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Taxing Fracking: Proposals for Ohio’s severance tax

This report explores how revenue from a fracking tax could bolster vital public services if it is not used to finance income tax cuts that would mostly benefit wealthy Ohioans, as Gov. John Kasich has proposed. The Ohio General Assembly should consider an adequate tax on oil and gas extraction to help restore local jobs, schools and services and assist communities impacted by drilling.

Executive summary

The Kasich Administration has proposed strengthening the severance tax, but the General Assembly won’t have the debate. Job losses mount and local economies falter as the result of billions cut in the state budget. There is urgent need to raise revenues to restore jobs and services and help impacted communities with up-front costs of drilling. Every day the oil and gas extracted from Ohio’s land will never be replaced, yet legislators are not even talking about keeping a share of that value to build opportunity for Ohio’s future.

Current severance tax

Ohio’s severance taxes are among the lowest of all energy states. Regardless of the price for a barrel of oil, the driller pays a dime per barrel for the severance tax and another dime in a conservation fee. Whether oil is selling for $35 or $150 per barrel, Ohio is getting just 20 cents. The severance tax on natural gas is also low, at 3 cents (including a half-cent conservation fee) per thousand cubic feet (mcf). Whether natural gas is selling for $10.00 or $2.28 per mcf, Ohio is getting just 3 cents.

Kasich’s proposal

Gov. John Kasich proposes raising rates on fracked oil and natural gas liquids to 4 percent with a tax break that lowers it to 1.5 percent for up to 24 months. Fracked dry gas would be taxed at 1 percent. A small share of the revenues – no more than what would be raised at today’s low rates – would be used for oversight and regulation of the industry. The rest would be given back in income tax cuts.

Rates should be higher

Kasich’s proposal could raise up to a billion dollars over four years. A 5 percent severance tax rate (on all production, no loopholes) could generate up to $1.8 billion over the same time period. An additional 2.5 percent could raise another $900 million. None of this is enough to restore the nearly $2 billion cut from Ohio’s K-12 schools and the $1 billion cut from communities for services ranging from pothole repair to senior centers. But a severance tax at 5 percent or 7.5 percent could start to restore jobs and investment in local communities and local services.

Tax loopholes should be eliminated

Kasich’s proposal includes tax loopholes that allow frackers to recover the costs of drilling. The tax break lowers the severance tax rate on oil and natural gas liquids for the first year, and up to another 12 months, from 4 percent to 1.5 percent. This loophole may cost as much as $603 million over four years.

Tax cuts are the wrong use

The state has lost 275,000 jobs since 2005, when the Ohio legislature cut the state income tax by more than 20 percent. Kasich proposes using severance tax revenues for further income tax cuts, an approach that has not created jobs in the past. Furthermore, most families won’t benefit from Kasich’s proposed tax cuts, which would average only $42 for median-income Ohioans, but would give $2,300 to the top 1 percent, those averaging incomes of $321,000 a year. Revenues should be used instead to keep cops on the beat, firehouses open, teachers in the classroom and to maintain vital services that families depend on, like senior centers, community mental health, trash pick-up, clean water and pothole repair.

Local communities impacted by drilling face a treadmill of costs

The Kasich proposal for local impact fees would require well owners to make an up-front payment of $25,000 (based on estimates of needs related to roads) but would require that fee to be paid back.  This ignores not only many costs associated with drilling activity, which range from roads to health care, schools, emergency services, and waste disposal, but also the recurrence of drilling impacts related to repeated well stimulation. Horizontal drilling has unusual costs that recur as the well is stimulated over and over: swarms of workers, truckloads of supplies, well preparation, wastewater disposal or recycling. The “treadmill” of drilling and fracking activity means heightened and more continuous industrial impacts on rural infrastructure and stress on community services. As a result, communities impacted by drilling will need resources on an ongoing basis. The severance tax is the tool of public finance used to assist impacted communities in states with significant energy production. For example, Colorado provides 63 percent of its severance tax to local government.  Montana provides 39 percent; North Dakota, 11 percent; Wyoming, 35 percent.

Drillers are going to drill if the resource is there

The oil and gas industry is vociferous in opposition to Kasich’s proposal. But imposition of the tax won’t discourage oil companies that have spent billions on land leases. The leases already create a contractual obligation to drill. Leases expire after three to five years and although they may be renewed, there is a cost to renewal.

Recommendations

  1. The tax rate on all oil and gas needs to be higher than 4 percent. A 5 percent severance tax rate would help restore local jobs, schools and services and assist impacted communities. An additional 2.5 percent should be used to create a permanent fund dedicated to economic recovery from the drilling and to provide for environmental risk.
  2. There should be no tax breaks. Loopholes for cost recovery such as those in Kasich’s proposal were first used as horizontal drilling and pressurized extraction were under development.  Other states have such breaks, but they reflect years of legislative fights that oil company lobbyists won. There is no reason to adopt the outcomes of those battles in a new tax structure in Ohio.
  3. All production from the well – dry gas, wet gas and oil – should be taxed at the same rate. Natural gas may be low in cost now, but it has been high in the recent past. The proposed severance tax fee is based on percentage, so when taxation falls with market value.
  4. Funds should not be used for tax cuts.  Revenues should be used to restore services, help local communities with drilling costs and start building a diversified economy when wells run dry.

Introduction

The severance tax is used to ensure that the wealth of the land, mined and sold by private interests, provides lasting benefits to the people of a region or state. As oil and gas drilling expands in Ohio, Gov. John Kasich has proposed boosting the severance tax, a good idea. However, the proposed rates are too low; tax breaks would erode collections yet don’t interest a defiant industry; and the complexity mirrors states where energy taxes have been distorted by decades of legislative wrangling. There’s much to debate, but Ohio’s House of Representatives, reluctant to even talk about taxes, stripped the proposal from the budget bill it passed in April and sent over to the Senate.

Last year’s budget cuts undermined the economic recovery by causing thousands of layoffs in schools and local government. An adequate severance tax could help restore jobs, lower class size, open closed senior centers and turn streetlights back on. But even if the legislature would consider it, Kasich wants to use the money for more tax cuts, and tax cuts that favor the wealthy – again. Middle-income households would get an average of just $42 per year under the Kasich proposal; wealthy households averaging $321,000 in income would get $2,300.[1]

Adequate taxation of mineral wealth is a responsible recommendation the legislature should embrace, the sooner, the better. A natural resource boom doesn’t last. A severance tax provides for the present and prepares for a future after the minerals are depleted. The oil companies’ land leases to drill expire within 3 to 5 years: now is the time to act.

Depending on market prices, a 5 percent severance tax rate on oil and gas production – with no loopholes – could yield up to $1.8 billion over four years for job creation, economic recovery and restoration of investment in Ohio.[2]  Investment funds rise to  $2.7 billion with a rate of 7.5 percent.  This could help repair some – but not all – of the damage of the slashing of $2 billion cut to schools, the $1 billion cut to communities, and a $500 million cut to instruction in colleges and universities.  Revenues should be used to restore jobs, local economies and services and to help communities impacted by the drilling boom. Prudent leadership would use some of the money for a permanent fund to lay the groundwork for a strong, diversified economy after the drillers are gone, and to establish a cushion in the case of liability if the air, water and/or soil are poisoned by drilling.

What is a severance tax?

Citizens and businesses alike pay taxes to support civil society. The severance tax is different: it is the tax that allows the people to share in the wealth of natural resources removed forever from the land. In developing nations, valuable minerals and natural resources may be abundant and vigorously extracted, but the people often remain poor. In The United States, the wealth reserved through the severance tax is typically used to boost opportunity: to strengthen schools, keep tuition low, build roads and bridges, plan for a diversified economic future, and protect communities from environmental degradation that is often a part of the extractive process.

 

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