Severance tax pitfalls

The issue of whether a state tax should be imposed on the production of natural gas is a surprisingly complicated one. There are some arguments against it that we consider blatant nonsense—in particular, the idea that it would make the natural gas companies go away. But other considerations are worthy of reflection. For instance, if natural gas production were a major source of state revenue, that could become a motivation for state governments to increase drilling as rapidly as possible while turning a blind eye to threats to public welfare—very much as the Federal government has done with oil drilling in the Gulf of Mexico, and with potentially similar results.

We have criticized the “what if they go away?” argument before. Shale gas can’t be outsourced the way textile manufacturing or phone call centers can. A company can’t decide it’s going to drill in India or the Philippines because those countries will let them do it cheaper. A large swath not only of the Marcellus Shale, but of the portion of the shale considered to be the “sweet spot” lies under Pennsylvania and New York. That’s where the gas is, and that’s where the drillers are going to be.

But the problems that can be created by associating drilling activity with state income are indeed troubling. One only has to look at the Gulf states and their reaction to the moratorium on offshore gas drilling after the BP disaster to see how trapped by the drilling industry that whole area has become, both for individual workers and for the states as a whole. Regardless of evidence that the health of both human beings and the ecosystem on which so much Gulf economic activity depends have been seriously compromised, politicians in both Louisiana and Mississippi are clamoring for more drilling—while nothing has been done to address the weaknesses in the system that allowed the disaster to happen in the first place. We must take great care that our state representatives do not become similarly beholden to any extraction industry.

One solution to this problem is to limit what the proceeds of a severance tax can be used for. It’s clear that the funds should not go into the general treasury, where the temptation to use them to balance the budget would become overwhelming even for the most scrupulous officeholders. Instead, specific areas should be targeted that don’t provide easy political fixes for officeholders with a short-term mentality.

One such area could be the funding of the agencies needed to regulate the industry. Unfortunately, there is some problem even here; indeed, some have argued that the lax oversight of the Mineral Management Service over oil drillers such as BP is due to the fact that the agency recognizes the companies it regulates as its source of funding. However, suppose the budget for agencies like the Department of Environmental Protection was set high enough to ensure strong, competent oversight, but otherwise independently from the levels of gas production, so that any excess funds from higher production went to other areas. In that case, the incentive for agency employees to overlook problems in the interest of increasing production (and associated taxes) might be avoided.

Another use of tax proceeds, mentioned in an earlier editorial ( riverreporter.com/issues/10-03-04/edito rial.shtml ) would be to invest in what we called the “successor economy,” that is, economic activities that have been identified as having long-term potential to continue and replace the void left when gas drilling has stopped. One could set up a trust and specify a period of time during which no income could be drawn from it, allowing the principal amount to build up. Income from this trust could eventually be used by the local municipalities in the Marcellus Shale area (think, for instance, the Sullivan County creamery), and to that extent state policymakers would not have a direct incentive to encourage drilling just for the sake of the money.

We’re sure there are many other proposals worth considering as to how to use severance tax proceeds without simultaneously providing an incentive to the state and its agencies to be poor stewards. Thus, as frustrating as it is in one way to see the Pennsylvania legislature shilly-shally over the issue, we think it’s something worth taking some time to get right.

But the one thing that doesn’t make any sense at all is to fail to impose a tax because the poor downtrodden gas drilling companies can’t afford it and will go elsewhere. Get a grip. That’s the argument the Millennium Pipeline used in order to evade paying its full burden of taxes in Sullivan County. And we all know how that one turned out.

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