Columns » Ernest Dumas

Gas tax for dummies

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Does it worry you that Gov. Beebe is about to kill the goose that laid the golden egg, as a little band of Republicans maintain? A 5 percent tax on the gas that big Texas and Oklahoma companies harvest from the Fayetteville shale in northern and eastern Arkansas, they say, would cause the companies to stop drilling in Arkansas or else cut back so much that it would scotch the economic miracle wrought by the shale development since 2004.

You do not have to depend on them for the answer, or even on the hired scholars at the Walton business school at the University of Arkansas, who were paid by the energy companies to estimate the value of their exploration to Arkansas.

You can work out the answer for yourself and it will be more reliable than theirs. It's really too easy.

Take the gas production from wells in the shale in 2007: about 90 billion cubic feet. (For purposes of your math convert that to 90 million mcf. An mcf is 1,000 cubic feet, the standard way to measure gas production.) It will be far more than 90 billion this year and more beyond because production has been tripling every year. The 90 billion feet is in only eight counties of north central Arkansas, but when pipelines are completed into the Delta the drilling will spread all the way to Lee and Phillips counties on the Mississippi River.

Now assume that the market price of the gas is $7 an mcf. It is closer to $10 this week, but prices fluctuate and the production companies do not reap the full price at the pipeline entry. But $7 is very conservative. At $7 an mcf, that 90 billion cubic feet would reap the companies and royalty owners $630 million. A 5 percent tax on that would lower their income for the year by $31million, to $599 million, right?

Not really. Both the production companies and the royalty owners (who typically get one-eighth of the revenue) get to deduct the severance taxes from their federal and state income taxes. So a little over 40 percent of the severance tax will be coming back to them from the federal and state governments. (Let's assume a 35 percent federal rate and 7 percent state rate, which actually is 42 percent.)

That produces an effective severance tax rate of only 3 percent of the market price of the gas rather than 5 percent. So the severance tax will reduce their net income by only $19 million, from $630 million to $611 million.

Here's the question: If your income is be reduced by that paltry sum, would you throw in the towel, or reduce your investment by even a dime?

The big gas companies won't either. Much higher severance taxes than 5 percent in Texas and Oklahoma and in most other gas states have not slowed them there. No one can explain why they would act differently in Arkansas. They hate the Razorbacks? The Clintons?

OK, but the Walton school academics who were hired by the gas people estimated that a 5 percent tax would reduce exploration by 13 percent, which they based on a questionnaire sent to the exploration companies. But why would the investors limit their profits in even that small way? It beggars logic.

The Walton study actually explains why it would not happen. The demand for natural gas is expected to rise for many years and though gas prices fluctuate (they reached $15 an mcf in 2005) they are on a steady upward trend. Exploration in the shale may be slowed by the slow development of transmission lines across the region and by the lack of equipment and trained workers, not by any tax that the state is likely to levy.

The study estimated that the economic impact of shale exploration in Arkansas from now through 2012 to be $17.9 billion. It is hard to question the economic models used to guess such things, but the impact will be large, though probably not that great.

For one thing, the scholars inflated the tax dollars that the state gets from shale production. Just one example: They figured that the companies paid $29.2 million in income taxes on their shale gas in Arkansas last year. They calculated a tax of 6.5 percent for corporations and 7 percent for partnerships on the net income from the gas. But these are out-of-state companies, and incomes are apportioned among the states where each company operates based on a number of factors. Although the gas is from Arkansas, much of the income taxes on the profits will be paid not in Arkansas but in Texas, Oklahoma and perhaps other states where they may have passive subsidiaries (Delaware and Nevada would be good guesses).

But whatever the economic impact in Arkansas, it will be even greater for Texas and Oklahoma, where most of the income from the Arkansas gas will go because that's where the investors are.

But surely the reflexive critics have other arguments against the severance tax besides the phony one of shrinking exploration. They do. Here they are:

• The taxes would be passed on to homeowners through higher gas bills. It can't be done. If the companies could somehow pass the tax along it would be to the entire country, not Arkansas.

• If Arkansas taxed their gas at 5 percent, the companies would move to Mississippi, where there are untapped gas formations. You think so? Mississippi levies 6 percent without the generous exemptions Beebe's proposal would allow.

The revenue would be almost meaningless for the highways, which need much more. The severance tax would be the equivalent of at least 5 cents a gallon on gasoline, the largest highway tax increase in history. The Republicans would rather you pay a nickel a gallon more at the pump. I hazard a guess that you wouldn't.

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