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any one sector of the economy is generally much more elastic (responsive to price) than is the economy-wide supply of labor. In particular, there might be large numbers of aliens willing to work in the agricultural sector such that an increase in the cash wages would increase the number of potential workers so that the wage would be bid back down. In such a case, because employers cannot easily substitute capital for labor in the harvest of many crops, the demand for labor may be much less responsive to price than is the supply of labor; thus, the employers would bear the burden of the tax and receive the benefit of exemption from the tax. If exemption from the tax reduces labor costs, as this analysis suggests, the ultimate beneficiaries of the exemption from FUTA tax could be consumers of agricultural products as the cost of bringing goods to market is reduced.

On the other hand, the exemption pertains only to farm workers admitted under certification by the Secretary of Labor that the existing domestic labor supply is inadequate. If the admission of foreign workers is limited in response to the Secretary of Labor's finding, the supply of labor to agriculture may not be as responsive to price as suggested above, and the benefit of the tax exemption may accrue, in part, to the workers in the form of higher wages.

Regardless of the incidence of the tax, some argue that it is unfair to impose FUTA taxes on the labor of workers who generally are not likely to collect unemployment benefits. Proponents of extending the exclusion also argue that temporary agricultural workers generally are not subject to FICA taxes, and therefore should not be subject to FUTA taxes. Opponents of extending the exclusion respond that conformity between FICA taxes and FUTA taxes is not a determinative factor in the imposition of either tax, because they are structured differently and serve different purposes.

6. Tax credit for producing fuel from a nonconventional source (sec. 29 of the Code)

Present Law

Certain fuels produced from "nonconventional sources" and sold to unrelated parties are eligible for an income tax credit equal to $3 (generally adjusted for inflation) per barrel or BTU oil barrel equivalent (sec. 29) (referred to as the "section 29 credit"). Qualified fuels must be produced within the United States. Qualified fuels include:

(1) oil produced from shale and tar sands;

(2) gas produced from geopressured brine, Devonian shale, coal seams, tight formations ("tight sands"), or biomass; and

(3) liquid, gaseous, or solid synthetic fuels produced from coal (including lignite).

In general, the credit is available only with respect to fuels produced from wells drilled or facilities placed in service after December 31, 1979, and before January 1, 1993. An exception extends the January 1, 1993, expiration date for facilities producing gas from biomass and synthetic fuel from coal if the facility producing the fuel is placed in service before January 1, 1997, pursuant to a binding written contract in effect before January 1, 1996.

The credit may be claimed for qualified fuels produced and sold before January 1, 2003 (in the case of nonconventional sources subject to the January 1, 1993 expiration date) or January 1, 2008 (in the case of biomass gas and synthetic fuel facilities eligible for the extension period).

Legislative Background

The nonconventional fuels production credit was originally enacted in the Windfall Profit Tax Act of 1980, with a requirement that the property generally be placed in service before January 1, 1990.

In the Technical and Miscellaneous Revenue Act of 1988, the placed-in-service date was extended for one year, from January 1, 1990, to January 1, 1991. The Omnibus Budget Reconciliation Act of 1990 (“1990 Act") extended the placed-in-service date for two years, to January 1, 1993. Additionally, the 1990 Act extended the credit sunset date so that sales of qualifying fuels occurring before January 1, 2003, would be eligible for the credit.

The 1990 Act also reinstated gas produced from certain tight formations as qualifying for the credit, and repealed the requirement that the price of such gas be regulated.

The expiration date for placing in service facilities producing gas from biomass and synthetic fuels from coal (and for receiving credits for fuels produced at such facilities) was further extended by the Energy Policy Act of 1992 to January 1, 1997, for binding contracts in effect before January 1, 1996.

Analysis

Overview

Subsidizing the development and production of nonconventional fuel sources through the tax code may be justified if the subsidies provide a more socially desirable allocation of economic resources. These desirable outcomes could include a more efficient utilization of natural resources or a more equitable treatment of owners of different, but competing, energy sources. In any case, the revenues foregone through the operation of the tax subsidy are analogous to direct expenditures made to accomplish the same social goals. In general, a comparison of the costs and benefits of a subsidy such as the nonconventional fuels production credit is necessary to determine if the revenue loss caused by the operation of the tax provision is offset by the benefits generated by the credit. In addition, the size of the subsidy provided should be examined to determine if a similar level of social benefits could be generated in a less costly manner.

One justification for the section 29 credit is that the social value of certain domestic oil and gas production exceeds the market value of the recovered fuels. Because this high-social-value energy production competes directly with fuels produced using conventional methods, some suggest that too little of the high-social-value production will take place without a subsidy.22 For instance, national security concerns may dictate that relatively small volume or relatively high-cost domestic reserves of oil and gas be tapped instead of relying on imports of similar fuels from abroad.23 In this way, production subsidized by the nonconventional fuels production credit would supplement domestic reserves of oil and gas that could be recovered using conventional techniques.24

Alternatively, environmental goals such as concerns with venting methane (a greenhouse gas) from coal deposits or landfills into the atmosphere may dictate that these sources of methane be captured and utilized as a fuel (natural gas).25 In this case, the market price of the fuel does not take into account the environmental damage the methane may have caused if released into the atmosphere. A subsidy to producers may be warranted to reflect this social benefit in the firm's total receipts for production of the gas.

An original justification for the nonconventional fuels production credit was to subsidize the development of new alternative technologies to recover oil and gas.26 Because of the ease with which

22 It should be noted that, in addition to the tax credit, nonconventional fuels production receives the same tax incentives (e.g., percentage depletion, the expensing of intangible drilling costs, etc.) as conventional methods of recovering oil and gas as well as the benefit of various direct Federal spending subsidy programs.

23 Under the "national security" argument, the social cost of a fuel such as oil is greater than the market price due to considerations such as the cost of maintaining a strategic petroleum reserve designed to limit the economic dislocation that might be caused by disruptions in markets for these fuels.

24 Note that the nonconventional fuels production credit was enacted in the wake of two substantial rises in the world price for oil. In this context, fuels produced from nonconventional sources reduce the need for imported fuels perhaps leading to a reduced trade deficit or less price variability, and could have been viewed as having social value in excess of their price.

25 While burning methane as a fuel source releases carbon dioxide into the atmosphere, to the extent the methane displaces other fossil fuels, the total amount of carbon dioxide generated remains approximately constant. The net reduction in greenhouse gases results from less methane being released into the atmosphere.

26 Senate Report No. 96-394, 96th Congress, 1st Session, p. 87.

certain recovery technologies can be copied by others in the field, the originator of the technological advance might be unable to capture all the economic benefit from the advance. Viewed in this light, the credit is intended as a spur to technology. By increasing the expected profitability of these projects, the section 29 credit encourages investors to undertake projects that might have been rejected in the absence of the tax subsidy. To the extent that technological advance is spurred by the credit, the benefits of the newly advanced technology should be included with other benefits (and detriments) and this total compared to the revenue cost of the credit to determine if the revenues forgone have been efficiently spent. The relevant legislative history indicates that Congress believed some subsidy was necessary to encourage industries attempting to produce alternative energy sources to permit them to develop to the stage where they could be competitive with conventional fuels.27 It was believed that the information gained from the initial efforts at producing these sources of energy would be of benefit to the entire economy. Apparently, it was not Congress' intent that the credit would become a permanent fixture in the tax law. The credit was designed to apply only for a limited period of time, after which Congress expected "no special incentive will be needed" since over the life of the credit the affected industries should have matured and become competitive even absent a governmental subsidy.28

If it is determined that the subsidized activities have not yet developed into self-sustaining, competitive industries, a decision as to the continuation of the credit as it applies to these fuels may be based on whether or not these producers will ever reach that status. If the production of particular nonconventional fuels will not become competitive in the foreseeable future absent a subsidy, then extending the credit with respect to these fuels would be contrary to the original goals of Congress. On the other hand, if it is anticipated that these fuels will reach a mature and competitive state in the near future, then extension of the credit may be warranted up to the point in time when competitive status is achieved. Continuation of the credit beyond such a point would not comport with the original legislative intent and would provide a competitive advantage for those fuels vis-a-vis competing fuels not qualifying for the credit. With respect to qualifying fuels that have already achieved a competitive posture, a similar analysis should lead to the determination that such fuels should no longer receive the tax credit. Efficiency of the tax credit

As noted above, the amount of the section 29 credit is adjusted for inflation (except for natural gas produced from a tight formation). The credit amount (in 1979 dollars) is $3 per barrel of oil or oil equivalent-defined as the amount of fuel that has a heat content of 5.8 million BTUs. In 1994 dollars, the credit had a value of $5.76 per barrel of oil (or oil equivalent). For natural gas, the 1994 credit figure is $1.04 per thousand cubic feet (mcf).

Tables 2 and 3 present data on the size of the section 29 credit relative to the market prices for oil and natural gas, respectively.

27 Ibid.

28 Ibid.

In constructing these tables, the size of the credit was computed for each year from 1979 to 1994, and then divided by a representative annual average market price for the relevant fuel.29 Tables 2 and 3 indicate the relative size of the incentive to production provided through the credit. While there are substantial year-to-year fluctuations in the relative size of the production incentive, there has been a clear upward trend over the life of the credit. In particular, in 1994, the section 29 credit provided producers with a tax subsidy approximately equal to 44 percent of the average domestic price of oil at the wellhead, and 57 percent of the average market price of natural gas at the wellhead. The increase over time in the relative size of the credit results from the credit being indexed to changes in the overall price level combined with a downward trend in the real (inflation-adjusted) price of oil and natural gas. The data contained in Tables 2 and 3 are summarized in Figure 1.

29 For oil, the average domestic first purchase price was used, and for natural gas the average wellhead price was used as the representative market price. Actual sales price of oil and gas at the wellhead will deviate somewhat from these average figures. In particular, lower quality oil will sell for a lower sales price, meaning the credit will be a greater percentage of price for lower grades of oil qualifying for the credit.

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