The Oil Depletion Allowance: The Largest Tax Loophole in American History

The tax code has numerous loopholes in it that reduce tax burdens, as many Americans discovered upon the New York Times report of President Trump’s taxes, which told a tale of tax avoidance. There are, however, not as many as there used to be and the most substantial one was the oil depletion allowance.

In 1913, as the oil industry was starting to grow in the United States, Congress passed as part of the Underwood Tariff a modest oil depletion allowance that permitted a reduction of up to 5% of gross taxable income from an oil well, and this was only based upon the initial value of the property. However, this was expanded in 1926 with a whopping 27.5% reduction of taxable income. This provided a huge incentive for people to buy oil wells, as at most a bust would lose you 10 cents on the dollar if you were in the top 90% in income. Politicians from oil rich states, particularly Louisiana and Texas, were the greatest guardians of this provision, which constituted a massive windfall for oil producers and thus quite a chunk out of potential revenue. Its proponents justified it as being good for the economic growth of the United States as well as important for its defense. Opponents thought the allowance too high and a waste of money at 27.5%. Author Robert Bryce wrote the following about how the allowance operated in practice: “An oilman drills a well that costs $100,000. He finds a reservoir containing $10,000,000 worth of oil. The well produces $1 million worth of oil per year for ten years. In the very first year, thanks to the depletion allowance, the oilman could deduct 27.5 per cent, or $275,000, of that $1 million in income from his taxable income. Thus, in just one year, he’s deducted nearly three times his initial investment. But the depletion allowance continues to pay off. For each of the next nine years, he gets to continue taking the $275,000 depletion deduction. By the end of the tenth year, the oilman has deducted $2.75 million from his taxable income, even though his initial investment was only $100,000” (Spartacus Educational).

The era of Democratic legislative dominance began after the 1930 midterms, and Texas Democrats came to occupy many powerful positions: John Nance Garner was House speaker and then vice president, Sam Rayburn was chair of the Interstate and Foreign Commerce Committee before becoming House speaker for all but four years from 1941 to 1961, Rep. Hatton Sumners chaired the Judiciary Committee until 1947, Rep. Joseph Mansfield chaired the Rivers and Harbors Committee until 1947, Reps. Marvin Jones and later W.R. “Bob” Poage chaired the Agriculture Committee, and Rep. George Mahon would chair Appropriations from 1964 to 1979. Furthermore, Senator Tom Connally was a key ally of President Roosevelt, and in the 1950s, Senate Majority Leader Lyndon B. Johnson was key in preventing any reduction of the Oil Depletion Allowance. Senator Russell B. Long (D-La.), as a member of and from 1966 to 1981 chair of the Senate Finance Committee, was also a key defender. Taking on this giant of a tax break was, as one might gather, a formidable task.

This allowance was frequently capitalized on by wealthy people including Hollywood figures, who may not otherwise have been interested in purchasing oil wells or shares in oil wells. Bob Hope and Bing Crosby had particular success here as “They each paid $40,000 to Monty Moncrief (a successful Texas oilman as well as their golfing partner) for a 25% share in a West Texas venture. For this particular venture, both stars earned $5,000,000 each on their initial $40,000 investment. When the depletion allowance was taken into account, $1,375,000 of the $5,000,000 was tax-free. Other Hollywood stars who experienced similar successes in the oil business included Jimmy Stewart, Gene Autry, Don Ameche and Frank Sinatra, who fittingly titled his first oil well ‘Crooner No. 1.’ ” (Nocera). The oil depletion allowance made oil a practically irresistible investment, as the dividends paid were high and the risk was low as you could deduct losses on the investment from your taxes.

This generous tax break didn’t go unchallenged: Senators Paul Howard Douglas (D-Ill.), William Proxmire (D-Wis.) and John J. Williams (R-Del.) regularly tried to reduce the oil depletion allowance, but were stymied by the political leaders of the day, including President Dwight Eisenhower, Lyndon B. Johnson, and Speaker of the House Sam Rayburn. Although John F. Kennedy had as a senator voted to reduce the allowance, Texas was one of the key states to his victory in 1960, so he needed to tread lightly on the issue. Nevertheless, after Kennedy’s assassination in 1963, conspiracy theorists, such as Barr McClellan, speculated that he was offed partly to protect the allowance on the behest of LBJ. Once Johnson became president, any proposals for reducing the allowance were dead in the water as they would face his veto.

Without President Lyndon B. Johnson on hand to veto, in 1969 the Senate reduced the deduction from 27.5% to 22% in a compromise. In 1975, with an increase of liberals in the House and Senate, the oil depletion allowance was completely removed for companies that produced over 2,000 barrels a day, and gradually reduced for smaller producers until it hit 15% in 1984. This is where the oil depletion allowance stands today, a shadow of its former self.

References

Depletion allowance. Encyclopedia Britannica.

Retrieved from

https://www.britannica.com/topic/depletion-allowance

Nocera, J. (2019, January 30). How a 91% rate sparked the golden age of tax avoidance in 1950s Hollywood. Los Angeles Times.

Retrieved from

https://www.latimes.com/business/la-fi-nocera-tax-avoidance-20190129-story.html

Oil Depletion Allowance. Spartacus Educational.

Retrieved from

https://spartacus-educational.com/JFKoildepletion.htm

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