Matsui because it is a question I think that there has been a great deal of confusion over. H.R. 4779 will correct what really is an unfortunate bias in the windfall profits tax, and it was a flaw in the windfall profits tax legislation which created a great deal of inefficient production and prevents a lot of attractive energy products from reaching consumers. What this bill will do will be to correct that problem. I know you know that California is the Nation's fourth largest oil-producing State, and California's potential for even more production in the future is vast because the State has about 20 percent of the proven reserves in the United States. Part of the problem is that those proven reserves are in heavy oil, and the bulk of the heavy oil lies within my congressional district in California. The industry defines "heavy oil" as 20 degrees specific gravity or lessAPI, or less. The Government has defined it as 16 degrees or less. When you get down to around 16 degrees, this oil doesn't flow; it just kind of oozes. And, in fact, in some areas it is so asphaltic that they mine it and haul it away in a truck. You can make a lot of useful products out of it, however, including gasoline. However, to get it to the surface, this heavy oil has to be heated, and you heat it primarily by pumping steam into the ground. And, obviously, to create steam you have to have some kind of energy to convert the water into steam. And therein lies the problem-because the windfall profits tax changed heavy production by inadvertently penalizing producers for using residual fuel oil, one of the least attractive refined products, the bottom of the crude oil barrel. Before the tax was imposed, producers would ship off crude. There were a number of refiners that would do very minimal pulling off of light distillates; then send the residual back. And that would be burned in the boilers. And you had a very nice relationship, which was fairly efficient in using an entire barrel of crude. What happened was that the windfall profits tax imposed a tax on a barrel of crude leaving the property. And since residual had such a narrow margin of profit to it, what happened was that obviously producers now having a new economic reality simply burned the crude in the boilers instead of the residual fuel oil. So we lose those distillates that were otherwise pulled off. Now, what that means is that-for example, the California Energy Commission indicated that as much as one-third of the net heavy oil production is used in thermal-enhanced oil recovery; that is, one-third of the heavy oil brought out of the ground is burned to bring more heavy oil out of the ground. In 1983, that meant about 100,000 barrels of crude were burned. Now, it is enough to lose the valuable petroleum products that would otherwise be obtained, but you have also emission problems because the crude burns dirtier than does residual fuel oil. As you know, our State has very stringent air pollution requirements, and it is simply a more expensive proposition. In addition, if you will just examine some of the crude-for example, in my area, the Kern River crude is about 121⁄2 specific gravity, and that means that we are losing about 11⁄2 million gallons of useful distillates a day. If it is down in the Los Angeles basin, Wilmington crude, about 191⁄2 specific gravity, or 20, that is about, in one day, half a million gallons of gasoline and napthas alone going up in smoke, if you will. A report from the California Division of Oil and Gas, I think, really says it as clearly as we possibly can, and this is the thrust of the legislation entirely: The greatest potential for increasing the net production of heavy oil lies in reducing the amount of crude used to fuel steam generators. Residual fuel oil can be burned in steam generators in lieu of crude oil, resulting in a more energy-efficient operation. Resid yields more heat per barrel than crude oil, and the lighter hydrocarbons in crude oil would not be wasted on steam generation. Until the recent passage of the Windfall Profit Tax Act, burning resid was common practice. Now, however, the tax makes such practices economically prohibitive. What I am trying to do is to turn that around. The bill lets producers offset the windfall profits tax on a barrel of crude for each barrel of resid they use in enhanced recovery, and it would remove the bias created by that windfall tax. I recognize there is no time left in this session for further work on this bill, but I do hope that we can understand that this is not an attempt to circumvent the windfall profits tax; what it is, in fact, is a legislative effort to correct a clear problem that was not foreseen when the windfall profits tax was passed. Mr. Chairman, I thank you very much for this opportunity. [The prepared statement follows:] STATEMENT OF HON. WILLIAM M. THOMAS, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF CALIFORNIA Mr. Chairman, I want to thank you and the other members of the Subcommittee for this opportunity to testify on H.R. 4779. H.R. 4779 is the latest version of legislation on which I have worked since 1981. It will correct an unfortunate bias in the Windfall Profit Tax, a flaw that makes a great deal of oil production inefficient and prevents a lot of attractive energy products from reaching consumers. H.R. 4779 will discourage wasteful use of our crude oil resources. I am sure members of the Subcommittee know that California is the nation's fourth largest oil producing state and of California's vast potential for future oil production; the State has nearly 20% of the proven reserves in the U.S. What many members may not know is that the bulk of California's reserves lie within my congressional district and that most of that crude oil requires special treatment if it is to be produced. Much of California's oil resources are "heavy" crudes, which the industry defines as crude having a specific gravity of 20° or less and which the government has defined as having a specific gravity of 16° or less. Such crudes do not flow: they ooze if they move at all. They can be used to make gasoline or other useful products but they impose difficult burdens on producers. Heavy oil must be heated before production. This is achieved by pumping steam into the surrounding area. Steam generation in turn requires burning some other fuel to create heat. The Windfall Profit Tax changed heavy production by inadvertently penalizing producers for using residual fuel oil, one of the least attractive refined products. Before the tax was imposed, producers bought residual fuel oil, powered steam generators with it, and then shipped crudes off to refineries where useful products like gasoline were extracted. Refineries sold resid back to the producers, creating a fairly efficient use of an entire barrel of crude. The Windfall Profit Tax stopped the practice because the tax is imposed when crude leaves a producing property. Adding the tax to residual fuel oil's cost makes it uneconomic for producers to continue using resid as a primary fuel source. Instead, producers are burning a major part of their daily output in order to create needed steam. As the Windfall Profit Tax does not apply if producers use crude on the property, the oil industry has resorted to crude as a power source. In effect, Congress has forced the oil industry to make decisions on the basis of the tax code rather than economics. The California Energy Commission indicates that as much as one-third of net heavy oil production is used in thermal enhanced oil recovery, and that as much as 9% of total state production disappears into this economic rathole. In 1983, that means almost 99,786 barrels of crude were burned each day. While it is difficult to estimate the loss of refined products with precision because of refineries' differing abilities to handle heavy crudes and because of variations in crudes themselves, we can develop a fairly good picture. Assuming the crude was 12.6° Kern River crude, for example, we lose about 1.4 million gallons of useful distillates each day; 19.4° Wilmington crude's use would cost us over half a million gallons of gasoline and naphthas alone, and as much as 2 million gallons of useful distillates in total. up: A report developed for the California Division of Oil and Gas pretty much sums it "The greatest potential for increasing the net production of heavy oil lies in reducing the amount of crude used to fuel steam generators. Residual fuel oil can be burned in steam generators in lieu of crude oil, resulting in a more energy-efficient operation. Resid yields more heat per barrel than crude oil, and the lighter hydrocarbons (e.g., gasoline, diesel, and naphtha) in crude oil would not be wasted on steam generation. Until the recent passage of the Windfall Profit Tax Act, burning resid was common practice. Now, however, the tax makes such practices economically prohibitive." 1 H.R. 4779 is intended to end this waste. The bill lets producers offset the Windfall Profit Tax on a barrel of crude for each barrel of residual fuel oil they use in an enhanced recovery process. This simple legislation would end the tax's bias and promote more efficient use of our crude resources. The bill is designed to be revenueneutral, as Treasury Department estimates show. I recognize that there is no time left in this session for further work on this bill. I do hope Subcommittee members will work with me next year to secure passage of this legislation, however, and would welcome an opportunity to discuss it further with any of you who might be interested. Chairman STARK. Thank you for your testimony. Mr. SCHULZE. I have no questions, Mr. Chairman. Chairman STARK. Our next witness is the Honorable Mike Lowry, distinguished gentleman from Washington. Without objection, your complete testimony will be made part of the record. Welcome, and we are pleased to have you. You may summarize, or however you wish, do this in approximately 5 minutes that we have allotted to you. STATEMENT OF HON. MIKE LOWRY, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF WASHINGTON Mr. LowRY. Thank you, Mr. Chairman, and members of the committee, for the opportunity to testify. H.R. 1343 is intended to correct an inequity in the Tax Code between mutual savings banks and stock savings banks. As you know, Mr. Chairman, section 593 of the Tax Code provides a deduction for bad debt reserves for certain financial institutions, providing they have a certain amount of their assets in housing-related instruments. But there is an inequity between stock savings banks and mutual savings banks in that, to receive the full benefit of section 593, mutual savings banks must have 72 percent of their assets in housing-related instruments; but stock savings banks must have 82 percent of their assets in housing-related instruments. This bill simply moves the stock savings banks to 72 percent of their assets in housing-related instruments, as is the case with mutual savings banks. That is what it does. I think we can see the 1 William F. Guerard, Jr., "Heavy Oil in California," California Division of Oil and Gas (Sacramento, 1982), p. 10. need for that equity, and I would ask favorable consideration next year. [The prepared statement follows:] STATEMENT OF HON. MIKE LOWRY, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF WASHINGTON Mr. Chairman and Members of the Committee, thank you for giving me this opportunity to comment on H.R. 1343 which I introduced in February of 1983. I would like to commend the Committee for choosing to further consider the wide range of legislative proposals on today's agenda. Put very simply, H.R. 1343 is intended to correct the arbitrary and inequitable distinction in the tax code between mutual savings banks and stock savings banks. A distinction which makes it more difficult for stock savings banks to qualify for favorable tax treatment under Section 593 of the tax code. It is my understanding that correcting this inequity would have negligible revenue impact. For many years Section 593 has granted favorable tax treatment to mutual savings banks through a special deduction for bad debt reserve. Mutual savings banks can claim the full deduction only if at least 72% of their investments are in qualified housing related assets. Both mutual and stock savings and loan associations may also use this deduction, but in contrast, they must meet an 82% qualified assets test. I would ask you to note that all S&L's must meet the same assets test regardless of the form of ownership. Historically, mutual savings banks were required to meet a lower qualified assets test than S&L's because savings banks were organized for different purposes and were granted different powers than S&L's. Until quite recently, savings banks were limited to a mutual form of ownership. In 1980, however, Congress and some States, including Washington State, gave mutual savings banks the authority to convert to stock ownership. In recognition of this new form of ownership, the 1981 Economic Tax Recovery Act, modified section 593 to enable stock savings banks to qualify for the deduction for bad debt reserve provided to other thrifts. Under the 1981 ERTA provision, stock savings banks must meet an 82% qualified assets test rather than the 72% assets test applied to mutual savings banks. H.R. 1343 would correct this discrepancy by treating both mutual and stock savings bank in an identical fashion-both would meet the same 72% test. During debate on ERTA the Senate passed an amendment which would have accomplished the intent of H.R. 1343. Unfortunately this provision was modified in conference at the insistence of the Treasury Department. This discrepancy between stock and mutual savings banks makes no sense. On an arbitrary basis, the ERTA provision provides that stock savings banks be treated like S&L's, not like other savings banks. Stock savings bank must meet the 82% test simply because they converted from mutual to stock ownership. Conversion from mutual to stock ownership does not change the basic characteristics, purposes, or powers of the institution. A tougher assets test for stock savings banks simply serves as a disincentive to conversion. On the other hand, no disincentive was created for S&L's converting from mutual to stock ownership-since, despite different forms of ownership, both types of S&L associations meet identical qualified asset tests. More importantly, however, this disincentive works at cross-purposes with present federal banking policy which has explicitly increased the opportunities for thrift conversion to stock ownership. The reason Congress and individual States have pursued this public policy is to enable the thrift industry to strengthen its capital base and net worth through stock conversions. After several devastating years in which many thrifts have taken a terrible beating due to continued high interest rates, any action to strengthen these institutions is important. Failure to modify section 593 would frustrate the conversion option provided to mutual savings banks under recent changes in banking law. As far as I know, the only objections to this bill have been raised by the Treasury Department. Their objections do not appear to challenge the logic of my bill-that a fundamental inequity exists between stock and mutual savings banks. Instead, Treasury Department "opposes piecemeal changes in Code section 593." Treasury contends that any modifications should be delayed until a comprehensive review of federal policy relating to thrifts is completed. As a member of the House Banking Committee I am intimately familiar with the current controversy surrounding banking legislation. While I share the Treasury Department's enthusiasm for a comprehensive review of our nation's financial serv ices industry-I have learned that no one can be quite sure when that process will be completed. Specifically, I have had no quarrel with the Treasury Department's intention to conduct a review of section 593 due to changes in the asset powers of thrifts. On the other hand, the same factors which have delayed such a review-the continuing frailty of the thrift industry and uncertainty surrounding current legislation—will in all liklihood result in indefinite delay. I do not think it is good policy nor is it fair to continue to deny equitable treatment to a whole class of institutions. Treasury took its initial position on this bill in 1981 and confirmed this position every year since 1981. During that period of time, unfortunately, Congress has been unable to resolve the bigger issues. I think it is time that we took the small step necessary to correct this obvious inequity. Mr. Chairman and Committee members, I urge you to consider this bill promptly and to act favorably on H.R. 1343. Thank you again for this opportunity to air my views on this issue. Chairman STARK. The Chair wants to apologize to the distinguished gentleman for being so tardy in getting around to his bill in this session. And it is one we have discussed, and I am aware of the inequity that exists; and I believe it exists only in the State of Washington. Is that correct? Mr. Lowry. Well, I am told there are only 22 stock savings banks in the entire United States. The State of Washington has quite a few. In fact, some of the stock savings banks, this would not even apply to. So there are very few institutions that I know. Chairman STARK. Any members wish to inquire? Mr. SCHULZE. No questions, Mr. Chairman. Mr. LowRY. Thank you, Mr. Chairman. Chairman STARK. Our next witness is Mikel Rollyson, tax legislative counsel for the Treasury Department, who will be given a free play to romp through the bills that are before us today. And it is my understanding, Mike, that you are going to basically summarize for us whether the Treasury supports, opposes, or is indifferent to each of the bills, and make that a part of the record; and that you do have a rather lengthy tome. And it is also my understanding that you would like to have that appear in the record in its entirety. STATEMENT OF MIKEL M. ROLLYSON, ACTING TAX LEGISLATIVE COUNSEL, DEPARTMENT OF THE TREASURY Mr. ROLLYSON. Yes. I promise not to read the whole thing. I know you have numerous witnesses. Chairman STARK. With that in mind, you may proceed in any manner you desire. Mr. ROLLYSON. I would like to summarize our written statement and keep my oral statement rather short. There are several of these bills which the Treasury does support, and I would like to summarize briefly those that we do support for you. H.R. 2129 relates to the allocation of property taxes among tenant shareholders in housing cooperatives. We believe this bill would result in taxes attributable to the tenant shareholder in housing co-ops being allocated more fairly among those shareholders. And, therefore, we have no objection to that bill. H.R. 2686 would remove an unintended impediment to certain management companies from electing to be treated as business de |