Oklahoma should eliminate tax breaks for the oil and gas industry that are no longer needed and are threatening the state’s fiscal stability by squeezing out resources for schools, roads, public safety, and other keys to long-term economic growth, according to a new issue brief from Oklahoma Policy Institute. Policymakers created the tax exemptions to encourage what were at the time novel, expensive, and risky methods of drilling, but these techniques now are standard practice, making the exemptions unnecessary and counterproductive.
Revenue from oil and gas production is a vital component of the state’s tax system. It provides the funding to educate our children, protect our communities, maintain our transportation grid, and assist those in need. Oklahoma assesses a 7 percent gross production tax on oil and gas extraction, except when prices fall below a certain floor. However, horizontal drilling and deep-well drilling benefit from tax breaks that lower the tax rate to just 1 percent for horizontally-drilled wells and 4 percent for deep wells. The tax breaks can be claimed regardless of the market price of oil and gas and for 48 months after initial production or date of first sale.
The state paid out or accrued $645 million in tax rebates and credits to the industry over the latest 3-year period (FY 2010 – FY 2012). Most of the credits – $537 million – went to producers of horizontal wells. As a growing share of Oklahoma production comes from horizontally-drilled wells, the cost of these credits will continue to grow exponentially in coming years, and could reach $400 million or more annually without legislative action.
Unless Oklahoma lawmakers curb oil and gas tax breaks, their cost is certain to escalate significantly in coming years, seriously threatening Oklahoma’s ability to fund core public services and meet its financial obligations. In a time of scare resources, it is wrong for Oklahoma to make unnecessary tax breaks to energy producers a higher priority than support for schools, health care, and infrastructure.
OK Policy recommends that the Legislature allow all gross production tax preferences to expire on or before their sunset date. Currently, the exemptions for horizontal and deep well drilling are due to expire July 1, 2015, while the other exemptions have a sunset date of July 1, 2014. If lawmakers decide to continue the exemptions or keep them as interim measures until an eventual expiration, they should also adopt the following reforms:
- Provide all drilling subsidies only when prices fall below a reasonable price floor;
- Put an annual cap on gross production tax breaks;
- Tax horizontal drilling at the same rate as horizontal drilling.
The brief contends that gross production tax breaks are not needed to encourage oil and gas production. In particular, we find that:
- State oil and gas tax preferences do not significantly influence the decision to drill. In a survey of Oklahoma oil and gas companies, state tax incentives were ranked as the least important factor affecting drilling decisions, ranking well below estimates of reserves, drilling cost and the commodity price;
- Oil and gas tax preferences are rarely decisive for the profitability of drilling. Even though drilling costs are high, horizontal and deep wells have considerably higher production rates and greater reserves than do vertical wells;
- Companies are unlikely to shift production elsewhere based on tax rates and preferences. Oklahoma will remain an attractive location to drill due to our ample reserves, existing levels of production, skilled workforce, and established infrastructure, with or without tax subsidies.
By eliminating or curtailing its tax preferences for horizontal and deep well drilling, Oklahoma can continue both to allow energy producers to operate profitably and ensure that the state can support the services that enable our families, communities and businesses to prosper.
For the full issue brief and a 1-page summary, click here.