mellon’s Treasury, depletion had become a well of flowing gold for the oil companies.
In equity, this was as great a scandal as Teapot Dome was in fraud, and could have been the basis for reform, but there was another difficulty—there had been administrative problems. How could anyone estimate the value of the oil under a well in the 1920s? You had to know how much oil there was down there and its fetching price in the future; one guess multiplied by another one, as a senator said.
One day late in 1925 Mellon s spokesman had just told the House tax committee that depletion should be limited to “the man who makes the discovery" when the chairman of the committee said he wanted to wipe it out entirely because it was a wartime measure and was 110 longer justified. Representative Cordell Hull, echo wrote the original income lax law, agreed. The committee, however, limited itself to reporting that obviously discovery depletion, “the purpose of which was to encourage the wildcatter or pioneer, should be limited to those who make an actual discovery.”
Disregarding this report, Senator David Reed of Pennsylvania, whose father had been one of the original members of the Mellon syndicate in Gulf, suggested simplifying things with “an arbitrary percentage for all taxpayers.”Reed related to his fellow Finance Committee members that he had been told by the president of the Mid-Continent Oil and Gas Association at lunchtime that the industry had spent more money, for drilling in 1925 than the value of their oil production. “So,”concluded the senator, “the industry can truthfully say that it has not made a cent on all its business of last year.” The Mid-Continent man, Reed added, had suggested a deduction of 25 percent of their gross income. Fin’s appears to he the earliest printed proposal ol a rate for percentage depletion.
Senator Reed Smoot of Utah, one of Russell Long’s predecessors as chairman of the Finance Committee, assured Senator Samuel Shortridge of California that in taxing income from mineral production, the cost of production didn’t matter, it just didn’t matter:
The Chairman: There is no depletion on this program. The question of depletion is entirely wiped out.
Senator Shortridge: Well, what would be the basis then?
The Chairman: That is for us to determine. . . .
Senator Shortridge: No matter what it cost to produce it? . . . the cost of producing an ounce of gold may vary extremely in different sections.
The Chairman: Well, it would not matter whether it was of the same value or not. You can produce gold perhaps cheaper in California than we can in Utah, but we can produce silver cheaper than you can.
Senator Shortridge: Yes. . . .
Senator Reed of Pennsylvania: In other words, you take account of depletion by giving them a lower income tax rate?
The Chairmans That is exactly it. . . .
Senator Reed: We deduct depletion based on gross income.
The Chairman: Oh. we want depletion done away with entirely . . . we would get away with the question of depletion entirely.
Not from. He said with.
Reed carried the 25 percent proposal in the Senate debate, contending that the oilman’s “capital is constantly disappearing’' as it is “depleted by the flow of oil and gas.” Couzens, himself forty times over a millionaire, tried to limit depletion to actual investment. Discovery depletion, he said, had awarded $4 million to Gull Oil alone in two years, and Gulf was hardly a wildcatter. With the war over, the supply of oil ample, and the wildcatters all but forgotten as the pretext for the allowance, Couzens remarked, he did not see why “the Standard Oil Company, the Gulf Oil Company, and other big oil companies" could not pay their income taxes like every other company.
It was a bitter debate. Couzens and an oil-man-senator from Oklahoma named William Pine differed over whether one of them was a liar or the other an ignoramus.
“We owe it to the people of the country to simplify this law,” Senator Reed stated. “The whole thing is in the line of simplification, getting rid of this everlasting accounting.”By one vote the Senate defeated an amendment to approve a rate, not of 25 percent, but of 35. A member of the Finance Committee, William King of Utah, called what the Senate was doing “gross favoritism . . . under the guise of simplifying the law.” In what reads now, after the passage of years, as resignation, Senator King, a Mormon and former jurist, said, “I cannot understand this great solicitude for the Standard Oil Company, the Shell Oil Company, the Sinclair Company, and the other great organizations, whose annual profits are many hundreds of millions of dollars. ... I am afraid we are blinded because of the power and the bigness of great corporations and sometimes deal unjustly with the people.”The Senate approved 30 percent by a vote of 48 to 13, and the conferees accepted (as a compromise on behalf of some sentiment in the House for 25 percent) the figure of 27.5 percent.
Although rattled by Couzens’ attacks on him, Mellon had maintained his crusade to lower taxes on wealth and business, and the 1926 revenue bill was widely regarded as his triumph. When President Coolidge signed it into law, Mellon was standing beside him. During Mellon’s tenure as Secretary of the Treasury, his family’s Gulf Oil more than doubled its assets.
Bromides about the history ol depletion often emphasize that 27.5 percent was adopted in 1926, but the killing off that year of the restriction of the privilege to wildcatters’ newly discovered wells was a change at least as important as the percentage system. The original idea of a specific incentive to expand U.S. oil supplies was blurred, and a new privilege began to generate its adaptable new reasons for existing.
As soon as the Democrats swept in, President Roosevelt began trying to abolish percentage depletion. His Treasury Secretary, Henry Morgenthau, Jr., told House taxers in 1933 that it was “a pure subside to a special class ol taxpayers and should be eliminated. Among the few senators who agreed was Russell Long’s father, Huey, who said its elimination would prevent “those who have already had 100 percent coming back and getting another 100 percent.” In 1937, two weeks after Lyndon Johnson was sworn in as a freshman congressman, Roosevelt sent Congress a message condemning depletion and other loopholes as attempts to dodge the payment of taxes" and “mulct" the Treasury, and Morgenthau called depletion “perhaps the most glaring loophole.” In spite ot the Depression, the New Deal, and Roosevelt, Congress did nothing.
Came the war, “the crisis of democracy. Six weeks after Pearl Harbor, Morgenthau again spoke against depletion and was promptly told by the chief lawyer of the Independent Petroleum Association of America that “this issue, if pressed, will force practically every oil producer in the country to abandon his work and come to Washington. Morgenthau implored the Congress: “ This loophole,” he said, “is a special privilege,” and the money was needed tor the war. Senator Taft observed that 27.5 percent was “to a large extent a gift ... a special privilege beyond what anyone else can get.” For the industry, former Senator Thomas Gore said depletion had worked, providing an adequate domestic supply of oil, “and we are now asked to abandon that policy in time of war.”The Congress answered the Administration’s appeal by extending depletion to ten new minerals, including ball and sagger clay. When Roosevelt vetoed the 1944 tax bill, citing as reasons the extension of depletion 10 potash and mica and a comparable special treatment for timber. Congress overrode him.
“I know of no loophole ... so inequitable. President Truman told the Congress in 1950. It bore, he said, “only a haphazard relationship to encouraging oil exploration. In 1942 Morgenthau had tried to stop oil’s second most important tax privilege, the immediate writing off of intangible drilling and development costs on successful wells; Truman’s Treasury chief told Congress that depletion plus the write-off provided a mechanism for pyramiding oil assets without paying any or much income lax.
Finally, a reform movement with staying power took hold on the Hill, “It began in 1951 when they brought in a new tax bill,”Paul Douglas recalls in his office in Washington. “Hubert Humphrey organized a seminar. A man would come in from the Treasury in secret, at night. It was like Christians meeting in the Catacombs.”
The Truman Administration was on record, but, Douglas says, “They didn’t mean it. They gave us no help. Truman didn’t really mean it on civil rights, didn’t really mean it on tax reform.”The band of liberals pressed the fight, but felt increasingly isolated, abandoned, and assailed.
Sam Rayburn, a rural Texan, was Speaker of the House. Dwight Eisenhower, a Republican born a Texan, became President. Lyndon Johnson, an ambitious Texan, took over the Senate. And then Robert Anderson, a canny Texan who was intimate with each of the other three, became Eisenhower’s Secretary of the Treasury. In such a context, the demands of La Follette, Couzens, Roosevelt, Morgenthau, and the others that depletion be abolished were given up as hopeless, and the reformers retreated to a strategy cajoling for reductions. How about 15 percent? No? Well, then, what about 15 percent just for the very biggest oil companies? No, the question in the fifties was not, would oil lose depletion; the question was, what else would it get?
The history of depletion was summarized, somewhat personally, by Speaker Rayburn in an interview in 1960, the year before he died. “Depletion has been in effect for thirty-four years, and the Democrats have been in control twenty-eight of those,” he said. “Do you suppose if we’d wanted to do anything about depletion that we wouldn’t have done it by that time? But,” said Rayburn, who regarded oilmen as ingrates at election time, “they just hate.” They had tried “to destroy me. Destroy Lyndon Johnson. Destroy me.” His biographer, C. Dwight Dorough, said Rayburn was close to tears and covered his face with his hands.
Even so, sentiment for reform had built steadily. In 1951 only nine senators voted for Humphrey’s cut in depletion. Seven years later thirty-one voted for Proxmire’s. Five years ago thirty-three voted for the Williams cut and thirty-five for Douglas’. Douglas and Humphrey are gone, but so are Johnson and Rayburn.
As chairman of the powerful Finance Committee, Russell Long is the most strategically placed congressional ally of the oil industry. He is probably the shrewdest and most active defender of depletion in the Senate. He knows the subject and pounces at once when someone slips in debate. He often cites statistics prepared at his request, as he says, by the staff of the committee; his chairmanship entails his managing the tax bill on the floor. Whatever the House was to do on depletion this year, no one gave the reformers much chance in Russell Long’s committee. They would have to make their charge from outside the walls as in the days of yore.
“We gonna move heaven and earth to protect 27.5 percent,”says Long’s friendly, country-style administrative assistant, Bob Hunter, “1 couldn’t kid you if I wanted to—we’re violently interested! We’re not gonna be lulled by 26 percent, 25, 24 . . .”
Senator Long is also an oilman. He readily acknowledges that he inherited valuable oil and gas properties and that he has participated in drilling thirty or forty wells. He says his income from the inherited properties exceeds what he makes in the Senate. When asked how much he has also made in drilling wells, he answers vaguely.
Hunter sa)s that the few shares of stock Longheld in the Win or Lose Corporation were “worth quite a bit. He has these oil holdings all over the slate because of that. He has no conflict of interest.”
During the full debate on depletion in l964, Long placed charts on the oil industry’s profits in the rear of the Senate chamber. Senator Douglas observed that they were well-fashioned and bore evidence of being an expert job, but left out the income from overseas operations.
There was an unusually personal exchange between Long and then Senator Joseph Clark of Pennsylvania. Clark, a committed foe of depiction, remarked that for many years his own main source of income had been his royalties from Humble Oil holdings. Long observed that as a matter of fact, under the Douglas amendment to cut depletion on very large oil incomes, which Clark was at that moment supporting, Clark’s income would have been protected from a depletion reduction.
“The oil depletion allowance is so unconscionable that I cannot sleep very well some nights when I realize that I am the beneficiary of it,” Clark retorted to Long. Unfazed, Long asked Clark if he was making more than a million dollars a year from his royalties—no, $60,000 to $70,000 a year. Clark replied. Well, then, said Long, the Douglas amendment left Clark “well protected.”
“In my judgment,”Clark said, “there is no conceivable excuse for my getting tax-free income because my great-grandfather . . . had the good fortune or the good luck to squat on that land.”
Senator Long’s Populist father, Huey, went into the oil business under dubious circumstances in the last year of his life. Those were brazen days in Louisiana. The Kingfish had such total control of the statehouse that his wealthy foes called him a dictator, and with cause. Alter he was elected to the Senate, his hand-picked successor as governor, O. K. Allen, and the entire Long slate were elected by the believing people, The time was the fall of 1934, about six months after Huey had sided with Kenneth McKellar’s amendment to abolish percentage depletion.
From its inception the Win or Lose Corporation looked like a political oil company. The president was State Senator James A. Noe, a good friend of Huey’s. The vice president was Colonel Seymour Weiss, whom one Long biographer called Long’s “prime minister and chancellor of the exchequer,”perhaps because Long did too. The company’s secretary was Huey’s personal secretary, Earle Christen berry. And these three men were the only incorporators.
Russell Long says Senator Noe told Huey Long that he wanted to apply for a state oil lease in the part of the state he represented (the leases were not awarded by competitive bid in those days) , and that his father told Noe that he was agreeable to going into the business if it wasn’t going to cause him “a political problem.”Lease No. 309, executed on behalf of the state by Governor O. k. Allen, gave Noe the right to drill a minimum of fifty wells on state lands in the bed of a river and five bayous. This is the start that gives Russell Long his inherited oil income, because as of 1940, as records on file in Baton Rouge show, Huey’s widow owned thirty-one shares, a third of the company, and was the president. When it was liquidated in 1951, she owned eleven shares, and Russell Long six. O. K. Allen. Jr., had four.
After Huey Long was assassinated in 1935, the company obtained a number of other state leases, Russell Long says; but he emphasizes that he of course had nothing to do with this. “What I inherited,”he says, “was the equivalent of 6 percent of the stock in the company.”
In addition, Russell Long has participated, with his mother, brother, and sister, in the drilling of about thirty or forty wells in Louisiana’s Sligo field and in De Soto Parish south of there, the senator says. It began when his mother was offered the opportunity to participate as a partner in drilling a well between a dry hole and a gas well. With “the children’s insurance money,”she went in on it, and a very good gas well came in. “As a partner she participated in other wells, and because she had good fortune, she offered her children the opportunity to participate in it.”
Long was elected to the Senate twenty-one years ago. How much has he made from this drilling? “I guess we’re probably ahead, but not by a great deal,” he says. “In drilling and producing we’ve probably made . . . we’re doing ... at least it’s made me conversant with what we’re talking about.”
In 1957 Long defended 27.5 percent in the name of Grandma Jones, the holder of a little bit of stock in an oil company who would lose $5 a year under a proposed reduction ol depletion. Holding forth in the best Louisiana tradition, he declared, “I would like to protect Grandma Jones’s little $20 dividend.”It appears that he is also protecting his own oil income of some sum in excess of $42,500 a year. The oil depletion allowance enriches him personally.
Senator William Proxmire of Wisconsin, vice chairman of the Joint Economic Committee, asked what he thinks about oilman-senators taking part in debates and votes on oil matters, said at once, “Certainly those with oil interests ought to disqualify themselves on the issue.”There is no way to know how many senators this would silence on depletion, since their statements on their holdings are shut from public view in sealed envelopes in the U.S. Comptroller General’s office, but if Proxmire’s opinion were the rule, the chairman of the Senate Finance Gommittee would have to step aside.
Long sees no conflict or impropriety in the situation. “I come from an oil-producing state, and if I was not cooperating with oil against those people who are out after it, I really don’t think I’d be representing my state,” he says. In Louisiana, he says, just about everybody who has much is in oil. It also brings the state 74,000 jobs. “I’ve never heard anybody complaining about someone from a state that produces cotton being interested in cotton"— and the same goes for electronics, or tobacco, he says.
Once he and Senator Eugene Millikin of Colorado were discussing this very subject, Long says, and Millikin told him that anytime he, Millikin, had a financial interest in something “parallel to the best interests” of his own state, he never worried about it. By that doctrine, Long says Millikin told him, the Colorado senator had an interest in shale oil.
Besides, when Long was in state government as an aide to the governor, he says, he helped treble the state severance tax on oil and gas. “I don’t know of any way you coulda raised my taxes more than that.”
He contends, “We just haven’t come down to the thing yet that a legislator has to have no interests or dispose of his outside interests. Theoretically a legislator is not expected to be unprejudiced and unbiased. . . . If someone has a conflict of interest, that’s something that should be considered when he’s up for re-election.”
His argument is not unprecedented. Senator Robert Kerr of Oklahoma, as the second-ranking Democrat on the Finance Committee in the fifties and early sixties, candidly and effectively protected depletion while profiting from it himself. Senator Douglas remembers how Kerr would hunch his chair around to share the head of the committee table with the chairman, Harry Byrd, who was getting old. Kerr parried charges of conflict of interest with the argument that the people of Oklahoma knew he was in the oil business and elected him because they approved of what he was doing.
Kerr and his family owned about a fourth of Kerr-McGee Oil Industries, Incorporated. Records at the Securities and Exchange Commission show that in the seven years before Kerr died, this company paid less than 13 percent income tax on total aggregate profits of $77 million. This was about usual for oil companies at that time. In 1958, for instance, companies producing oil, gas, and the products of these and coal paid 13 or 14 percent federal and state corporate income tax. The effective rate for all industries was 50 percent. With oil and gas paying a third of that paid by other industries, Senator Kerr had something to defend, just as Senator Long does.
In the protection of the industry’s privileges, oil money in elections is even more important than oilmen in high office. One of Congressman Lyndon Johnson’s services to the New Deal was raising money, including Texas oil money, for Democrats running for the U.S. House in 1940. The notoriety of contributions from such Southwestern oil millionaires as H. L. Hunt and the late Roy Cullen cannot rival the ubiquity of contributions, season after season, from the nation’s leading oil families. Only the historically famous slipup involving $2500 shadily offered to a righteous senator prevented a bill to free natural gas from federal price control from becoming law in 1956. Officials of twenty-nine of the largest companies gave (in sums of $500 or more) a recorded $344,997 to Republicans and $14,650 to the Democrats in the 1956 general election campaign. That same year, three family groups whose wealth is associated with oil—the Mellons, Pews, and Rockefellers—contributed $469,554, all of it to Republicans. In the year of the Kennedy-Nixon campaign, officers and directors of the American Petroleum Institute gave Republicans a recorded $113,700 and Democrats $6000; in 1964, a significantly different situation, $98,310 to Republicans and $24,000 to Democrats. And these figures are just the spray from the gusher.
When a man gets roughly half his income taxfree, his idea of common prudence often impels him to invest some of it in the election of his political friends, and usually he can decide who they are by how they vote; but new candidates can be a special problem. In the midst of the intensifying assaults on depletion in the Senate in 19571958, oilmen had more than the usual interest in how the new candidates of 1958, especially the unreliable Democrats, might vote if elected.
One consultant and functionary of the Democratic senatorial campaign committee was dispatched to the West with certain instructions. According to former Senator Douglas, who says she consultant told him the story while the two of them were driving one night from Pullman, Washington, to Lewiston, Iowa, Frank Moss, a county attorney, was running for the U.S. Senate in Utah. The Democratic messenger reached Moss by telephone and said to him, “Judge, would you like $10,000?”
“Would I like $10,000?” Moss exclaimed. Why, it could make the difference between victory and defeat. He could finance two TV programs and probably three on radio, which would mean a great deal in a state like Utah. “Have you got the $10,000?” he asked.
“Well, I’m sorry to say there’s a catch to this. You can have the $10,000, provided you will agree to maintain the 27.5 percent allowance on oil.”
There was a silence on the other end of the line, and then Moss said, “Well, I don’t know. We’ve struck oil in this state. It may be all right. But I don’t know about it. I don’t know about it, and I don’t want to commit myself on something I don’t know about. If the only way to get the $10,000 is to be for something I’m not sure about, I’ll just have to say I won’t accept it.”
The man from Washington said, cursing to himself, “Oh, my God. we’ve got an honest man, and we’re sending him down to defeat.”
He then telephoned a wealthy liberal Democrat in New York and told the story. The Democrat asked the candidate’s name again, and where be was running, and wrote a check for $10,000, with no strings attached. Douglas told this story in Utah and thinks it made the difference: Moss won.
Moss gave his own interestingly different recollection of the incident. “It’s basically correct,” he said. “I do remember this man calling me and saying he could get me some money and that all I would have to do would he for him to be able to assure the donor that I would support the oil depletion allowance when it came before the Senate. . . . He just said. ‘I can get you this money if I can assure them. . ”
Moss says the man did not name the donor, nor does Moss recall a sum being specified. “I have heard him say since that he had tears in his eyes even though he had had to he the conduit for the offer.” the senator adds. Moss has always felt friendly toward the man for going on and helping him in the campaign.
The emissary, who works in Washington now for a union-related group, says the conditional oiler he bore west that year was not just for Moss, hut for a number of senatorial candidates
“I was informed that if I could get some of these fellas out west to express their fealty to the golden principle of 27.5 percent, there might be a pretty good piece of campaign change involved,” he says. Operating out of Los Angeles, “I passed the word to a number of the candidates.” He named, offhand, five of the candidates in whose races he took or sought to take a hand.
Although Senator George Smnthers of Florida was chairman of the Democratic senatorial campaign committee in 1958, Lyndon Johnson ran it, along with Bobby Baker. That year the committee reported expenditures of $319,000.
Who was the donor, or who were the donors, behind the political munificence in 1958? “Oh, that wouldn’t be fair,” the messenger said. And what did the other candidates say? He laughed. “You figure that one out,” he said.
Of the other four candidates he named, one was not elected; another was elected but has since died. A third, Senator Gale McGee (Democrat, Wyoming), who now upholds depletion, says that he recalls no discussion with the man on it nor any contributions from its beneficiaries, who, McGee says, backed bis opponent that year. The fourth, Senator Howard Cannon (Democrat, Nevada), says he “did meet" with the man in 1958, but they definitely did not discuss the depletion allowance. The messenger later said that Moss was the only senator he talked to personally about it.
Senator John Kennedy voted to reduce depletion, but when he ran for President with Johnson on the ticket, he needed campaign money; he equivocated on depletion. As President he proposed certain reforms to increase the industry’s share of the tax burden, but when Senator Williams asked Kennedy’s Treasury Secretary, Douglas Dillon, if 27.5 percent itself should be changed, Dillon replied, “We have studied that matter at some length. We probably have not studied it enough. I do not know how to study it enough.”
Oilmen figured correctly they had little to fear
from Johnson on depletion (everybody understood that, and the debate just died away) . Robert Kennedy was out of the question for the oilmen—they sensed in him an enemy—but Eugene McCarthy’s record was complicated. His first five years in the Senate he voted in committee and on the floor to reduce depletion, but early in 1964 he voted against the same reduction he had supported before. He characterizes his record as always voting for a reduction “when the procedure was orderly or had some chance of success.” There are some reports that he raised $40,000 for his campaign one day at the Houston Petroleum Club. He recalls that the guests were listed as a business group, not oilmen particularly, and says that while contributions may have developed from the meeting, he does not know in what amount or from whom. J. R. Parten, a liberal Houston oilman who supported McCarthy, was present, and it was on this same occasion that Senator Ralph Yarborough of Texas (who votes for depletion on domestic production while criticizing allowing both depletion and huge foreign tax credits on foreign production) became one of the few senators to endorse McCarthy.
Vice President Humphrey was yet another question. Murray Seeger has reported in the Los Angeles Times that when Humphrey’s man refused to assure a group of oil millionaires in the Houston Petroleum Club that Humphrey would support 27.5 percent, they shut their wallets against him. Richard Nixon was still for depletion, like a substantial majority of Republicans in Congress, and his campaign was funded accordingly. Preliminary reports indicate that the Mellons gave the Nixon campaign $215,000 and the Pews, of Sun Oil, contributed 584,000.
The oil industry has three distinct kinds of privileges, or, if you prefer, incentives: proration, import controls, and tax advantages. One of the choice moments during the Hart antitrust committee’s hearings on oil imports last spring occurred in the context of the melancholy amusement of Dr. Blair, the group’s chief economist, that such energetic proponents of free enterprise rely on state intervention to such an extent. Harold McClure, Jr., president of the Independent Petroleum Association of America, was on the stand.
An oil industry program to get a production limitation movement going in the 1920s was aborted when the U.S. Attorney General ruled in 1929 that the plan, advanced in the name of conservation, would be an attempt to win immunity from the antitrust laws. The companies then turned to the states. In 1930 the great East Texas Field came in, leading to overproduction, waste ol oil, and very low oil prices. As W. J. (Jack) Crawford, the tax administrator of Humble Oil, says, “We had to let a president of Humble quit to become governor to establish proration,”that is, production control. Governor Ross Sterling, the former Humble president, ordered state troops into the oilfield to stop all that wasteful free enterprise. According to an oil history subsidized by Jersey Standard, the commander of the troops “had been called away lrom his duties as chief counsel for the Texas Company.”
The system, which is most significant now in Texas and Louisiana, tells producers exactly how much oil, and no more, they may legally produce each month. The total production is in effect what the buyers want to buy. On rare occasions when the state oil agencies have authorized more production than the companies have wanted, the companies have refused to buy the excess. This is called “pipeline proration.”
Control of production entails control of prices to whatever extent the scarcity of the product affects the prices for it. Thus the states and the federal government (which bans “hot oil” in interstate commerce) are acting in effect as the production limitation division of an oil cartel. If the companies did the work themselves they would be violating the antitrust laws. Proration is perhaps the last significant persistence of the early New Deal experiments in the collusion of government and big business to control production and prices.
Officials of the oil states generally insist they do not intend to maintain prices and that their only purpose is conservation. There is general acceptance of the need to protect each owner’s rights in an oil pool and to get the most oil out of it that is technologically feasible. Neither objective, however, entails limiting production to set prices, which is the import and effect of the states’ “market demand proration.”
As a high Jersey Standard official said in 1939, “Price has influenced the proration authorities. . . . The record is so clear that it would be stupid to say it hadn’t. . . . It is quite natural.
When he was chairman of the Texas Railroad Commission, the oil-regulating agency in Texas, William Murray conceded that it the commission dropped oil production way down, the price would go up, and, “If we let the stocks [the above-ground supplies of oil] run up, we would create waste, and you would also break the price.” The companies realized proration was to their interest, he said, and “became the biggest policing agents of all. They even had their own detectives.”
The U.S. proration system, the Senate Small Business Committee concluded in 1949, forms “a perfect pattern of monopolistic control over oil production and the distribution thereof . . . and ultimately the price paid by the public.” A lifelong student of the oil industry, Cornell economist and dean Alfred Kahn, told the Hart committee that as the postwar corporate tax rates increased, skyrocketing the value of the depletion allowance, the industry developed surplus oil that would have lowered prices—except for the sharp production cutbacks which were ordered by the Texas Commission. Instead of falling, U.S. prices rose. Proration. Kahn said, lets the majors “fix their own prices and make them stick.”
Even this system, however, could not by itself have protected U.S. oil prices from cheap Arabian imports in the fifties. The Middle East has about 60 percent of the world’s oil. It flows up the pipes so powerfully out there, the average well produces 5000 or 10,000 barrels a day compared with the average American well’s fourteen barrels a day; it costs only ten or twenty cents a barrel to produce; and it can be delivered to our East Coast for $2, about $1.25 cheaper than U.S. oil. Freely imported, it could sharply reduce the price of U.S. crude oil and everything that comes from it—gasoline, heating fuel, raw materials for the petrochemical industry, and therefore also plastics, tires, sweaters, medicines, antifreeze, detergents, and other things. The fact that this has not happened is not an accident in an open marketplace.
In 1952 the Federal Trade Commission staff reported that seven international oil companies, including the five American giants, constituted an international oil cartel that owned two thirds of the world’s oil. These seven—Jersey, Gulf, Texaco, Standard of California, the firm now called Mobil, and the two foreign-based internationals—limited production, divided up markets, shared territories, and followed a system of pricing that eliminated price differences among themselves to any buyer at any given destination point. So said the staff of the FTC. The pricing system, “Gulf plus,” set all prices at the proration-maintained Texas coast price plus freight. Thus the Texas-based system became the foundation of a world oil cartel.
The great Middle Eastern fields were well known before World War II, but the majors did not produce much from them. During the war, the American firms in Saudi Arabia sold Arabian crude to the U.S. Navy for $1.05 a barrel, although its cost, including royalty, was 41 cents; and thus the postwar pricing pattern was initiated. As the FTC report said, the difference between low-cost Arabian crude and the higher-cost Gulf Coast oil was “intercepted by the major oil companies.”The world market was not as pliable as the U.S. market, and the world price fell relative to rising U.S. prices. The majors’ imports of the cheap Arabian oil into the high-price U.S. market began at the end of the 1940s.
The question was, how much would be too much? At what point might even the U.S. price break? The majors’ interest called for the highest combined profit from their U.S. and foreign sales, kept in a ratio that would not endanger the U.S. price. Meanwhile the domestic producers became concerned that they were losing out in the market to the majors’ increasing interest in the $1.25 profit difference on the imports.
Apart from straight protectionism, the only argument for import controls has been the contention that lower U.S. prices would cause high-cost U.S. producers to quit and exploration in the United States to decline. Oil and gas now provide three fourths of the nation’s energy supply, and visions are conjured of enemies torpedoing our tankers and America “running out of oil” during a national emergency. The traditional protectionist solution would have been a sharp increase in the ten-cents-a-barrel tariff. The Kefauver antitrust committee suggested this, noting that the revenue would become the government’s: Yarborough of Texas proposed 84 cents a barrel but could not get his bill out of committee.
Instead, there somewhat mysteriously appeared, in the 1958 Trade Agreements Act, an authorization for the President to establish mandatory controls over oil imports if he found that they threatened to impair the national security. (They did not have to impair it—the threat was enough.) Majority Leader Johnson had declared the year before that the imports were “an immediate threat to national security.”In 1959, with Robert Anderson presiding over the Treasury, Eisenhower promulgated a mandatory quota program which gave the profit differential not to the government, but to owners of U.S. oil refineries. Importers and the domestic majors were mollified by this one stroke, at once so costly to the government and consumers. The “import tickets" given to the refineries were worth about $1.25 a barrel and have actually become negotiable; they are bought and sold among companies. The oilworker union’s publicity director, Ray Davidson, says they are “just currency issued by the Department of Interior.”Oddball arrangements like the “Brownsville turnaround" for Mexican oil and quota allocations in U.S. territories justified by related social pruposes have contributed to a certain uneasiness among the informed, some of whom have said aloud that it’s a wonder there hasn’t been a scandal.
In 1962 the approved import percentage became 12.2 percent of the demand east of the Rockies, Today about one filth of the nation’s oil consumption is provided by imports. Jersey estimates that in another fifteen years the imports will be meeting about three fourths more of the U.S. demand than they are now.
U.S. independents, who naturally want imports reduced, have been looked upon as the guarantors of competition in the industry, but a certain fatalism about their plight seems to have set in—even in the dens of the Hart committee, where competition is the code word. Economist Henry Steele of the University of Houston told the Hart panel that $2-a-barrel oil in the United States would entail the loss of only 5 percent of U.S. production. Others estimate that such a change might save U.S. consumers between $2 billion and S7 billion a year by forcing down prices. Republican Senator Roman Hruska of Nebraska warned that the more-imports line of the liberals like Senator Philip Hart of Michigan would be “driving all the business into the hands of the majors,” but the antitrusters were not fazed. The newer question among them is whether imports can be increased rapidly enough so that U.S. prices can be reduced. The wishes of the importers are fugitive in words, but have been approximated (by a New York oil investment banker testifying for the industry this spring) as “modest relaxation of the import quotas year by year.”Nothing too sudden, such as Machiasport.
Senators Kenneth and Edmund Muskie of Maine, two leading figures in Democratic presidential politics, have joined their fellow New Englanders in support of an ingenious proposal that would in effect exempt New England from the import controls. The federal government would authorize Occidental Petroleum to import its low-cost crude oil from Libyan fields into a “free trade zone” at Machias port, Maine, refine it in Maine, and sell the products, especially heating oil, at lower prices in New England. Virtually the whole American oil industry opposes this, for it would breach the high price dike.
Washington, one can see, has awakened to the question the majors started worrying about at least twenty years ago: how much is too much, or, to phrase the issue from the consumers’ point of view, why aren’t gasoline prices falling?
An important segment of American industry is also becoming restive. Perhaps there is, as a Houston banker has remarked, a kind of gentleman’s custom in business circles that unless your own interests are directly allocated, you do not criticize another segment of business, but the petrochemicals people believe they are being hurt directly by the import controls. They say the liquid raw materials (called “petroleum feedstock”) on which they soon must rely will cost them 60 percent more than foreign petroleum companies pay, and the U.S. oil industry has been trying to raise the U.S. prices even further. Threatening to build their new plants abroad so they can get the cheaper feedstock, the nine biggest petrochemicals firms have banded together to seek their own exemption front the import program—their own Machiasport, as it were.
John Blair engaged in a revelatory colloquy during the Hart hearings with M. A. Wright, president of Humble and therefore a top official of jersey Standard, of which Humble is the wholly owned domestic subsidiary. Blair presented tacts showing that in the last few years, Jersey has lowered its price for Arabian oil in Japan while the price of gasoline in the United States has gone up four or five cents a gallon. Then:
Blair: Are we to conclude therefrom that at the same time that you were raising the price to the American consumer, your company was reducing the price to foreign buyers?
Wright: You are working in two separate worlds when you speak about what you do in the U.S. compared to what you do abroad, and what you say is exactly night.
Blair said it would seem to weaken, not strengthen, national security to have Americans paying higher prices for their basic materials while foreign competitors get lower prices. Wright said the purpose of the system is our assuring ourselves of an adequate supply of oil within the United States.
“And when we have controls,” Wright added, “we naturally are supporting a price situation. That is true.”
Everything seems to be cohering now in this controversy. Look here, remarked Dean Kahn earlier in the year, the first five companies that raised U.S. oil prices all produce more than 70 percent of their own crude oil, which they also buy from themselves: they are increasing their own profits in their end products. Ah-ha! charged in Proxmire staffer Marty Lobel. Paying themselves more for their own oil, they increase their apparent profit at the producing end so they can claim more depletion!
Instead of deducting all their costs, oilmen can ring up, free of tax, 27.5 percent of their gross income on oil and gas production, up to a limit of 50 percent of their net income from it. In practice this means that in the oil and gas-producing business, between 40 and 50 percent of net profit is tax-free, year after year as long as the production continues. When depletion passed in 1926 the corporation tax rate was 12.5 percent. The impact of the formula was magnified by the World War II rates. Taking the present corporate rate and surtax into account, the effect of the original formula has been quadrupled.
In 1960 the oil industry received 44 percent of its pre-tax income tax-free. The Treasury’s 1958-1960 depletion survey indicated an even higher rate of about 55 percent tax-free, with the realized rate as a percentage of the gross running just a point or two below the 27.5 percent maximum. For these three years, Treasury said, all mineral producers, considered together, claimed as depletion more than 50 percent of their net income from extraction.
The income thus placed beyond the reach of the tax collector has been increasing steadily. Early in World War II the estimate was $80 million—then $200 million. By 1950 it was half a billion; by 1960 $2 billion; by 1962, the Treasury estimates, the total depletion allowances for all minerals were close to S4.5 billion, $2.3 billion of that for oil and gas companies.
Looking at it from the investor’s interest, Fortune (April, 1963) estimated that the thirty largest U.S. oil companies took Si.9 billion in depletion deductions in one year early in this decade. The lop ten companies had $1.5 billion. The estimated one-year tax-free allowance for Texaco was $216 million, for Gulf $228 million, and for Jersey S399 million.
It seems conservative to estimate that depletion will have placed $20 billion of pre-tax oil income beyond the reach oi U.S. income taxation during the 1960s. This means that other taxpayers have forked over an extra $10 billion or so in one decade. The Johnson Administration Treasury Department tax-reform studies of 1968 say the tax loss from depletion is now $1.3 billion a year. If the government doesn’t get the money it needs out of one hide, it has to take it out of another.
Corporations get about nine tenths of all depletion, and naturally the bigger corporations get most of that. One percent of the crude oil and gas and petroleum refining companies got 87 percent of oil’s corporate depletion in 1960—they were the three dozen companies which each had total assets of $100 million or more. The bulk of the companies, 95 percent of them, got just 4 percent of the depletion. They were the twenty-nine hundred companies that each had total assets of less than $10 million.
This is the pattern that gives a sharp edge to former Senator Douglas’ long-standing proposal, now being carried forward by others, to leave the allowance at 27.5 percent for taxpayers making less than $1 million and drop it to 21 percent for those between $1 million and $5 million, but cut it to 15 percent for those making $5 million or more. Very carefully, (for their big brothers really are watching) some of the independents are now explaining in Washington that since the smaller operators are often the high-cost producers, they have a lower net in ratio to gross, and therefore the 50 percent of net limitation should be graduated to carry out the purpose of the Douglas proposal.
Little by little, through analogy but mostly by political tit-for-tat, oil’s percentage depletion has spread into all the natural resources industries. Fearing, perhaps, that water fountains or air conditioners might be next, the Congress has actually specifically excluded “soil, sod, dirt, turf, water, mosses, minerals from seawater, the air, or similar inexhaustible resources.”That tiny concession to 1913 market value, granted because of a court decision, thus gives us a classic example of the selfenlarging capacity of a loophole. Tax-free income is now allowed, at rates ranging from 5 to 23 percent of tine gross but always limited to half the net, in every mining business “from aluminum to zinc"—coal, sulfur, iron ore, uranium, clay, stone, oyster shells, clam shells, even sand. Almost 1500 companies took depletion on sand, gravel, and stone in 1960. Timber gets 130 percent of its operating income exempt from tax. Humble’s Jack Crawford thinks one might well ask why coal gets a to percent allowance when eve have enough coal to last us 1000 years. “Or oysters.” Gulf Oil’s uppermost officials take the more usual industry approach— they warn, or exult, that “any change in the depletion law will affect every extractive industry from gold to gravel.” One is almost grateful that we don’t have diamond mines.
In ordinary industries, capital costs have to be deducted over a period of years. In oil and gas, the costs of dry holes are deductible at once as losses, “even though in the large,” the tax-reform study says, “the expense of nine dry holes is part of the cost of one producer. . . a 90% writeoff in one year is an enormous advantage under a tax rate of 48%.”There is more. If a well comes in, from 75 to 90 percent of the capital costs of drilling and developing it can be and usually are also deducted as they are incurred. These costs are called “intangibles” and include labor, fuel, overhead, land clearing, and in general all costs other than equipment with salvage value. Economist Kahn calls this write-off “clearly a special privilege in every sense.” Expenses similar to intangibles in industries other than natural resources must be capitalized and written off over a number of years. The tax-reform study says the tax loss from the intangibles write-off is $300 million a year.
As Treasury Secretary John Snyder explained in 1950, if 90 percent of the costs of a producing well are recovered tax-free at the outset, only 10 percent of the investment remains to be recovered through depletion; hence depletion based on the entire income in effect overlaps the deductions for intangibles. This leads critics to charge that “a double deduction" is being allowed—“a double benefit,” Stanley Surrey, Johnson’s Treasury tax expert, calls it. Industry people say that two different concepts are involved. Since intangibles are not depletable, the two deductions are mutually exclusive, a California Standard spokesman insisted in 1959.
Oilmen can also, because of intangibles and dry hole deductions, “drill up” their profits in a given year to the extent they find advantageous on their tax returns. As Senator Williams says, a man can make a million dollars and live off the nontaxable depletion allowance “by piling all his other income into intangible investments.”
The effective income tax rate for all manufacturing is 43.3 percent; for petroleum, it is 21.1 percent. Only other mineral industries, lumber, and financial institutions receive comparable consideration, nor do even these figures showing oil paying half the going rate reach the extent of the matter. The tax-reform study says that the 21.1 percent is derived from returns that cover both extractive and nonextractive activities of the oil industry, whereas an integrated company could earn equal amounts from each kind of activity, pay nothing in tax in production and 46 percent of the rest, and show an overall rate of 23 percent.
The industry counterattacks with figures showing that excluding excise taxes, it pays about the same percentage of its gross income in taxes (in the range of 5 percent) as other industry does, “The total impact on your business is the important thing, not the technique for collecting the tax,”says Crawford. By the time Senator Long reaches the end of this line of thought, he is contending that “the oil industry pays more taxes than anyone else.”
In recent years the minerals industry has been making tax use of contrivances called “carve-outs” and “ABC transactions.” Both are based in “production payments,” which are rights that are “sold” to profits from future production from a well or mine. Johnson’s and Nixon’s Treasury people agree that these devices are now costing the United States $200 million a year, and they are spreading. Nixon wants them stopped.
The carve-out works this way. The year the producer sells his “carved-out production payment,” he reports the sale price as income subject to depletion. This lets him make an end run around the 50-percent-of-net limit on depletion by artificially increasing his “income” that year. But then his expenses in later years, to produce the oil he is making the payment with, are deducted from no or reduced income. He is “losing money” for tax purposes. By changing the timing of his income he pays less tax over the period.
A little oil company in the Southwest explained to its stockholders in 1968, concerning its sale ot a $6 million production payment on one of its properties, “This transaction shitted taxable income from 1969 into 1968 and will produce a greater depletion deduction for the two-year period. Representative Sam Gibbons of Florida has explained how a company can operate two equally profitable properties with carve-outs timed to alternate each year so that they wipe OUL each other’s taxes entirely and leave an additional loss to be deducted against income from other sources.
The ABC deal is a complicated and variable three-party transaction. A, the owner, sells his mineral interest to B for a reserved production payment, but then sells the production payment to C. A gets capital gains, B excludes the production payment from his income, and C gets income subject to depletion which is usually enough to eliminate his taxable income.
Atlantic Refining Company and then the merged Atlantic Richfield paid the United States no income tax at all from 1962 through 1967, although its net profits aggregated almost halt a billion dollars. It was this situation that provoked the ranking Republican on Ways and Means, Byrnes of Wisconsin, to say, “Frankly, I no longer know what to write my constituents.”Gibbons said it was rather inconsistent to report half a billion of income to tire SEC and tell the tax collector you didn’t make anything. No one contended it was illegal. The point is, it is legal. What is more, the New York Times has reported that the president of Atlantic Richfield, without a sign of emotion, will argue that the oil depletion allowance should be higher.
The company has recently offered a written explanation of its taxless years to the House Ways and Means Committee. It had acquired the oilproducing properties of two companies through an ABC transaction for $75 million, but one of the two firms’ properties “did not generate taxable income until 1967.” Atlantic also engaged in extensive exploratory efforts that “generated tax losses.”In 1968 it made a small federal tax payment, and this will be increasing now. The company’s big strike on the North Slope proved, the company said, that its program and the related tax incentives “have accomplished what they were intended to do,” The company’s 1968 annual report states $149 million in profits; there had been a stock split in the summer.
Senator Albert Gore, the Tennessee Democrat, and Representative Gibbons have called attention to an ABC transaction whereby Continental Oil Company bought Consolidation Coal, the world’s largest coal company in terms of sales. Under IRS rulings, the net effect was that the oil company paid no income taxes at all on its $460 million of profits from operating the coal company—profits with which it was buying the company—but was permitted to deduct its $128 million in coal-mining costs. The coal company paid no taxes on its income from the sale because it was liquidated under a certain section of the tax code. “I can foresee a situation, not far off,” Gore warned, “when we will no longer have an independent coal industry. We may well have all major energy sources—petroleum, coal, uranium—under the control of a very few powerful corporations.”
On foreign production, U.S. companies can take the U.S. depletion allowance, reducing their potential U.S. tax liability. The Texas Independent Producers and Royalty Owners Association, which flirts with opposing foreign depletion publicly every lew years, has pointed out that it gives majors a great advantage because net profits are so high abroad in relation to the gross. Johnny Mitchell, a past president of TIPRO, wrote the top officers of more than two dozen oil companies proposing that the foreign deduction be whittled down, but T1PRO pulled short of backing him up.
Of probably greater practical significance is the foreign tax credit, which is available to all U.S. firms abroad but is uniquely important in oil because of the high foreign levies on oil companies. Except for long-standing royalties of about 12 percent, U.S. oil companies apply their large payments to foreign governments, dollar for dollar, as offsets against tire remainder of their U.S. taxes due on their foreign income. Usually this cancels out these U.S. taxes.
It is a fair question to ask how much U.S. income tax, on both foreign and domestic profits, is paid by the five international majors that dominate the U.S. industry, Jersey, Texaco, Gulf, Mobil, and California Standard. The answer is that during the five years 1963-1967 these companies paid, on total net profits before income tax of about $21 billion, federal income tax of about billion. Their five-year U.S. income tax rate was 4.9 percent. They paid foreign governments more than five times as much.
Jersey’s five-year rate was 5.2 percent, Texaco’s 2 percent, Gulf’s 8.4 percent, Mobil’s 5.2 percent, and California Standard’s 2.5 percent. On the basis of figures in George Spencer’s U.S. Oil Week, the twenty-three largest refiners in the United States, including the big five, paid in the same period $2 billion U.S. income tax on total earnings before income taxes of $30 billion. The aggregate rate for the twenty-three firms figures out to about 7.2 percent.
Compute these figures up, down, or sideways, they tell a similar story. Backing up the Texaco figures to the beginning of the sixties, the company’s U.S. income tax rate for the first seven years of the Kennedy-Johnson era is 2.1 percent. On pretax income of almost $6 billion in the decade 1958-1967, Gulf paid U.S. income taxes ol a third of a billion, a rate of 5.7 percent. California Standard’s ten-year average is 2.3 percent, Mobil’s 4.4 percent. In 1967, twenty-nine larger oil companies with net pre-tax income of $8 billion paid 8.6 percent U.S. income tax, compared with 20.9 percent which they paid to foreign governments and some states.
The foreign tax credit probably lies behind an interesting inversion in Jersey’s tax patterns since World War II. Through 1953 the federal income tax the company paid as a portion of both U.S. and foreign income was about 16 percent, while its payments to foreign governments averaged another 19 percent of its pre-tax income. In 1954, however, as foreign-earned income came piling in and the foreign tax credit and foreign depletion worked their wonders, Jersey’s U.S. tax payments dropped to 11 percent as its foreign payments turned upward. By 1958 the nation’s largest oil company paid the U.S. Treasury one percent, while it paid foreign governments 40 percent, of its pre-tax income.
For Gulf the turnaround year was 1952. It had been paying about a fourth of its U.S. and foreign pre-tax net to the U.S. Treasury, but the fifteen years from 1953 to 1967, its U.S. income tax on total pre-tax income of about .87.6 billion was less than $400 million. For three straight years in the late 1950s it was less than one percent. While turning over just one twentieth of its pre-tax income to the Treasury since 1953, the company the Mellons built has been paying more than a fourth of it to foreign governments.
This has been the pattern for California Standard, too. For the first nine years of the two decades 1948-1967, its U.S. income tax was five times its payments to foreign governments. In the rest of die period it paid about one seventh the U.S. tax rate it had before, while its rate of foreign government payments increased about threefold.
“I want you to tell me the whole story,”Wilbur Mills said to Humble’s M. A. Wright this spring. “Why is it a company that operates here and abroad can . . . pay an effective tax rate of 1.6 percent on its total tax income?”
The figures showing Jersey’s tax rate at 1.8 percent or some such are quite prejudicial, the reasonable and equable Jack Crawford of Humble says, because first, they imply that other companies are paying the full statutory rate, whereas the investment credit alone can reduce taxes a fourth; second, Jersey, operating in seventy countries and earning half its income from abroad, has many factors applying to its tax rate, including the foreign tax credit; third, including foreign income in the U.S. corporations’ tax rate is “patently unfair,” and fourth, the foreign income tax paid is sometimes not even mentioned.
With a show of emotion evidently unusual for him, Crawford, discussing the situation in his Houston office, exclaims, “All you have to do is convince the man in the street that the oil companies are getting away with murder. ‘I’m paying 30 percent, and Standard Oil of New Jersey is paying 1.8 percent. Those rich bastards!’ ”
Jersey’s domestic subsidiary, Humble, earned $607 million in 1967, 51 percent of Jersey’s total income. As a proportion of its domestic income only, Jersey’s federal tax was about 26 percent. The company told House taxers that the equivalent figure for 1968 is about 30 percent and that its U.S. and foreign income taxes are about 45 percent of its U.S. and foreign income. The Mid-Continent Oil and Gas Association has come up with a similar retort, to wit: eliminating foreign income from the figures, the twenty-one largest refiners paid 19 percent of their income in U.S. taxes in 1966 and 1967; including foreign income and taxes, they paid 37 percent of total income in U.S. and foreign income taxes. But are the majors’ payments to foreign governments taxes, or are they actually royalties paid to the oil-owning governments and therefore ordinary business deductions? The difference is a dollar-for-dollar credit versus a deduction worth 50 cents on the dollar.
“It is an income tax,” says Crawford, Chairman Mills, noting the similarity in the size of the U.S. and foreign levies, agrees. They are “quite clearly royalties,” says Senator Edward Kennedy. “If those same payments were made to the landowners in this country, they would be royalties and would be deducted, not credited.”If a bird looks like a duck and quacks like a duck, you call him a duck, Kennedy said during the Hart hearings. “Someone was very clever in naming this as a tax.”
A U.S. government taxman has acknowledged that in 1948 he briefed Saudi Arabian officials on “the difference of the effect on the [oil] company between a royalty and an income tax.” In 1950 the government of Saudi Arabia levied an income tax for the first time. Subsequently the various foreign oil-owning governments have added what are called taxes of 50, 60, and even 65 percent to their take from the profits of the U.S. firms. The result has been to transfer U.S. income taxes to foreign countries.
Dr. Blair has estimated the tax loss to the United States. Working from income statistics for 1961, he concluded that in five major oil countries abroad, U.S. firms had almost $700 million in foreign taxes available to offset estimated U.S. tax liabilities of more than §500 million, which also resulted in $169 million in excess credits, applicable either against U.S. taxes due on income earned in other foreign nations or to carry back or forward to reduce taxes in other years. Dealing with the payments as royalties instead of taxes would have netted the United States about $175 million.
“The first thing you think about is, is this really a tax or a royalty?” says Nixon’s taxman at the Treasury, Edwin Cohen. The idea that royalties only go up 12.5 percent is a mirage, he says. “We’ve found royalties up to 97 percent.”
Cohen is also interested in the writing oil of intangibles abroad, which lets U.S. firms generate tax losses deductible against U.S. income. The proviso is that they must be reporting to the United States from abroad on a country-by-country basis, but except for Jersey (which has an unusual situation), almost all the companies do. Drilling up on the margin to generate losses, Cohen says, “They never pay anything. We never get any benefit.”
He is considering whether the intangibles writeoff overseas should be prohibited, or the companies required, when they find oil abroad, to restore to the United States the drilling lax losses they claimed earlier. Compared with this issue, he says, foreign depletion is an idle question. “We are subsidizing their foreign exploration and getting nothing in return.” He is also weighing eliminating the country-by-country reporting option and dropping a tax wall between U.S. and foreign income.
The main objections to depletion and other U.S. oil policies now under criticism are that they are unfair to taxpayers and consumers and enhance monopoly trends in the oil industry. The central line of defense is that the national security requires a strong domestic industry, which in turn requires protections and tax advantages. Representative Lloyd Meeds of Washington says. “The salient fact is that the individual must bear the burden of this loss.”Representative Charles A. Vanik of New York estimates that since it was first allowed, depletion has cost about $140 billion, “paid at the expense of almost all of the other taxpayers of the country.”These men are members of the House Ways and Means Committee.
Their theme runs through the debate of the last two decades. Back in 1950 President Truman told of an oil millionaire who raked in $14 million over a five-year period but paid only $80,000 income taxes for the period, about half of one percent, compared to the lowest rate of 20 percent for a single man who earned less than $2000 a year. Senator George Aiken, the Vermont Republican, said in the 1957 debate that others must “dig into their pockets" to make up the money lost by depletion. Now Proxmire says the ordinary taxpayer must wonder why he pays 14, or 16, or 20 percent of his hard-earned money to the federal government when a company like Atlantic Richfield pays nothing whatever.
Another approach to the same point considers what the lost money could have been spent for. Ten billion dollars in the 1960s would buy a lot of model cities, an expanded public-housing program, more scholarships for college students, more war on poverty. A Yale research economist told the House taxers this year that the loss from depletion is three times federal spending on law enforcement, three times the school-lunch and food-stamp programs, six times our spending for public housing, three times the expenditure for the Alliance for Progress.
Then there is the dimension of unfairness to other industry. The IRS reported that in 1964 the petroleum industry reported net income after taxes of $1.7 billion as per the Internal Revenue Code, but $5 billion as per its own books of account. This ratio of 33 percent compared with a ratio of 88 percent for all nonpetroleum manufacturing.
The spread of the depletion privilege into other natural resources can only have contributed to the general cynicism about it. When professional lootball players seriously asked the Senate Finance Committee for a personal depletion allowance, Paul Douglas counter-suggested allowances for movie actors, poets, and mathematicians, all of whom deplete themselves with the passing years. The late Senator Richard Neuberger of Oregon introduced a bill to let any taxpayer deduct one percent of his income for each birthday after he became forty-five on the theory that “a locomotive engineer’s eyes, a schoolteacher’s frayed nerves, a day laborer’s legs, an author’s brain . . . wear out, also. . . . We should have a depletion allowance for people.”
Industry people often express pride that they are selling better gasoline for only slightly more, exclusive of taxes, than in 1926, and they predict that tampering with depletion will result in higher prices. Indignations about depletion are futile to whatever extent a higher corporation oil tax would be passed on to the consumers in prices. However, as Proxmire says, if it could all be passed on, why are the oil people “fighting like tigers"? Senator Williams says: “Yes, if we increase taxes, some of it does siphon down to the consumer, but not all of it.”
Much of the argument for depletion is based on the riskiness of drilling for new oil. Before committees in Washington, oil’s witnesses concentrate on figures showing that such drilling is down, rigs are stacked, oil-field employment is declining.
Gulf’s president, Bob Dorsey, told House taxers this spring, “About one time in ten, those investing in wildcat drilling will find oil, but only about one in fifty has a favorable return on that kind of investment. Yet such investments have been made possible because of . . . percentage depletion.” Senator Mike Monroney of Oklahoma makes the argument vivid: “People simply will not put nickels in slot machines unless there are nickels in the jackpot.”
The often used one-in-ten (or one-in-nine) figure, however, applies to new-field wildcat wells, which make up only a seventh of the wells drilled. The success ratio is higher for every other type of well. The chances are three out of five that any of all the wells drilled will be a producer. The exploratory wells, including those “new-field wildcats,” have two out of five chances of being producers. Three out of four of the development wells, which drain proven fields, are successful.
The majors drill mostly development wells. In 1967, Gulf drilled or participated in drilling 1242 wells, of which 964. were producers. Mobil drilled 397 producers and 133 dry holes. California Standard drilled 533 producers and 159 dry holes. It is the independents who do most of the exploratory drilling, 85 percent of it, says IPAA’s McClure. Yet the depletion allowance goes in overwhelming bulk to the majors, not the independents, and it rewards not discoveries, but pumping oil out of the ground. For a dry hole, you get nothing.
“The oil industry has become a business for investors interested in precalculated expenditures and returns. . . . The little man can’t get in the door anymore,” says Texas independent Johnny Mitchell. Representative Minish says, “Oil has one of the lowest rates of failure in any business in the United States, and two thirds of the depletion allowances are claimed by companies with assets of over a quarter of a billion dollars.”
If oilmen are so venturesome, why do they need subsidies? Representative Bush of Texas has divested himself of his oil holdings, but was in the business for eighteen years. On an NBC program, Representative James Scheuer of New York asked him, “Why should we take the risk out of your oil business? You don’t want us to limit your profit, George, why do you want us to limit your risk?”
“The whole case for the 27.5 percent depletion allowance rests upon national security,” says J. R. Parten of Houston. “We have fueled two world wars, largely out of our oil and gas resources, and in my opinion this would not have been possible without the tax incentives,” depletion and the write-off.
In its statement to Ways and Means this year, Texaco said that the present tax treatment of oil has been one of the most significant factors in developing oil production and reserves essential to the national security and that any action to “impair the present incentives . . . would be to gamble with national security.”
Giving oil every credit to which it is entitled, does the national security argument still hold? The rationale of the import system as well as percentage depletion is based on it.
As Kahn says, “People just say ‘national security,’ and everybody is supposed to turn his tail and run.”Instead, Senator Kennedy began inquiring last spring. “What,” he asked Wright of Humble, “do you consider to be our national security? National security against what? A ground war in Western Europe ... a land war in Asia . . . guerrilla wars. . . ?”
“We’re not thinking about protection from atomic war,” Wright said with candor: “the thing we are endeavoring to guard against is the termination of imports abroad due to political emergencies.” He mentioned strikes, turnover in political parties, and boycotts against shipments to the United States; but that was all. “These kinds of things we want to He able to survive,” avoiding some other country having control over “our economic destiny,” he said.
Senator Long would add the chance of war in the Middle East, and even with Canada. Senator Tower would consider rising Soviet power in the Persian Gulf and the Mediterranean. “We could conceivably get in conventional war with Russia, although I don’t foresee it,” Tower says.
To Proxmire, the national security argument is ridiculous. “Import controls and proration are programs to create an artificial scarcity and high prices.” There is a lot of flexibility, he says, in our need for and supplies of oil. Kennedy, too, asks whether the remote possibility of rationing might he less costly than the present program costing $4 or $5 billion a year.
One is forced to the factual question, how much oil have we and what other fuels could we use? In “proved reserves,” the United States has about 31 billion barrels of oil. At present levels of consumption this is a tenor eleven-year supply. Nuclear war would wipe out the cities where most of the oil is used: people, if any, would be needing drinking water, not oil. What kind of prolonged emergency, then, would require more than a ten-year supply of oil? If this is an awkward question, it is an even more awkward fact that our capacity to refine crude oil now exceeds our capacity to produce it by a million barrels a day.
“Proved reserves” is a concept that excludes known reserves for which available methods of production have not yet been installed. And secondary recovery methods (such as pumping water, gas, or even air into the oil reservoir) are frequently less expensive than discovering new oil. By 1965 one third of domestic oil was produced by such methods. The Interstate Oil Compact Commission estimated in 1966 that our proved reserves could be increased by more than half simply by installing additional equipment for these proved methods, and that more than 60 billion barrels more are probably physically recoverable by newer methods, including injecting steam or hot water into the reservoirs. This increases our actual probable U.S. reserves for emergency needs to about 110 billion barrels, a supply for fifteen to thirty years. And these figures do not include the new finds in Alaska.
Beyond this, other kinds of fuel are available. There are about 2000 billion barrels of shale oil in the West, 80 percent of it owned by the people of the United States, and even the established oil industry increasingly concedes that great quantities of this oil will become commercial!) available. Oil production from tar sands is another newly developing technology. The government is experimenting actively in the hydrogenation of coal into oil. Why, one might ask. has not the oil industry conducted a crash program to open up the fabulous oil shale reserves?
In sum, it is almost impossible plausibly to imagine a national emergency sufficiently prolonged that the United States is cut off from abundant foreign oil. runs out of its own oil, and cannot contrive substitutes. And if this analysis is correct, oil’s main line of defense is chimerical.
However, some of oil’s Washington critics have taken a different tack. As Jerry Cohen, staff director of the Hart committee, says, their idea is to hear out the tale of woe about declining exploratory drilling and shrinking U.S. reserves and then, instead of arguing, agree and ask, “Yes, well—since the policies we have are not working, what shall we change?" Having described the troubles of the industry, Wright found himself saying in effect that it’s really not as bad as all that. “They’re caught in their own trap,” Cohen says.
Other serious challenges to the national security argument of the industry have come from a study conducted for Johnson’s Treasury and finally (after much obfuscation and delay) made public. The CONSAD Research Corporation’s technical study said percentage depletion is “a relatively inefficient method” of encouraging exploration for new reserves—more than 40 percent of depletion is paid for foreign production and nonoperating interests in domestic production. The report concludes in effect that for each $10 in tax benefits, we get only $1 more worth of oil reserves than we would be getting anyway. Wilbur Mills said that despite the industry’s story about depletion and domestic reserves, “Now, we’re not so sure.”
The clamor against depletion is unfair, oil’s defenders say, because it assumes that the companies are making unreasonable profits, and they are not. Oil’s most aggressive counterattack relies upon statistics showing that on the basis of net assets, oil’s profit rate is about the same as that for other manufacturing.
“The oil and gas industry does not make excessive profits,” Texaco’s J. Howard Rambin, Jr., told the House committee. “Studies by the First National City Bank of New York of corporate profits over the twenty-year period, 1949 to 1968, showed that the rate of return on the net assets of the oil and gas industry averaged 12.8 percent, virtually the same as the average for all manufacturing industries.” During the last decade, he said, it was half a point lower than all manufacturing.
Crawford says he assumes that the producing end of the industry is making a greater rate of return than the rest of the industry. “I frankly don’t understand,” he says, “why we don’t make more money than other industries.”But, “if our profits arc out of line, who can say that depletion is not justified?”
The industry’s profits figures distort the realities in some ways. As Douglas pointed out in 1964, they may exclude foreign profits, which are dramatically higher than their domestic profits, liven so, profits are higher in the producing part of the business, to which depletion is solely pertinent, than for the integrated (“downstream”) operations. First National City Bank figures for return on net assets of leading oil companies show a spread of two to five points between these two kinds of income in the last five years. In 1967 die bank’s figures showed integrated operations making 12.7 percent and producing operations making 15.9 percent.
The example of Amerada Petroleum, almost entirely a producing company, is instructive. It had the highest rate of earnings on sales of any of Fortune’s 500 industrials for every one of the eight years 1958 to 1965. By 1967 the foreign tax credit had become a factor for it. and on total pre-tax earnings of $104 million it paid less than $1 million U.S. tax.
There is also the question of the bulkiness of oil’s profits. Jersev now makes $100 million a month.
The New York Times reports on 500 companies in the manufacturing and service industries. For 1967, the 33 oil companies in the 500 companies got more than one third of all the 700 companies’ total earnings.
First National City Bank’s “Monthly Economic Letter" for last April surveyed 2270 manufacturing companies in 41 categories with net income of $26 billion in 1968. Ninety-six oil producing and refining companies had a total net income of $6.1 billion, almost one fourth of the income of all 2250 companies.
Fourteen senators protesting the oil-price increase this year noted that the combined net profits of the twelve largest oil companies had increased by 33 percent in just four years and that each of them has set new profit records for itself in each of the last four years.
Perhaps another part of the explanation of the industry figures lies in the industry’s high relative profit rate as a percentage of sales, instead of assets. As Fortune’s reports show, oil and mining have the lowest sales per dollar of invested capital of any of the industrial groups. Taking Fortune’s listing of the top twenty companies, the seven oil companies had a profit rate as a percentage of sales twice as high as the thirteen that were not oil companies, 10.4 percent to 5.3 percent. (In absolute terms, the one third that were oil companies had total profits that equaled those of the two thirds that were not oil companies.)
It does not seem likely, as Senator Williams has remarked, that the oil industry will have to pass the hat. But to whatever extent it is true that oil’s profits are not, in reality, as high as one would expect under the circumstances, overinvestment may be indicated. Economists of the marginal analysis school in general believe that if there is a prospect of high profit in an area of business and free access to it, capital will flow into it until the prospect for returns declines toward or down to the level for other investment opportunities. It is in fact one of the weightier charges against depletion that it has caused a serious misallocation of economic resources in favor of oil and gas.
Finally, there are some problems of consistency in the industry’s various defenses.
In 1959 Wilbur Mills told a panel on depletion that he worried that foreign depletion was shoring up oil production that might be “taken by somebody else and inure to their defense.” Scott Lambert of California Standard replied that by and large the oil was available to us and helped develop our allies. Yet, Mills rejoined, we encourage the use of American dollars to develop the foreign resources and then “say it is contrary to the national interest for those same reserves to come to the United States.” Lambert retorted, “But we are realizing the benefits fully when these resources are developed by our citizens and sold overseas. We are getting profits.” That hardly put the question to rest.
By rewarding production rather than discovery, depletion encourages the depletion of domestic reserves, contrary to its frequently cited purpose of building them up for national security. The imports reduce the need for U.S. oil and the motive to drill for it. Yet both depletion and imports are defended in the name of national security.
The government in effect puts a floor under oil prices, but as Proxmire says, will not intervene to keep them from rising. Kennedy asks why imports are never increased as a means of offsetting unnecessary price increases.
In 1963, President Kennedy tried for four minor changes in the law affecting oil taxes; he got one, worth about $40 million revenue a year. “So you have reduced the special privilege by two and two thirds percent,” Douglas said to Secretary Dillon. “It is a small percentage,” Dillon said. “A very small percentage,” Douglas said.
Senator Kennedy proposes decreasing depletion to 15 percent for larger companies, eliminating it for the largest foreign producers, ruling out the fast write-off for intangibles, and eliminating the foreign tax credit for what are actually foreign royalties. He would make certain mineral production payments ineligible for capital gains treatment. Senator Abraham Ribicoff of Connecticut wants to stop the intangibles write-off and cut depletion in half.
The political power of oil is the main force at work against such reforms, but there is also a feeling that these subjects are impenetrably complex and nothing can be done with assurance. Yet, as economist Kahn has said, “it seems intolerable to have to decide about everything before deciding about anything.”
Since “market demand proration” and the enforcement of its effects through the Connally “hot oil “ act amount to government price-fixing for oil, such proration should be repealed, leaving actual oil conservation programs intact. Oil imports should be increased rapidly, as by the Machiasport and petrochemical companies’ plans, until the U.S. oil price breaks downward toward the world price. To whatever, if any, extent controls continue to be justified, the “import ticket” system should be replaced by a straight tariff, giving the profit from the controls to the Treasury instead of the refiners.
These changes would help consumers, but hurt the highest-cost U.S. producers. Since these latter include many of the oil people who can be considered small businessmen, tax changes should help the independents and help retard monopoly trends in the industry.
One recurrent sophistry in the defenses of the depletion allowance is a refusal to distinguish between the major companies and the rest of the industry in tax policy. “Today the oil-producing industry is sick and cannot afford the burden of increased taxation.” John Connally, the then Vice President’s sidekick and governor of Texas, told the House tax committee in 1963. There is an international oil industry dominated by five U.S. companies. There is a domestic oil industry, made up of companies varying from huge to small and of many individuals. Tax policy can make these distinctions.
The most notorious of the loopholes, percentage depletion, should be repealed, in gradual steps to ease the pain and facilitate necessary adjustments, but in the end, entirely. As La Follette, Couzens, Roosevelt, Morgenthau, and many others have said, the principle is entirely wrong. Profit from the sale of discovered minerals is income, not capital. Repealing percentage depletion would permit every businessman to continue to take full depreciation or cost depletion on all actual investment. Oil and mineral producers, like other businessmen, would also continue to recover all their operating costs, but then they would have to pay ordinary corporate tax rates. Such a thorough reform would go a long way toward assuring the public that Congress may also do what it should about the exclusion for capital gains, “charitable deductions,”real estate write-offs, the tax “losses" of hobbyistfarmers, and the rest.
But if Congress will not repeal 27.5 percent, it should be graduated or restricted to benefit the independents and small companies that actually do the exploratory drilling. Certainly there is no sense in allowing companies foreign depletion for depleting oil that belongs not to them, but to foreign nations.
The fast intangibles write-off for the minerals industry is simple favoritism and should be stopped, except perhaps again for the drilling and development of wells or mines that are actually discoveries, or else according to a limit on the taxpayer’s taxable income. The use of production payments to wipe out tax obligations obviously should be stopped and probably will be.
Proposals to cut or abolish the foreign tax credit meet the rejoinder that the foreign governments would increase their take from the companies for the difference. As the Economist says of the Middle Eastern governments, these oil-owning nations are getting better and better at “squeezing the oil companies without actually strangling them to death.” The emergence of Arab guerrilla movements is also a factor.
In the alternative, the pre-1918 situation could be restored, whereby the U.S. companies are permitted to deduct their tax payments to foreign governments from their gross income. But the situation is too technical and too honeycombed with competitive effects on many companies in different environments for a simple solution.
As Treasury’s Cohen says, the problem is not which rules to change but just to get a fair quantity of income from U.S. companies operating in the flush foreign oil fields. The write-off for intangibles should be disallowed abroad, and Cohen’s other ideas should be listened to with attention. As it is, the oil companies are administering their own foreign aid program with U.S. money.
And there are deeper issues, still. Nine of the 20 largest industrial corporations in America, ranked by assets, are oil companies. Of the top 10 in profits, 5 are oil. In the last 13 years, 20 oil companies with assets of more than half a billion dollars have acquired 226 other companies and 18,737 gasoline service stations. This, in the national economic context now of the one hundred largest corporations owning nearly half—48 percent—of the nation’s manufacturing assets.
Senator John Carroll, of Colorado, told the Senate during the depletion debate in 1958, “The moral question ... is, Why did Congress enact suc h a tax law? Why has it remained on the statute books through the years? Why does Congress permit these huge tax windfalls?” Robert Engler wrote in The Politics of Oil, “Few questions are asked about this furthering of private wealth and power and its impact upon the American society.”
The tax gifts from politicians are given back to them, in part, as political contributions. Legal or not, this is a kickback to politicians, “I’ll give you tax money assuming that you’ll give me some of it back for my career in politics.” That, making due allowance for every principled exception, is the truth of it.
The nation should be producing its own oil from its naval reserves or offshore. This would give us an independent standard by which to evaluate the performance of the subsidized oil industry. The nation, through a public oil company, should be planning to produce oil for the public treasury from the publicly owned oil-shale reserves in the West. How else can the growing concentration of the industry in a few companies be stopped? How else can the public equities in public property be preserved?
On successive days last April on the Senate floor, two American senators, both Democrats, one from the South, the other from New England, summed all this up, in their very different ways.
“As one who represents a slate producing a good deal of oil,” said Russell Long, “I do feel a sense of compassion for someone who so poorly understands Americans as to think they are corrupt and pirates when they are in fact good, hardworking citizens, trying to make an honest buck, the same as everybody else.”
“The whole matter of quotas of oil importation has developed into a national scandal. It is a scandal,” said John Pastore of Rhode Island the next day. “We in New England, perhaps naively, never really knew the depth and breadth of control that the oil industry had fastened on the government . . . . Can you imagine a company [Texaco] with a net profit of $754 million paying a federal tax which amounts to only 1.9 percent of its before-tax income? . . . the unholy alliance I spoke of before has, in the past, reached to the very highest levels of government . . . this is a time of consumer revolt. This is a time of taxpayer revolt.”
Mr. Dugger, thirty-nine, a graduate of the University of Texas, is publisher and editor-at-large of the Texas Observer, a fortnightly; has reported and written for the Time Inc. magazines, contributed to more than a dozen newspapers, and is the author of two book’s. With a commission from the Atlantic and the help of a Stern Family Fund grant for investigative reporting, Mr. Dugger traveled, researched, and interviewed over a six-month period to collect his facts.