The effect of the corporate alternative minimum tax on investment in oil

I.
INTRODUCTION
This paper investigates whether changes in the U.S. corporate income tax made over the last decade may have contributed to the steep decline in U.S. oil and gas exploration activity that occurred during the same decade. The issue arises because oil and gas exploration exhibited a sharp decline following the substantial changes in the U.S. corporate income tax inห้องสมุดไป่ตู้roduced by the 1986 Tax Reform Act, and oil and gas industry spokespersons allege
Firms subject to the AMT may have either a higher or lower cost of capital than firms permanently on the regular tax system. Perhaps surprisingly, this paper also finds that in many circumstances investments are actually favored under the AMT relative to the regular tax system. As a result, the net effect of the AMT provisions on investment incentives can be capricious.
This kind of economic difference is cause for concern . . ..U.S. tax policy that singles out oil companies for adverse tax treatment is inappropriate, potentially detrimental to the economy, and adversely impacts the competitiveness of U.S. oil and gas companies in the world market.. .Reform of the U.S. tax system as it applies to the oil industry is critical. The AMT [alternative minimum tax] should be repealed or substantially reformed, and capital cost recovery rules should be modified. (Oil and Gas Journal 1995)
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VOL. 3/NO. 2/l 998
tax reform. The issue is important because the lower domestic exploration activity will diminish U.S. energy security by increasing reliance on oil imported from foreign countries. Evidence that corporate tax policy contributes to increasing our dependence on foreign sources of oil may prove useful to policymakers and others interested in more fully understanding the economic impact of federal tax policy. The corporate alternative minimum tax (AMT) is the aspect of corporate tax reform that industry spokespersons claim to be responsible for both the decreased level of oil and gas drilling activity and the reduced level of risk that firms would be willing to accept in their oil exploration activity. For example, Victor Beghini, president of Marathon Oil, testified before Congress that [An exploration and developmentproject] if done in the U.K. by a U.K. company would have a net present value 30% higher than that of the project done in the U.S. by a U.S. company.
The Effect of the Corporate Alternative Minimum Tax on Investment in Oil and Gas Exploration and Development
JEFF P. BOONE
Mississippi State University
ABSZ’ RAC~ This paper investigates the assertion that the U.S. corporate alternative minimum tax system diminishes exploration and development investment by U.S. corporations operating in the extractive petroleum industry. The analysis is based on an after-tax investment model in which number of wells drilled and exploration risk are endogenous variables. The model is solved using 1) the values of the relevant tax parameters specified by the tax code and 2) empirical estimates of the non-tax parameters and exogenous variables. The analysis shows that the alternative minimum tax has reduced by 9% the optimal number of exploration wells as compared to the optimal number of exploration wells prior to the introduction of the alternative minimum tax. The analysis also shows that the alternative minimum tax has 1) reduced the optimal level of exploration risk and 2) increased the importance of well-designed incentive compensation agreements for firms operating in the extractive petroleum industry.
that this decline is due to reduced tax incentives for exploration activity that followed from *Direct comspondence to: Jeff P. Boone, Mississippi State University, all MS 39762; Tel: 601/325-1634; E-Mail: jboone@.
P.O. Drawer EF, Mississippi State,
Journal of Energy Finance & Development, Volume 3, Number 2, pages 101-128. CopyrIght 8 1988 by JAI Press Inc. All rights of reproduction in any form reserved ISSN: 1085.7443
The corporate alternative minimum tax (AMT) is a tax system that exists parallel to the regular corporate income tax (RT) with its own tax rates, credits, deductions, and revenues that are often different from those under the RT system. Congress introduced the AMT as part of the Tax Reform Act of 1986 (Public Law 99-514) in an effort to prevent profitable corporations from avoiding the corporate income tax by heavy utilization of tax preferences. Corporate taxpayers calculate their income tax liability under the RT system, again under the AMT system, and pay the greater of the two tax calculations. As compared to the RT system, the AMT system generally adopts a more expansive definition of gross revenues and allows less generous deductions While industry participants apparently believe that the AMT adversely affects incentives to invest in oil and gas exploration and development, this belief is not uniformly supported by research into the investment incentive effects of the AMT. In particular, simulation analysis by Dworin (1987) reports that the AMT impedes investment and induces greater reliance on equity financing, but Lyon (1990) concludes that