Resident Scholar Alan D. Viard

This is the latest twist in a story that began back in 2004. Knowing it had to scrap export subsidies that had run afoul of World Trade Organization rules, Congress decided to replace them with an incentive for domestic production. An easy solution would have been an across-the-board tax reduction for all sectors of the economy. In every sector, after all, producers earn income by selling products that directly or indirectly meet consumer needs.

But Congress decided that some ways of meeting consumer needs were better than others. Manufacturing, construction, agriculture and movie production were good and deserved a tax break. Services, except certain architectural and engineering services, were bad and merited no tax relief. So Congress adopted a tax break for "qualified production" that reflected these distinctions. For activities that make the favored list, tax rates are effectively lower--for example, 32.9% rather than 35% this year.

Handed the thankless task of implementing this tax break, the Internal Revenue Service valiantly produced pages of regulations trying to explain the key distinctions. Brewing coffee at a retail shop doesn't get the tax break, but roasting coffee beans away from the shop does. Manufacturing cars is tax-favored, but customizing them is not. And so on.

Congress put movie production on the tax-favored list, but with one exception. In a nod to virtue, Congress denied the qualified-production tax break to movies that depict performers' actual sexual conduct. To be sure, Congress' moral zeal did not extend as far as one might have thought. Firearms production, tobacco farming and alcohol distilling all made the tax-favored list. And they're still not being targeted, at least for the time being. A tribute perhaps to powerful, and well-funded, lobbies with deep pockets?

Today's target of choice is oil and natural gas production. Last week, the Senate Finance and House Ways and Means committees each approved bills to deny the tax break to oil and gas companies. The Finance Committee bill applies to only the six largest oil and gas producers, while the Ways and Means bill applies to the entire industry. Under both bills, coal mining and other forms of energy production keep the tax break.

At first, it may seem odd that the production of a vital energy resource is being assigned to the same category as adult movies. But explanations are not hard to find.

With high gasoline prices on voters' minds, Democrats are eager to exploit public hostility against "Big Oil," even if it means adopting policies that have nothing to do with lowering prices at the pump. Also, most of the oil industry's political contributions have gone to Republicans. Some Democrats reportedly say it's payback time.

And there's always revenue--$9 billion to $11 billion over the next decade. The bills earmark this money for an array of subsidies for solar, wind, clean coal, conservation and other favored projects.

The only redeeming aspect of the latest development is that it provides an opportunity to rethink the flawed concept behind the qualified-production tax break. Congress should drop the distinction between good and bad production, permitting the market to determine the best ways in which producers can meet consumer needs. The same tax rate should apply to all industries--services and manufacturing, oil and natural gas, and even adult movies.

Congress may have thought it was striking a blow against obscenity when it denied the tax break to adult movies three years ago. But Congress' own manipulation of the tax code has become the real obscenity.

Alan D. Viard is a resident scholar at AEI.