The Political Attraction of Severance Taxes

Published August 3, 2014

As the topic of severance taxes heats up in Pennsylvania and Ohio, it’s worth investigating exactly what severances taxes are and why they are implemented.

When legislators debate severance taxes, it is seldom about making sure localities have enough resources to deal with the increased traffic, and consequent wear and tear on the roads and other public infrastructure, or greater environmental protection enforcement designed to protect the people closest to the impacted area.

More often, the taxes are an estimate of how much money government officials can take from one group, typically job-creators that harvest natural resources, without completely removing their incentives to do business in the state. That makes it possible for politicians to fund their pet projects or popular measures in election years with general-fund monies at the expense of local communities and business owners.

Pennsylvania provides an interesting case because instead of a severance tax, it has an impact fee, which is assessed on every well drilled in the Marcellus Shale formation. The fee is based on natural gas prices and the Consumer Price Index; companies drilling natural-gas wells in 2013 paid the state government $50,000 for each new well.

This fee has brought in $630 million since 2011, with 60 percent of the impact fee revenues staying at the local level, used by counties and towns hosting wells, and the other 40 percent going to fund government agencies involved in regulating well-drilling and to a fund set up to improve infrastructure around the state.

Even though the impact fee has contributed more than half a billion dollars in revenue for local governments, Democrats in the Pennsylvania legislature are now pressing for a severance tax, arguing Pennsylvania is the only major natural gas-producing state in the nation that does not have one. Although this is technically true, this statement makes it seem as if gas companies are not paying their “fair share,” a claim that could not be further from the truth because in addition to the impact fee, the natural gas industry must pay all the normal taxes that other businesses pay.

This includes Pennsylvania’s already second-highest-in-the-nation corporate income tax, royalty payments to state and local governments for drilling on public lands, and income taxes landowners pay on their royalties.

A similar series of events is unfolding in Ohio, where Gov. John Kasich is advocating a 2.75 percent severance tax on oil and gas producers in the state, with 15 percent of the revenue going to local governments and the remainder getting sucked into the state’s general fund. Although these new taxes are supposed to fund a statewide income tax cut, it’s easy to foresee politicians raising the latter again in a couple of years while keeping the new tax on the books. Pennsylvania’s severance tax advocates provide a perfect example of such convenient amnesia.

Hitting up the fossil fuel industry for more money makes for great election-year politics with some constituencies, but it is bad tax policy. Some Ohio legislators are claiming the severance tax would “bring certainty” to oil and gas producers in the state: The one thing those producers can be sure of is that they’ll get rolled again the next time there is a statewide election and politicians are on the lookout for someone to “pay their fair share” to finance out-of-control government spending.

The projected revenue for Ohio, which is estimated at between $34 million and $220 million a year, will create higher costs for job producers that will ultimately be passed along to their consumers, hurting most those who are living paycheck-to-paycheck.

Instead of enforcing a severance tax to pay for projects outside the drilling area, Ohio should adopt a narrowly targeted Pennsylvania-style impact fee that would ensure local governments have enough resources to handle the increased use of local services while allowing businesses to continue to create high-paying, family-supporting jobs.

Isaac Orr ([email protected]) is a research fellow for energy and environmental policy at The Heartland Institute.