AS lawmakers debate whether to increase the gross production tax levied on horizontal drilling, they should keep in mind this old warning: If you want less of something, tax it more. Recent experience in Oklahoma shows that when taxes and fees become excessive, economic activity declines.
In 2010, facing a giant budget shortfall, lawmakers opted to increase many fees. Vending machine operators, in particular, were hit hard. Instead of paying a sales tax on items sold, vending machine operators buy a decal for a flat rate each year. In 2010, lawmakers voted to triple that fee, from $50 to $150.
Gov. Brad Henry defended fee increases at the time, saying budget writers were careful to “only increase fees that hadn’t been increased in literally decades to bring them up to the cost in general of the service provided. It would have been an easier exercise to just cut every agency by 15 or 20 percent and go home, but it would have left our economy in shambles.”
Instead, the fee increase made a shambles of the vending machine industry. According to Oklahoma Tax Commission records, the state had more than 54,000 vending machines at that time. By 2011, industry officials were projecting a 30 percent reduction in the number of machines due to the fee’s impact.
Rep. Charles Ortega, R-Altus, noted that lawmakers had expected the fee to generate $8.5 million. Instead, the fee’s real-world impact was likely to translate into “a loss of $6.5 million to the state by the time you factor in job reduction.” Within the year, lawmakers voted to roll back the fee to $75.
Today, a similar debate focuses on a far larger industry: oil and gas. Currently, a 1 percent gross production tax is levied on horizontal wells for the first four years of operation. That rate, initially enacted as a temporary incentive, is scheduled to expire in 2015. Other wells face a 7 percent tax.
Critics of the lower rate, particularly those representing tax consumers, argue that horizontal drilling is now commonplace and therefore the incentive no longer impacts drilling activity. The most aggressive critics think a return to the 7 percent rate for all drilling activity is warranted, saying it would generate hundreds of millions of tax dollars for education and other programs.
Those claims appear to be inflated. Estimates generated by the Oklahoma Oil & Gas Association, which take into account the impact of higher taxes on drilling decisions at the margins, show a higher tax rate would ultimately translate into fewer tax dollars.
Should the incentive rate expire in 2015 and the rate return to 7 percent, the association doesn’t claim drilling will dramatically decline aside from the first year. But its estimates show slower growth in drilling activity will occur.
With a 7 percent rate, the association estimates energy production will generate around $1 billion in taxes by 2020. But if the 1 percent rate is maintained, it estimates drilling activity will provide nearly $1.2 billion in taxes by 2020. Thus, those seeking more education funding through a higher tax rate could actually deprive schools of millions of dollars annually.
The debate on the horizontal drilling tax rate is ongoing. It’s worth having. But this debate can’t focus solely on the potential for more tax revenue from a higher rate. Economic activity doesn’t take place in a laboratory. In the real world, investments are fluid. Incentives — and disincentives — flow in more than one direction.