We must end oil and gas tax breaks to save Oklahoma communities

Oklahoma is facing a genuine budget crisis. Our schools, care providers, correctional facilities, judicial system, and other critical functions have absorbed year after year of cuts and are losing the ability to fill their basic missions. The loss of these services threatens the viability of entire communities and the lives of vulnerable children, veterans, and seniors.

This year, we’re facing yet another budget shortfall of between $750 million and $1 billion, but we’ve exhausted many of the one-time revenue sources and budget gimmicks that barely got us through shortfalls in previous years.

To prevent catastrophic cuts and put our finances back on a sustainable course, lawmakers must raise new recurring revenues. Part of the solution needs to include ending tax breaks for the oil and gas industry and restoring the gross production tax to its historical level of 7 percent.

Oklahoma’s average tax rate on oil and gas has plummeted

Oklahoma’s oil and gas industry is a cornerstone of the state’s economic strength, but in recent years, we haven’t asked the industry to contribute their fair share of the cost of public services that all of our businesses and communities depend on. Two decades ago, the Legislature approved special tax breaks to encourage horizontal drilling, which at the time was a new and experimental form of drilling. These subsidies did not cost much at first, but as horizontal drilling became standard industry practice, the cost ballooned into the hundreds of millions annually.

This tax break was set to expire in 2015, and the tax rate on new drilling would have returned to 7 percent, where it had been since the 1970s. But under pressure from the largest energy companies, lawmakers approved legislation in 2014 to keep the rate at just 2 percent for the first three years of all new drills before returning to the basic 7 percent rate. For horizontal wells which account for more than 90 percent of new wells, those first three years cover a large majority of their production — horizontal wells show a 70 percent decline in output after the first 12 to 18 months of production, according to a recent report from Oklahoma’s State Treasurer.

The result has been that the effective tax rate on oil and gas – the average tax rate paid on all production – has fallen almost in half just in the past five years, according to data from the Oklahoma Tax Commission. The effective tax rate on oil was just 3.0 percent in FY 2016 compared to 6.4 percent in FY 2012, while the effective rate on natural gas fell to 3.4 percent from 6.1 percent. So far in FY 2017, the effective tax rate is 3.3 percent on oil and 3.4 percent on gas. In other words, we are collecting less than half the standard 7 percent rate.

The lost revenue from taxing oil and gas less than 7 percent is over $450 million this year and is projected to rise to $513 million in FY 18.  That’s the equivalent of more than half of next year’s budget shortfall.

Oklahoma taxes oil and gas at the lowest rate in the nation

Oklahoma now taxes oil and gas production at rates below any other significant oil and gas producing state. A 2017 study by the Covenant Consulting Group for the State of Idaho found Oklahoma’s effective tax rate of 3.2 percent to be the lowest of nine states, a fraction of that of Texas (8.3 percent), North Dakota (9.4 percent), Montana (9.9 percent), Louisiana (13.3 percent), and Wyoming (13.4 percent). Similarly, a study by Headwaters Economics that calculates the effective tax rate over ten years of a horizontally-drilled well found Oklahoma’s rate on oil to be the lowest of seven peer states and our rate on natural gas to be higher than only Pennsylvania and Louisiana.

[pullquote]A study from the State Chamber of Oklahoma purports to show that Oklahoma’s tax rates are more in line with other states, but that study leaves out the local ad valorem taxes that are levied on production by every state other than Oklahoma.[/pullquote]

Both of these studies looked at both severance and ad valorem taxes to get a full and fair picture of the taxes paid on oil and gas production. By comparison, a  2016 study from the State Chamber of Oklahoma’s Research Foundation purports to show that Oklahoma’s tax rates are more in line with other states. This study was cited in a recent Oklahoman editorial and widely touted by the industry, but it is not a fair comparison because it leaves out the local ad valorem taxes that are levied on production by every state other than Oklahoma.

State taxes are not a major factor in companies’ drilling decisions

Energy groups representing the largest oil companies, including the Oklahoma Oil and Gas Association and Oklahoma Independent Petroleum Association, are vocal opponents of ending the tax break, claiming that increases in Oklahoma’s energy taxes will drive investment out of Oklahoma. But their central arguments don’t hold up.

As we demonstrated at length several years ago, state tax rates and tax breaks are of minor significance in determining companies’ decisions on where and when to drill, and they are rarely decisive for the profitability of drilling. A survey of Oklahoma oil and gas companies found tax incentives to be the least important factor affecting drilling decisions.

After we return to the 7 percent rate, Oklahoma will remain an attractive location to drill due to our ample reserves, existing levels of production, skilled workforce, and established infrastructure. Even if some companies give up their claims here, others will be ready and eager to step in.

It’s time to act

[pullquote]“We believe the oil industry should stand up and agree that returning the oil and gas production tax to its historical level demonstrates our commitment to help solve this serious state budget crisis” – Dewey Bartlett, Jr.[/pullquote]

The Save our State budget released last week by OK Policy and a broad coalition of partners calls for restoring the basic 7 percent tax rate on all production as part of a comprehensive framework to address both the short-term budget crisis and the state’s structural budget deficit. Ending the tax break is expected to generate an additional $470 million by FY 2019. A new  energy industry group, the Oklahoma Energy Producers Alliance, agrees. “We believe the oil industry should stand up and agree that returning the oil and gas production tax to its historical level demonstrates our commitment to help solve this serious state budget crisis,” said Dewey Bartlett Jr., former Tulsa mayor and president of Keener Oil and Gas. They have recognized that the energy industry suffers along with all of us when we cannot make basic investments in good public education, infrastructure, and public safety.

The Legislature has already acted this session to end tax breaks benefiting wind producers, declaring that tax incentives had served their purpose and the state could no longer afford to subsidize wind production. Those same principles should apply to our much larger tax breaks for oil and gas. The future of our communities depends on ending the unnecessary and unaffordable special deals subsidizing oil and gas companies.