Natural Gas Taxes: A Big Fracking Deal

It is always comforting to visit home over spring break and find out that everything is still the same as it was when you left. For instance, returning to my home in Pennsylvania this past week came with the unsurprising discovery that the state is still without a state budget, as it has been for the past 254 days. Some things never change.

So why does not PA have a budget? Well, there are a number of reasons, but one key sticking point has been Governor Wolf’s proposed plan to implement Pennsylvania’s first-ever severance tax on natural gas extraction, (a severance tax is just a fancy name for a tax on natural gas removal as a percentage of its market value). However, in Pennsylvania where there is a heavy reliance on fracking, this tax has been vehemently opposed by natural gas companies and by many lawmakers. Let us look at a few of their arguments:

Argument 1: A tax would force natural gas companies to leave the state.

First of all, this does not make sense economically. Pennsylvania sits on top of the Marcellus Shale formation, a source of natural gas that includes New York, Ohio, and West Virginia. It is one of the largest sources of natural gas in the United States, and it is not likely that frackers will respond to a new tax by throwing up their hands in defeat and leaving the area untouched forever. In fact, that has never really happened in other states. In Texas, the severance tax on natural gas production is 7.5%, yet it is still the biggest producer of natural gas in the country – with Pennsylvania taking the second spot. Even though taxes have increased in many states recently, the U.S. still leads the world in natural gas extraction.

Argument 2: Does not Pennsylvania already have impact fees on natural gas companies? Isn’t this money being used to improve the environment?

A common tactic of states that want to tax natural gas indirectly is to charge an impact fee, which is an annual fee charged regardless of production. Its revenues are generally redistributed to local counties to address environmental problems. But there are two problems with an impact fee, especially compared to a severance tax:

First, an impact fee is fixed, so it does not change depending on how much natural gas a company actually extracts. In economics-speak, that means it is a sunk cost: once it is paid, there is no incentive to scale back production. A severance tax, by contrast, can be lowered or raised to incentivize higher or lower levels of production.

Secondly, impact fees in Pennsylvania have not actually done a whole lot of good for the environment. Every year, 60% of the revenues from the impact fees go to municipalities and counties to use as they see fit, and although the money is sometimes used to address water concerns, most counties use it to improve roads or meet other expenses. The other 40% is given to the Marcellus Legacy Fund, of which only 25% is earmarked for environmental initiatives. So out of the $225 million raised last year by impact fees, only 10% was earmarked for environmental repair!

Argument 3: The natural gas industry produces jobs, and its presence is needed during a period of economic recovery.

First of all, as I mentioned earlier, a severance tax is not the end of the natural gas industry. But there are plenty of other growing industries, like wind and solar power, that could use the money from a severance tax to create jobs. And this is not just a lesson for the Keystone state: in 2012, wind energy in the United States alone employed 75,000 Americans, and that number is growing by the day.

Throughout the U.S., a lot of effort has been spent on resisting severance taxes on natural gas – even John Kasich met pushback when he suggested that Ohio’s severance tax should be raised. But this tax would not destroy the natural gas industry, is better than using impact fees, and will not hurt the overall economy, especially if its revenues are used to encourage renewable industries. We can only hope that once Pennsylvania finally passes a budget, a severance tax on natural gas will be an important part of the final package.