From the Archives: I don't need it but I'll take it – Revisiting oil and gas tax breaks

Note: This afternoon, the Task Force for the Study of State Tax Credits and Economic Incentives will be examining gross production tax exemptions. This blog post on the subject initially ran in March 2011.

A recent news report examining proposals to limit the federal tax deduction for charitable giving concluded with a comment that gets to the crux of the debate over tax breaks:

As one donor explained, he doesn’t give to charity to get a deduction — but he’ll take it if it’s there.

It seems as though Oklahoma oil and gas producers think the same way.

State tax breaks ranked last among 10 variables cited by Oklahoma oil industry executives as affecting their decision to drill, according to the findings of  a non-scientific 2008 survey by Oklahoma City University economics professor Steven Agee. However, most producers will gladly take them when they’re there: Agee found that 83 percent of respondents had claimed a gross production tax rebate.

Oil and gas producers justify the tax breaks for various forms of drilling based on the significant risk and costs involved in these forms of production. Yet less than half of respondents said availability of a gross production tax rebate was an influential part of their decision to drill.  Much more important were estimates of recoverable reserves; the geology of the prospect; estimated cost to drill and complete the proposed well; the price of oil and natural gas as shown in the futures market, and the location of the proposed well.   Professor Agee’s study reinforces the idea that tax breaks make a difference only at the margins, motivating  production when the price of the commodity is neither so low as to make drilling unprofitable nor so high as to make drilling profitable regardless of the tax exemption.

When Oklahoma gives tax breaks no matter what the price of oil and gas is — as it does with horizontal and deep well drilling (but not other forms of production) — it invites the suspicion that we are not incentivizing production so much as subsidizing the normal cost of doing business for a powerful and well-connected industry.

As Oklahoma grapples with its prolonged crisis of meeting growing needs with a shortage of revenue, the need to scrutinize all forms of public spending – including spending embedded in the tax code in the form of credits, deductions, rebates and exemptions –assumes renewed urgency. While income tax credits have drawn considerable attention of late from the Attorney General, legislators and others, the state’s system of tax breaks for oil and gas production has received only minimal scrutiny – even as their cost has risen to over $100 million annually.

As a new fact sheet from OK Policy explains, while gross production of oil and gas is normally taxed at seven percent of the price, various types of production are fully or partly exempt from the tax. The most favored treatment is for horizontal drilling and for deep wells drilled below 15,000 feet. These wells are taxed at 1 percent for a period of 48 or 60 months from the date of first sales in the case of deep wells, or from the month of initial production in the case of horizontal wells. Unlike exemptions for several other forms of drilling, which are subject to a price floor of $30 per barrel of oil or $5 per MCF of natural gas, horizontal and deep well drilling exemptions can be claimed regardless of how high the price of oil and gas is.

Producers claimed $83.4 million in rebates from gross production tax on horizontally-drilled wells in FY ’10, the Oklahoma Tax Commission reported.  That’s up from $35.6 two years before.  Rebates for deep well drilling were capped at a $25 million in FY 2010, but under legislation passed last year that cap will be lifted on July 1, 2011, and all deep wells will be taxed at 4 percent. The same legislation also changed how tax breaks for horizontal and deep wells will be paid. Rather than getting a back-end rebate on taxes paid, companies will pay at a lower tax rate up front beginning in July 2013. This concession was provided in return for a two-year deferral in the payment of rebates to help the state through this year’s revenue shortfall.

There are two big problems with these oil and gas subsidies. One, they tilt the playing field against smaller producers that conduct more traditional forms of drilling. Two, they leave the state with fewer resources to invest in education, public safety, health care and other services crucial to future prosperity for all. To more effectively allocate scarce public dollars, the Legislature should restore price floors on horizontal and deep well drilling exemptions, as well as limit the state’s obligations by setting an overall annual cap on the amount of credits.  These measures would provide us some assurance that we are offering incentives that make a difference, not gifts.