Taxing the Environment
Corporate Tax Breaks to Promote Environmental
by Gawain Kripke and Brian Dunkiel
Multinational Monitor magazine, September 1998
The industries most responsible for polluting the environment
and depleting natural resources frequently benefit from special
tax treatment in the United States. In stark contrast, tax benefits
for clean industries are worth billions less than the tax breaks
This coddling of polluters in the tax structure exists alongside
a comprehensive set of federal laws that seek to maintain clean
air, water, and soil and preserve species of plants and animals.
It appears that one hand of government does not know, or has chosen
to ignore, what the other hand is doing.
The industries that benefit from special tax breaks for polluting
activities are diverse and include:
* Chemicals-Polluters can write off almost all the costs of
cleaning up hazardous substances, including lawyer fees. Companies
that spill oil and dump toxic wastes receive this tax subsidy
even when the actions are intentional or the result of gross negligence.
* Mining-The industry enjoys outright tax subsidies for mining
toxic substances such as lead, mercury and asbestos. These subsidies
can exceed the value of the owner's investment in the mine.
* Oil & Gas-The oil and gas industry enjoys the best targeted
tax treatment available to any industry. For example, investors
can write off "passive" losses from oil and gas investments
but not from investments in other industries.
* Agribusiness-The tax code provides tax breaks to huge, chemical-intensive
agriculture without helping small farmers nor promoting sustainable
* Timber-Special tax benefits for the industry drive up profits
but do nothing to promote sustainable forestry. For example, special
rules permit timber companies to deduct capital costs immediately
while other businesses cannot deduct such costs.
At a time when there are no guarantees of government support
for the poor, the young or the infirm, one might ask whether there
should be guarantees of government support for businesses, particularly
those that degrade the natural environment and threaten health.
While federal appropriations provide plenty of "pork"
for polluters, at least these expenditures are subject to annual
review. Typically, they cost millions of dollars. Polluter "pork"
in the tax code, on the other hand, is not subject to annual legislative
action. Once a tax loophole is in law, it is more likely to become
embedded in the tax code than repealed.
GOLD DIGGERS: PERCENTAGE DEPLETION ALLOWANCE
The percentage depletion allowance, first codified early in
1 this century, is based on the idea that as minerals are extracted,
a mine loses value. The percentage depletion allowance permits
mining companies to deduct a certain percentage from their gross
income to reflect the mine's reduced value over time.
However, instead of allowing deductions that reflect the actual
loss of value, the percentage depletion allowance allows mining
companies to deduct a fixed percentage of gross income. The percentages
range from a 22 percent allowance to a 5 percent allowance, depending
on the mineral. For example, clay, sand and gravel receive 10
percent while uranium, sulfur and lead get 22 percent.
This fixed deduction often bears no resemblance to the actual
lost value or to the amount of investment. In fact, the money
that mining companies recoup through this tax subsidy generally
exceeds the total investment in the property.
In other words, the public provides more investment than the
Eliminating the percentage depletion allowance for mining
operations, and requiring mining companies to follow standard
rules for taking deductions, would save $300 million a year, according
to the U.S. Congressional Joint Committee on Taxation.
The subsidy encourages wanton mining-even beyond that warranted
by market demand. The result is more tailings piles, scarred earth,
toxic byproducts and disturbed habitats. Ironically, the more
toxic the mineral, the greater the percentage depletion allowance
subsidy is. Mercury, zinc, uranium, cadmium and asbestos are among
the minerals that receive the highest percentage depletion allowance
while less toxic substances have lower rates.
MONEY FOR MINING: EXPENSING EXPLORATION & DEVELOPMENT
Section 617 of the Internal Revenue Code allows certain costs
associated with the exploration and development of mineral resources
to be deducted in the year the costs are incurred, rather than
over the productive life of the mine. Under normal tax rules that
apply to other businesses, such "capital" costs are
investments in property like buildings or mines that last more
than one year and are written off over time as the property wears
out, or is depleted in the case of a mine. Immediate deduction,
or expensing, allows companies to write off costs of machinery
and equipment faster than they actually wear out. The result is
that tax bills early in the life of the property, or mine, are
lower and consequently save the mining company money.
Eliminating expensing, or immediate write off, for mining
exploration and development costs and special capital gains treatment
for coal and iron ore would save about $20 million annually, according
to the Congressional Joint Committee on Taxation and the Office
of Management and Budget.
Exploration and development costs include site location, determination
of quality and amount of mineral resource, and construction of
shafts and tunnels. Covered minerals include coal, uranium and
hard rock minerals such as lead, gold, copper and asbestos. Congress
enacted immediate write off of mine development costs in 1951
and exploration costs in 1966. In 1982, such expensing for corporations
was limited to 85 percent of costs.
Another tax break for mining companies is Section 631 of the
Internal Revenue Code, which treats the sale of coal and iron
ore as a capital gain. Capital gains are profits reflecting increased
values of stocks, bonds, investment real estate and other "capital,"
or lasting assets. Under normal tax rules, the sale of coal and
iron ore should be treated as ordinary income (e.g. wages, interest),
not capital gains income. It is preferable to have one's income
treated as capital gains rather than ordinary income because the
tax rate on capital gains is lower than the tax rate on ordinary
income for well-to-do taxpayers. This special capital gains treatment
for coal was granted in 1951.
PLAY NOW, PAY LATER: RECLAMATION DEDUCTION
Section 486 of the Internal Revenue Code permits mining ~
companies to deduct reclamation and closing costs immediately
when beginning mining, even though the eventual closing of the
mine and reclamation of the mine site will not occur for some
time. Without this special provision, general tax rules would
require the companies to wait to deduct those costs until the
mine site is closed, restored and the costs associated with these
Section 486 costs taxpayers $40 million a year, according
to the Congressional Joint Committee on Taxation.
The stated intent of the provision, when adopted as part of
the Deficit Reduction Act of 1984, was to encourage companies
to set aside monies for reclamation, but there is no requirement
that actual payment into a reclamation and mine closing trust
fund actually occur. Even companies which never reclaim a mine
can claim the tax break. Reclamation of coal mining sites is required
by the Surface Mining Control and Reclamation Act (SMCRA) of 1977,
but is not well enforced. There is no similar reclamation requirement
for hardrock mineral sites.
Since 1977, there have been more than 6,000 coal mines closed
but not reclaimed. There are more than 550,000 abandoned hardrock
mines. Local governments have the authority to control the nature
of the reclamation or closing activity, but enforcement has been
Closed mines can exact a serious environmental toll. In California,
wastes from one closed mine delivers an average daily dose of
4,800 pounds of iron, 1,466 pounds of zinc, 423 pounds of copper
and 10 pounds of cadmium into the Keswick Reservoir on the Sacramento
River, which serves as the source of drinking water for the town
PUMPING THE TAX CODE: PERCENTAGE DEPLETION ALLOWANCE
Independent oil companies-those oil companies that are not
substantially involved in retailing or refining activities -can
use a special "percentage depletion" method to write
off oil and gas investments. The percentage depletion allowance
allows these oil and gas companies to deduct a flat 15 percent
of their sales revenue, to reflect the declining value of the
wells as they are drained. This flat deduction bears little resemblance
to the actual loss in value over time and the independent oil
and gas companies often end up deducting more than the value of
The annual cost to taxpayers is $480 million, according to
the Joint Committee on Taxation.
Percentage depletion allowances were established by Congress
early in this century. In recent years, Congress has gradually
pared back the subsidy. Nonetheless, the percentage depletion
allowance is still an enormous benefit which serves little purpose
other than subsidizing production from certain oil and gas companies.
BAD TO THE LAST DROP: ENHANCED OIL RECOVERY
Section 43 of the Internal Revenue Code provides for a 15
percent income tax credit for the costs of recovering domestic
oil by a qualified "enhanced-oil-recovery" method. Qualifying
methods involve injecting fluids, gases and other chemicals into
the oil reservoir, and using heat to extract oil that is too viscous
to be extracted by conventional techniques. Costs covered by the
tax credit include the costs of equipment, labor, supplies, repairs
and injectants. The tax credit was adopted in 1990.
In addition, Section 193 allows for expensing, or immediate
write off, of so-called tertiary injectants used in enhanced oil
recovery. Again, as with Section 617's immediate write-off for
mining, investments in enhanced oil recovery methods are "capital"
costs that last more than one year and should be written off over
time as the investment is used up. This provision became law in
Sections 43 and 193 cost taxpayers a combined $60 million
annually, according to the Joint Committee on Taxation.
In general, it is environmentally desirable to extract all
the oil in a well to avoid waste and seepage. That said, much
greater energy savings could be gained by eliminating current
waste in the oil and gas industry.
Today, the oil and gas industry tolerates a degree of energy
waste and pollution that is hard to believe: an energy loss -through
spills, emissions, evaporative loss, venting and flaring, waste
generation, inefficient processing, pipeline and storage tank
leaks-that is equivalent to 1,000 Exxon Valdez oil spills every
year, according to the Friends of the Earth report "Crude
Enhanced oil recovery methods themselves often are bad for
the environment. They force oil and sometimes chemical injectants
into surrounding surface and groundwater, which can lead to contamination
of drinking water, soil, crops and wetlands.
DRILLING FOR DOLLARS: INTANGIBLE DRILLING COSTS
Section 263 of the Internal Revenue Code permits integrated
oil companies such as Exxon and Chevron to immediately deduct
70 percent of intangible drilling costs (IDCs). IDCs are the costs
of wages, fuel, repairs, hauling, supplies and site preparation.
The other 30 percent must be deducted over five years.
Again, under normal tax rules that apply to other businesses,
such "capital" costs should be written off over time
as the property wears out, or oil is depleted.
Smaller, independent oil and gas producers, which are not
involved in retailing or refining activities, can immediately
deduct all of their IDCs. In addition, independent producers enjoy
special treatment of IDCs under the Alternative Minimum Tax (AMT).
The AMT is an alternative tax system that was created to ensure
that profitable businesses do not avoid taxation because of extensive
write-offs. However, in the case of independent oil and gas producers,
the AMT is less effective because write-offs are permitted.
IDCs typically account for 75 to 90 percent of the costs associated
with developing an oil and gas well. When combined with other
tax subsidies, the ability to deduct IDCs effectively reduces
tax rates on oil and gas producers significantly below tax rates
on other industries. Unlike the percentage depletion allowance,
this tax break is largely claimed by corporate producers rather
than smaller. independent producers. Immediate IDC write-offs
cost taxpayers $200 million annually, according to the Joint Committee
on Taxation, and effectively lower income tax rates for oil and
gas companies to zero.
LUCKY LOSER: PASSIVE LOSS
The 1986 Tax Reform Act greatly limited the ability of taxpayers
to use tax shelters- losses, deductions and credits from so-called
"passive" business investments-to offset other income
such as salary or portfolio income (e.g. interest, royalties,
dividends, annuities and gains from the sale of investment property).
Today, investors have to "materially participate" in
a trade or business in order to offset salary and portfolio income
with passive losses. IRS rules say that a taxpayer "materially
participates" in an activity only if he or she is involved
in the operations of the activity on a regular, continuous and
These rules, however, do not apply to oil and gas investments.
Passive losses are still allowed to offset other income in the
case of investors who have a "working interest" in oil
"Working interest" is defined by the existence of
an unlimited and unprotected financial risk proportionate to the
oil and gas investment and is a weaker test than "material
participation." Congress decided that the financial risk
associated with oil and gas investments outweighed the need to
clamp down on tax sheltering.
The "passive loss" tax shelter for investors in
oil and gas costs the treasury $59 million a year, according to
the Office of Management and Budget.
SYN SINS: NONCONVENTIONAL FUEL PRODUCTION CREDIT
A remnant of the $88 billion "synfuel" program under
the Carter administration, Section 29 of the Internal Revenue
Code provides for a production tax credit of $5.75 per barrel
of oil-equivalent for certain types of liquid and gaseous fuels
produced from alternative energy sources. These fuels include
oil produced from shale or tar sands, synthetic fuels produced
from coal, and gas produced from geopressurized brine, Devonian
shale, tight formations, biomass and methane from coalbeds.
The Section 29 production credit applies to facilities "placed
in service" between 1979 and 1993 and may be claimed through
2002. The credit is available for gas produced from biomass and
synthetic fuels produced from coal or lignite until 2007 if the
facility was placed in service by 1996. Although set to expire,
Congress has extended the "placed-in-service" rule three
times since it first enacted the provision.
This provision costs the treasury roughly $1.36 billion a
year, according to the Congressional Joint Committee on Taxation.
In theory, the credit was supposed to lower the costs of producing
nonconventional substitutes for imported petroleum. Instead, the
credit has distorted fuel markets without displacing imports.
With oil prices low and costs of nonconventional fuel production
high, the credit has proven ineffective.
Total production of nonconventional fuels has not increased
since the credit was enacted, according to the Joint Committee
on Taxation. So, in effect, the credit has been a windfall for
a few producers and a waste of taxpayers' money. The generosity
of the credit has spurred coalbed methane production, which has
boomed the expense of conventional natural gas production.
The Section 29 credit has had unintended environmental consequences.
Coalbed methane developers in states such as Colorado, New Mexico,
Wyoming and Alabama have placed a new grid of wells on top of
older fields of abandoned oil and gas wells that have not been
When new methane wells are drilled, the gas moves up the new
wells and can move into underground aquifers and escape through
older oil and gas wells and even water wells. The result of this
gas migration has been polluted drinking water supplies, contaminated
irrigation systems and even explosions.
Maintenance of the credit may be justified in some limited
circumstances. One is for coal beds that are emitting methane
into the atmosphere. When coal beds are opened for mining, methane
escapes. Methane is a powerful greenhouse gas that contributes
to climate change. A "Section 29" well can trap the
methane so that it does not escape into the atmosphere. A similar
situation exists at landfills that emit methane as the rubbish
LOGGING LOOPHOLES: SPECIAL TAX TREATMENT OF TIMBER
Timberland owners and the forest products industry 1 enjoy
special tax benefits, including capital gains treatment of timber
income and expensing, or immediate write off, of capital costs.
Timber income has been treated as capital gains since 1944,
with the benefits mentioned above, of a lower tax rate.
While timber sales are artificially treated as capital gains,
real capital investments-including silvicultural practices after
seedling establishment, disease and pest control, fire protection,
insurance, property taxes, and management- are permitted immediate
deduction. and thus has been taxed less than other kinds of income.
Again, immediate deduction, or expensing, allows companies to
write off costs of machinery and equipment faster than they actually
wear out, or before the timber is harvested.
Unlike other businesses, timber producers are able to deduct
costs before the product, in this case, timber, is sold. This
gives timber producers an interest-free loan from the government
and can effectively reduce their tax rate on investments to zero.
When combined with capital gains treatment, timber receives a
negative tax rate or a net benefit.
These two provisions cost the treasury about $220 million
annually, according to the Joint Committee on Taxation.
These tax benefits are not conditioned on use of sustainable
forestry practices, including replanting a diversity of native
species after harvest, allowing natural reforestation or selective
LOOPHOLE IN THE SKY: TAX OZONE-KILLING CHEMICALS
In 1989, Congress enacted a tax on ozone-depleting chemicals
to provide an economic incentive to reduce production and use
of these destructive substances.
The tax complements international and domestic measures to
reduce and phase out these chemicals.
Ozone-depleting chemicals include chloroflourocarbons (CFCs),
methyl chloroform, carbon tetrachloride, haloes, methyl bromide,
and HCFCs (CFC substitutes). These chemicals are found in various
consumer products and are used in agricultural and industrial
Release of these chemicals into the atmosphere causes damage
to the stratospheric ozone layer which shields the Earth and its
inhabitants from the sun's damaging ultraviolet radiation. Ozone
layer destruction causes increased ultraviolet radiation which
can lead to higher rates of skin cancer and eye diseases such
as cataracts. Radiation may also decrease crop yields, stunt animal
reproduction and cause fast degradation of materials such as plastics,
wood and rubber.
In 1987, more than 120 countries negotiated and agreed to
the Montreal Protocol on Substances that Deplete the Ozone Layer.
While the Protocol called for the phase-out of many ozone-depleting
chemicals, some chemicals such as HCFCs and methyl bromide were
not included in the original agreement.
In 1992, however, parties to the Protocol amended the original
agreement to include HCFCs and methyl bromide. The Protocol requires
industrialized countries to cap methyl bromide production at 1991
levels and to phase out all HCFC production by 2030.
Due to the delay in listing methyl bromide and HCFCs under
the Montreal Protocol, however, these chemicals were not included
when Congress passed the tax on ozone-depleting chemicals. Political
pressure on Congress has worked to ensure that methyl bromide
and HCFCs are kept off the tax list.
Taxing methyl bromide and HCFCs makes good economic sense.
The existing tax has very successfully accelerated the phase-out
of harmful chemicals while at the same time spurred development
of ozone-safe alternatives.
COOKING THE BOOKS: CASH ACCOUNTING
The cash accounting method does not require a farmer to accurately
match expenses to income when paying income taxes. The rules date
back to the early part of this century when the IRS determined
that many farmers were not sophisticated enough to use more complex
bookkeeping procedures that are required of most businesses.
Since 1919, however, farms have become much larger and most
farms are run more like businesses. Today, large agricultural
operations are able to take advantage of cash accounting under
current law, and they are able to significantly reduce their taxes
by manipulating expenses, inventory and income.
Cash accounting is one of a number of special tax breaks and
loopholes that once lured non-farmer investors into agricultural
tax shelters and speculation. This speculation drove up land prices
and caused havoc in the farm economy. According to a 1982 U.S.
Department of Agriculture report, "The Effects of Tax Policy
on American Agriculture," "the tax preference may overstimulate
production and lead to lower product prices, or may cause the
values of limited inputs, such as land, to be bid up." In
general, these tax breaks, and the game-playing they invite, make
it difficult for smaller-scale farming to compete and survive.
In the tax reform of 1986 and subsequently, many of the worst
tax shelters in agriculture were eliminated. However, some, like
cash accounting, survived.
Since, as the 1982 USDA study found, cash accounting tends
to benefit richer farmers, who are able to manipulate the tax
system, it plays a role in the increased concentration of farmland
ownership with high-income farmers and businesses.
PIGS IN A POKE: DAIRY AND LIVESTOCK EXPENSING
Under current law, livestock breeders and dairy producers
enjoy special rules which provide favorable tax treatment for
When their livestock and cattle are sold, the profits are
counted as capital gains income which is taxed at the rate of
28 percent, even if the taxpayer is in a higher tax bracket.
However, the costs of purchasing, breeding and raising the
livestock are not treated as capital investments, but rather as
ordinary expenses. This is the best of both worlds for livestock
and dairy producers. Costs are deducted immediately and income
is taxed at a relatively low capital gains rate rather than as
This inconsistency is highly favorable for dairy livestock
producers and has helped to make cattle and other livestock operations
profitable tax shelter ventures.
Eliminating immediate deduction for costs related to raising
livestock and dairy would raise about $180 million a year, according
to the Joint Committee on Taxation.
UP IN SMOKE: TAX EXEMPT BONDS FOR INCINERATORS
Current law provides a tax exemption for interest income on
state and local bonds used to finance construction of certain
energy facilities. These bonds are classified as "private
activity bonds," instead of government bonds, because individuals
or businesses, rather than the general public, reap a substantial
portion of their benefits. Most private-activity bonds, including
hydroelectric facility bonds, are subject to certain limits set
by each state. However, bonds issued for government-owned solid
waste disposal facilities are not subject to these limits. In
general, the 1986 Tax Reform Act repealed the tax-exempt status
of most bonds used to finance projects with substantial private
involvement due to the fact that they served as tax shelters for
wealthy investors and oftentimes subsidized projects with little
overriding public benefit, such as golf courses. Tax-exempt bonds
for incinerators and a few other private-activity bonds escaped
Subjecting tax-exempt bonds sold to finance incinerators (solid
waste facilities that produce electric energy) to the private-activity
bond annual volume cap would raise about $240 million a year,
according to the Office of Management and Budget.
Incinerators emit harmful levels of highly toxic substances
into the air such as cadmium, mercury and lead. They are the leading
source of dioxin creation in the United States.
CLOAKING PROFITS: PUBLICLY TRADED LIMITED PARTNERSHIPS
Certain "publicly traded limited partnerships" enjoy
tax benefits not available to many other similar business entities.
On the one hand, these partnerships enjoy the advantages of being
treated like corporations in that investors can trade their interests
in public markets and investors have limited financial liability.
_~ On the other hand, they do not pay corporate income tax, essentially
skipping a level of taxation.
In 1987, the Congress changed the law to treat publicly traded
partnerships like corporations for tax purposes.
However, major loopholes remained, including an exemption
for partnerships that are primarily involved in natural resource
development. Thus, publicly traded partnerships involved in mining,
geothermal energy, fertilizer and timber enterprises can continue
to avoid a corporate-level tax while retaining the advantages
of being traded like a corporation.
According to a 1994 report of the House Natural Resources
Committee, this tax loophole can radically reduce tax revenues
For instance, one timber company was reportedly able to reduce
its tax liability from about 59 percent to about 3 percent.
Some companies engaged in natural resource development have
restructured as partnerships to avoid corporate level tax.
SPOILS OF SPILLS: POLLUTION DEDUCTION
Under current law, polluters who cause environmental harm
can fully deduct all the costs related to illegally released pollution,
including cleanup costs, legal costs, court settlements and even
the cost of the polluting substance itself.
For instance, when Exxon's Valdez oil tanker spilled 11 million
gallons of oil into Prince William Sound, nearly all the costs
related to the disaster were deductible. This included all the
costs of litigation, legal settlements, cleanup, studies and public
relations. Exxon settled a criminal case in court with the United
States and the State of Alaska for about $1 billion. However,
except for a paltry $25 million criminal fine, the entire settlement
was tax deductible for Exxon. The value of this deduction is approximately
one third of the settlement, or $300 million.
This situation arises because under tax law, a business may
deduct nearly all the expenses incurred as a matter of conducting
business. The law allows deduction of "ordinary and necessary"
business expenses, and the IRS has been liberal in its interpretation
of this clause. While the vast majority of business expenses are
deductible, Congress has disallowed a deduction for some egregious
or ethically complicated activities. For instance, illegal bribes,
kickbacks, fines, lobbying expenses and political campaign contributions
are not deductible.
Friends of the Earth estimates that disallowing corporate
income tax deductions for future costs associated with illegally
released pollution could save taxpayers at least $300 million
Eliminating the business deduction for illegally released
pollution would reduce the incentive to cut corners or to knowingly
risk dangerous accidents. Currently, the tax code allows costs
such as cleanup for negligent oil spills, intentional dumping
of toxic pollutants and litigation on the illegal filling of wetlands
to be immediately deducted. Ironically, investments in pollution
prevention are not immediately deductible. If, for example, a
company wanted to double-wall a pipeline or make other improvements
to prevent leaks, those costs would likely have to be deducted
over many years. If the pipeline burst and spilled oil into a
river, the company could immediately deduct costs of repair and
Gawain Kripke is director of Economic Campaigns, and Brian
Dunkiel is director of Tax Policy and staff attorney, at Friends
of the Earth. This story is based on the Friends of the Earth
report, "Dirty Little Secrets: Polluters Save While People
Pay; Exposing 15 of the Tax Code's Most Unfair Tax Breaks; 1998
Update." Erich Pica, Dawn Erlandson, Jessica Few and Adam
Van de Water helped research and write the report.