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Pennsylvania Loses Out in Natural Gas Drilling

July 6, 2008

By David Falchek, The Times-Tribune, Scranton, Pa.

Jul. 6–Gas exploration companies are spending millions and expecting to make many millions more from natural gas trapped in the Marcellus Shale rock formation in Northeastern Pennsylvania. Even conservative estimates hold that the Marcellus Shale, the majority of which underlies Pennsylvania, offers 50 trillion cubic feet of recoverable gas.

Yet, a key tax on oil, natural gas and mineral removal that has raised billions in public revenue in other states doesn’t exist in Pennsylvania. In the Keystone State, oil and gas exploration companies and their landowner partners are given a big pass.

“Pennsylvania has found itself in possession of vast mineral wealth,” said Justin Dahlheimer, a research associate with the Institute for Local Self-Reliance, a Minneapolis-based policy group. “The state is in a position to really benefit if it adopted a tax similar to other natural gas states.”

Taxing Issues

Income from gas wells is taxed in Pennsylvania, somewhat. The landowner who receives royalties from a well on his property will pay taxes on that as ordinary income. Similarly, the gas company, through its partnership with the landowner, also pays corporate income tax on the money it makes from the well.

What’s missing in Pennsylvania is the so-called severance tax, a tax on natural resources “severed” from the land. The tax is levied on gross revenue from wells and mines. The value of what is removed is taxed. So a company with a well that is producing gas worth $200,000 a year would pay $10,000 of taxes with a severance tax of 5 percent. As the value of oil, gas and minerals increase, the government’s share from taxes would also increase.

Severance taxes range from a few percent to 15 percent in Montana. Veteran petroleum-producing states Texas and Oklahoma, for example, have severance taxes between 7.5 and 8 percent. Pennsylvania is the only major natural gas state without a severance tax.

The Institute of Local Self-Reliance took a look at severance taxes throughout the United States as part of its New Rules Project. The group’s report released in June urges states to increase the severance tax in light of sagging government budgets, skyrocketing mineral and energy prices, record profits for energy and mining companies and the burden of regulating and hosting mining and drilling.

But in Pennsylvania, you can’t increase what doesn’t exist.

Long history, short taxes

The petroleum industry was born in Pennsylvania. Edwin Drake drilled the first oil well 150 years ago in Titusville, Crawford County. Pennsylvania’s high profile in the U.S. petroleum industry was short-lived, soon eclipsed by major discoveries in Texas and elsewhere. Oil wells and natural gas exploration never ceased in Pennsylvania. Part of the reason for the state’s lack of severance tax may be the desire to cultivate the industry and its high-paying jobs, said Patrick Henderson, executive director of the Senate Environmental Resources & Energy Committee.

“This industry has long roots in the state,” Mr. Henderson said. “(Lawmakers) didn’t want to discourage the industry.”

Local governments have tried, and failed, to glean revenue from the oil and gas industry. For several years, 10 counties in western and central Pennsylvania levied a property tax on oil and gas reserves. A state Supreme Court decision in 2002 called those taxes illegal, ruling that oil and gas could not be taxed as real estate.

As Marcellus Shale exploration spread in Northeastern Pennsylvania, Damascus Township in Pike County attempted to levy a $10,000 per well fee on drilling. But outcry from landowners and suspicion that the fee violated state law deterred supervisors from approving it.

Yet, Pennsylvania lawmakers are not talking about a severance tax. Mr. Henderson said there’s nothing on it before the Environmental Resources & Energy Committee.

House Bill 1373 would allow local governments to impose property taxes on oil and gas reserves, overturning the court decision on the issue. But that effort doesn’t seem to have much steam, or precedent, behind it.

Stephanie Weyant, spokesperson with the state Department of Revenue, said no one has asked that department about severance taxes, and department officials don’t have an opinion on it.

Naturally, the oil and gas exploration industry doesn’t want to see a severance tax in Pennsylvania.

Steve Rhoads, the executive director of the Pennsylvania Oil and Gas Association said the state taxes companies in other ways, namely, the state Corporate Net Income Tax, which is 9.9 percent. The industry has calculated that the corporate tax is the equivalent of a 6 to 8 percent severance tax.

“We are paying tax — and it’s substantial,” Mr. Rhoads said, adding that he believes that other states have either a corporate tax or a severance tax.

Most states, however, have both, according to a survey by the Federation of Tax Administrators earlier this year.

Neighboring Marcellus Shale state, West Virginia, has an 8.5 percent corporate income tax and a 5 percent severance tax. Petroleum powerhouse Oklahoma has a 6 percent corporate income tax and a 7.95 percent severance tax. New Mexico’s corporate tax ranges from between 4.8 and 7.6 percent and has a 7.1 percent severance tax.

In some states, however, the more lucrative severance tax is deducted from the corporate net income tax liability.

“If the industry is paying so much in taxes, why are they tripping over themselves to be there, offering 18 percent royalties?” Mr. Dahlheimer said. “A few percent severance tax is a drop in the bucket.”

Spending the windfall

Different states do different things with their ample severance tax revenue, according to the National Conference of State Legislatures. Few put it in their general funds, preferring to earmark the money, or parts of it, for specific purposes, including conservation and reclamation, direct payments to local governments hosting drilling or environmental enforcement and regulation.

In some states, including New Mexico and Wyoming, severance taxes are in a trust fund yielding millions of dollars in interest annually — a stable source of revenue for governments, and a future fund for economic revitalization of mining and drilling communities.

Mr. Dahlheimer doesn’t think the revenue from natural gas severance taxes should go entirely to balance strained state budgets. The most responsible move would be for the state to set up a trust fund that would be used to reposition their economies when the gas and gas companies are gone.

Contact the writer: dfalchek@timesshamrock.com

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