Severance taxes are our most volatile funding source. The severance tax is a specialized form of income tax that is levied when owners sell minerals. Oklahoma levies gross production, or severance taxes, on oil, gas, and other natural products taken from land or water. Since the revenue depends both on the amount of minerals extracted and the price of the minerals, it can vary greatly from year to year. The volatility in prices and production is amplified in Oklahoma by frequent changes in tax rates and incentives.
After falling in the mid-1980s and 1990s, the gross production tax rebounded in the 2000s to again be an important tax source. It raised $1.2 billion in 2008 and accounted for one-tenth of state and local tax revenue. In 2016, though, severance tax revenue was only $331 million, comprising just two percent of all tax revenue. Ranking third among states in 2008, Oklahoma now falls behind eight other states in revenue from severance taxes, according to the U.S. Census Bureau. Lower oil and gas prices and tax cuts explain the reduction in this tax.
Advantages of a severance tax are:
- the mining of minerals depends on state and local services like roads and public safety, therefore it is appropriate that producers contribute a share of the cost;
- since most of the minerals are used out of state, most of the tax ultimately is paid by non-Oklahomans; and
- since there is no property tax on minerals, the only tax paid is when they are mined or pumped; the tax system therefore encourages conservation.
Disadvantages of a severance tax include:
- the volatile nature of markets makes it risky to depend on the revenue from year to year; and
- the tax is not horizontally equitable since non-minerals producers with the same income may pay different taxes.
The severance tax is a percentage of the gross value of the resource. The taxes on natural gas and oil (from 1 to 7 percent of value) are the most important, but Oklahoma also levies taxes on uranium and ores. The gross production tax was first put in place in 1908. Rates were eventually increased to seven percent in 1971. In the later 1990s, lower rates were created for periods of low oil and gas prices. In recent years, the Legislature has created a number of tax rebates and exemptions to encourage and subsidize certain forms of productions, such as horizontally-drilled wells and 3-D seismic shoots. In 2014, the Legislature set the tax rate for most production to two percent for the first 36 months of production and then returning to the full seven percent rate, resulting in hundreds of millions of dollars annually in lost revenue. As part of the historic tax increase enacted in 2018, the initial rate was increased from two to five percent. There also is a 1 percent excise tax on petroleum above the gross production tax.
The revenue from gross production taxes is divided between different levels of government and is different for each tax rate. One percent of all gross production taxes is returned to the counties and schools where the wells are located. Remaining revenue goes to the state. Of this, the first $150 million of oil revenues are divided between three educational funds, with further revenue going to the General Revenue Fund. For natural gas, all state revenue goes to the General Revenue Fund.
Gross production taxes are paid to the Oklahoma Tax Commission monthly by the first purchaser of the minerals, and withheld from the payment to the owner of the mineral rights.