The cost of tax breaks for oil and gas production in Oklahoma is escalating rapidly. This fiscal year and next, total incentives for oil and gas production in the form of lower tax rates and rebates are projected to exceed $300 million, with the cost of the tax break for horizontal drilling alone expected to be $251 million in FY 2014 and $237 million in FY 2015. As Oklahoma struggles with flat revenue collections and possible budget shortfalls, there has been growing awareness among some state leaders that the favored tax treatment for horizontal drilling in particular, which is taxed at just 1 percent for the first 48 months of production, must be reconsidered.
A new study by Mark Snead and Amy Jones released by the State Chamber of Oklahoma attempts to defend the current tax system and warns against changes that would raise tax rates. The authors suggest that by raising taxes on oil and gas production, “policymakers can expect to trigger a series of incremental negative economic outcomes within the industry and state economy, many of which may be unintended.” They particularly emphasize that other oil-producing states, such as Texas and Louisiana, also “offer exemptions from severance taxes for drilling modern unconventional wells, primarily horizontal well and wells in tight formations.” The clear suggestion is that if Oklahoma curbs its oil and gas incentives, production and the jobs, economic activity, and tax revenue that accompany it will pick up and move elsewhere.
However, while the study makes a persuasive argument for the importance of the energy industry to Oklahoma’s economy, its case against curbing oil and gas incentives has two major shortcomings:
- The study provides only selective data on how Oklahoma’s tax structure compares to other states. The authors assert that “Oklahoma faces tremendous incentives-based competition from other energy-producing states” and then provide selective information on incentives offered in Texas, Louisiana and several “third-tier and emerging” energy states (Arkansas, Mississippi and Pennsylvania). Coming up with a fair apples-to-apples comparison of tax rates across states is extremely difficult because of the different mix of taxes and incentives. But a recent study by Headwaters Economics that looked at all taxes and exemptions was able to calculate an effective rate across states that reflected the average tax on an unconventional well over the first ten years of production. Headwaters found that even if Oklahoma were to eliminate the existing tax breaks for horizontal drilling, its effective tax rate would remain below that of Texas for oil and at the same rate as Texas for gas. While Texas does provide a significant subsidy for high-cost gas (up to 50 percent of drilling and completion costs for 10 years), it also assesses higher ad valorem taxes, as well as an oilfield cleanup regulatory fee and a regulatory tax. Meanwhile, North Dakota, which is enjoying the most robust exploration boom in the Bakken play, has an effective rate of 11.5 percent on oil production, much higher than either Texas or Oklahoma.
- The study provides no data or evidence to suggests that state taxes or tax incentives significantly influence the decision of where companies will drill. Even if it could be shown that by curbing its tax incentives, Oklahoma would have a higher tax rate or less generous incentives than its neighbors and competitors, would this have a detrimental impact on production in the state? The authors pose the question of whether financial incentives matter to the oil and gas industry; the only evidence they can muster is a 2009 survey of Oklahoma energy producers conducted by Prof. Steven Agee that found that close to half of respondents stated that incentives entered into their calculations of whether to drill (however, the survey found incentives to have the least importance of nine possible factors). But as we showed in our 2012 issue brief “Unnecessary and Unaffordable: The Case for Curbing Oklahoma’s Oil and Gas Tax Breaks,” tax incentives will rarely be decisive for the profitability of drilling, and companies are unlikely to shift production because of the presence or absence of tax breaks. With or without subsidies, Oklahoma will remain an attractive location to drill due to our ample reserves, existing levels of production, skilled workforce, and established infrastructure.
The question facing Oklahoma is not whether to support a robust and healthy energy industry. It is whether the state can and should continue to provide among the most generous tax breaks in the nation to subsidize a form of production that is no longer new, risky, or experimental at the expense of our ability to restore funding to our schools, address the staffing crisis in our prisons, meet our obligations to children in foster care, and provide long-awaited services for those with disabilities and mental illness.