Unconventional production raises unexpected tax questions, forum told

Unconventional oil and gas resource development has raised unexpected taxation questions that potentially could strain federal, state, and local government relationships, a public policy scholar at the Woodrow Wilson Center for International Scholars said.

State governments in particular are considering whether severance taxes need provisions to set money aside strictly to help counties and communities cope with development impacts, or to place a portion in a state-administered investment trust that can’t be raided if plunging commodity prices reduce revenue, said Barry Rabe, who also is a professor at the University of Michigan’s Gerald R. Ford School for Public Policy.

“There are several triggers built deep into tax codes,” he said in a Sept. 1 presentation hosted by the Wilson Center’s Canada Institute. “It’s an unexplored area, but I wouldn’t be surprised to see more of this in the next stage of tax reforms—possibly even reverse triggers to reduce a tax if prices fall very far.”

Severance taxes have a history dating back to before the Civil War, when Texas enacted its first such levy to try and capture revenue during an economic boom for broader public good, Rabe said. They appeal more to Republicans than Democrats because they usually export the taxation impact out of state and away from voters, he said.

“States which tend to be Republican tend to have the highest severance taxes, which often are a substantial portion of their general revenue,” Rabe said. “Texas Gov. Rick Perry has not had to worry much about education funding because of the severance tax’s substantial contribution, and Ohio Gov. John R. Kasich said earlier this year that his state’s tax needs to be raised because the oil and gas industry there is getting off too easily,” he noted.

When states have trouble

Since 2008, states where there previously was little if any oil and gas production had to quickly consider ways to keep new development from tight shales enabled by hydraulic fracturing and horizontal drilling a blessing instead of a curse, Rabe said. States that have not established trust funds tend to get into trouble when a severance tax represents 10-15% of total revenue and commodity prices plunge, he said.

States’ energy trust funds tend to work better than their counterparts overseas because they have to be more transparent and accountable, Rabe said. “States like North Dakota and Colorado started setting funds aside to hire more staff and started returning money to communities,” he said. “When you have a severance tax in a particular region, the state vs. local jurisdiction question emerges. This area hasn’t been looked at much, but it can be every bit as contentious as state vs. federal powers.”

State governments work hard to remain the primary resource tax collectors from production on nonfederal acreage, resisting not just federal efforts to impose levies but also local initiatives aimed at regulating activity, Rabe said.

When then-Pennsylvania Gov. Tom Corbett (R) signed a modest community energy development impact fee into law in early 2012, it included specific conditions communities needed to satisfy before receiving the money, he said. “That first year, seven such communities didn’t receive impact funds,” he said. Corbett also lost his 2014 reelection bid to Democrat Tom Wolf, whose campaign platform included raising the commonwealth’s oil and gas severance tax to help fund education.

More states also are looking hard at which approaches have, or have not, worked elsewhere, he said. “So much of Alaska’s economy is based on citizens receiving their December oil and gas production dividends,” Rabe said. “Those can’t be touched, so the state’s options are severely limited.

Revenue review delayed

“So much money has come into Alberta’s coffers from oil sands production and has gone right out again that there’s little left in its budget,” he said. “That’s why [Premier Rachel Notley] has begun to talk about establishing a trust fund, while the oil revenue review she launched has been delayed.”

He noted that Norway’s trust fund, which many state and national governments consider the most successful, even mentions pensions, which implies providing assistance to senior citizens eventually. “In the US, that would be like partially funding Social Security with oil and gas revenue—which isn’t going to happen anytime soon,” he said.

Rabe said states also are seeing conflicts-of-interest develop within agencies that both collect severance taxes and promote oil and gas development. US Interior Sec. Ken Salazar identified such a conflict within the US Minerals Management Service during US President Barack Obama’s first term, and started restructuring the agency by spinning its revenue collection responsibilities off into a new energy royalties and revenue department elsewhere in the department.

“Almost with the passing of each month, we see a new consequence from shale resource development which was not anticipated,” Rabe said. “Oil trains are a recent dramatic transportation example, with issues that still need to be worked out.”

He also suggested that federal interest in reducing flaring of gas associated with oil production and controlling methane emissions overall potentially could create jurisdictional creep, under which states that previously were primarily responsible will have to demonstrate to Washington that they are making sufficient progress. Tax proposals that are designed to raise money for specific purposes relatively painlessly still attract more support than proposals which contain taxes aimed at influencing consumers’ behavior, Rabe said.

Contact Nick Snow at nicks@pennwell.com.

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