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How to Structure a Severance Tax that is Fair to Pennsylvanians

The Pennsylvania General Assembly is drafting legislation to institute a severance tax on the natural gas extracted from the Marcellus Shale formation. The state budget for Fiscal Year 2010-11 set a deadline of October 1, 2010 for enactment of a severance tax that would take effect in January 2011. No revenue from the tax was included in the final budget agreement.

Why a Severance Tax?

Every state with mineral wealth, except Pennsylvania, imposes a severance tax to compensate residents for the removal of nonrenewable resources. The 14 states with greater production than Pennsylvania, including Texas, Alaska, Wyoming, Louisiana, Arkansas, Oklahoma, and West Virginia, have severance taxes. All have booming extraction industries. Since 2004, production has grown at an average rate of 5.2% per year in these 14 states.

The severance tax is an important source of state revenue to support services such as education, health care, environmental protection, early childhood education, and support for people with disabilities.

During the recent recession, the states with severance taxes fared much better than those without, as relatively high energy prices generated significant tax revenue. The Center on Budget and Policy Priorities notes that North Dakota and Montana were able to avoid budget shortfalls because of revenue from severance and other energy taxes.4

Natural gas severance taxes are typically structured as either a percentage of the sales price or as a fixed rate per thousand cubic feet (MCF) of natural gas, which is reset each year. Some producers in Pennsylvania have expressed a preference for having a fixed rate per MCF that is updated each year, as it may be easier to calculate and is more predictable.

A severance tax in Pennsylvania will generate significant revenue that will grow over time as new wells come into production. At a rate comparable to neighboring West Virginia, a severance tax would raise $71 million in 2010-11 and nearly $400 million per year by 2014-15.
Mineral extraction is a dirty business.

Natural gas drilling creates environmental hazards from a water/sand/chemical cocktail used in the extraction process - known as frac water - and from the gas itself. Well construction requires new roads to be built through pristine areas. Each well drilled requires 800 to 2,000 heavy truck trips to transport giant drilling rigs and water tankers to the site.5 This increased traffic requires frequent road reconstruction and bridge repair. Extraction industries are historically nomadic and boom-like, imposing social costs on rural communities including increased demand for public safety services and rapidly rising housing costs. For these reasons, severance tax revenue is often shared with local governments and set aside for environmental protection and remediation.


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