Government Played Critical Role in Shale Gas Boom

Today, the Washington Post had an insightful op-ed highlighting the large and critical role federal spending played in the boom in shale gas drilling:

Many often point to the shale gas revolution as evidence that the private sector, in response to market forces, is better than government bureaucrats at picking technological winners. It’s a compelling story, one that pits inventive entrepreneurs against slow-moving technocrats and self-dealing politicians.

The problem is, it isn’t true.

The breakthroughs that revolutionized the natural gas industry — massive hydraulic fracturing, new mapping tools and horizontal drilling — were made possible by the government agencies that critics insist are incapable of investing wisely in new technology.

(The piece also mentions that some of the research was performed at the Energy Research Center in Morgantown, WV.)

The positive role of government spending in product innovation is something I’ve pointed out here and here. Let’s hope that Jared Bernstein is right: that this op-ed will “put to rest the uninformed debates about why the government shouldn’t pick winners, and how markets know best, and all that gov’t can do is cuff the invisible hand, yada, yada.”

Will the Business Personal Property Tax Deter a Cracker Plant?

Today’s Daily Mail had an article about a proposed tax incentive designed to lure a potential “ethane cracker” to West Virginia. The proposal would reduced the assessment rate for property taxes from 60% to 5% for the cracker facility. This would dramatically lower the facility’s property tax burden, to the tune of about $500 million over the next 25 years.

So why does West Virginia need such a large tax incentive encourage a cracker facility to come here? According to Commerce Secretary Keith Burdette, it’s West Virginia’s dreaded business personal property tax. According to Mr. Burdette, “One tax that we aren’t automatically competitive in is personal property taxes because other states don’t have them — at least the states we are competing with don’t have them.” 
As a refresher, most states have some sort of property tax, usually levied at the local level. While most states tax only real property (land and buildings), West Virginia also taxes business personal property (machinery, equipment, etc). This tax is a so-called job-killer, despite little evidence of that being the case.
So since West Virginia taxes business personal property and other states don’t, we need to create expensive tax incentives because of that built in disadvantage, right? Well, it turns out that the disadvantage created by business personal property tax is easily cancelled out once you remember that West Virginia has incredibly low real property tax rates. 
The cracker facility has an estimated value of about $2 billion. How much of that value is real property and how much is personal property is uncertain, but statewide property tax collections show that overall, about 63.3% of business property value is real, and about 36.7% is personal (see our property tax primer). Using that ratio, our hypothetical cracker facility would have a real property value of $1.264 billion and a personal property value of $734 million.
So how uncompetitive is West Virginia? Let’s compare to one of our competitors for the cracker, Ohio. Ohio only taxes real property, applying an average tax rate on business property of $90.02 per $1000 of assessed value, which is calculated at 35% of market value. 
West Virginia taxes both real and personal property, applying an average rate of $2.87 per $100 of assessed value, which is calculated at 60% of market value.
The differences in assessment values and levying rates can make direct comparisons tricky, and its easy to assume that since West Virginia taxes both real and personal, rather than just real, that its tax burden is higher. But that is not the case, as the table below shows.
As the Daily Mail article stated, the business community often complains about the business personal property tax, and if you only look at half of the chart you can see why. It shows the cracker facility paying $12 million in property taxes in West Virginia that it wouldn’t pay in Ohio. But if you look at the total property tax bill, West Virginia’s is lower. Why? The facility would pay an extra $18 million in real property taxes in Ohio.
How uncompetitive can the business personal property tax be when our real property taxes are almost half that of Ohio? The same is true for our other competitor for the cracker, Pennsylvania. Rates and assessments for PA were hard to come by, but on measure like property taxes per capita, as a percent of GDP, and as a percent of personal income, they were all much lower in West Virginia than in Pennsylvania, even though they don’t tax personal property there either.
So, do we really need to give away $500 million to make our property taxes more competitive? Not when you consider all property. Of course that question ignores the facts that taxes do not strongly influence business locations, low taxes don’t create economic growth, and taxes are a minor cost of doing business.

OPEB Cap Costs Public Employees $5 billion

In his column this morning Phil Kabler briefly noted that the result of capping the state’s contribution to retiree health insurance was “that the burden was shifted onto current and future retirees.” This is something I wrote about last week, so it was nice to see this basic point acknowledged in print. Another point that has been absent from the debate on OPEB is how much in compensation public employees will lose because of PEIA’s decision to cap the retiree subsidy provided by the state.

The chart below provides some estimates.

In FY 2011, the state is estimated to pay approximately 67 percent or $148 million of total retiree health care costs, while retirees will pay about 33 percent or $72 million. With the 3.3 percent growth cap in place, by FY 2030 the state will only be paying about 9% of retiree health costs, while retirees will have to pay 89% of the costs (of course, no retiree will be able to afford this cost, but that is another discussion).

Over the 20 year period, the total costs of retiree health care is $13.7 billion. If the state continued to pay 67 percent of total costs (green bars) like it does today it would cost $9.2 billion over this 20 year period. With the cap in place (red bars), the state will pay only about $4.1 billion over the next 20 years for retiree health care costs.

If no other funding source is found to offset the cost shift to public employees, participating public employees will lose about $5.1 billion over the next 20 years in compensation. Of course, even if a funding source is found it is highly unlikely to defray even half of the $5.1 billion in lost compensation.

Solving the OPEB Problem is in Reach

Last night the Charleston Area Alliance hosted a discussion between Senator Brooks McCabe, PEIA director Ted Cheatham, and yours truly on how to address the state’s growing OPEB (other post-employment benefits) liability. As readers may know, we published a detailed report on how the state should handle this problem back in January. I do not have much more to add to the discussion that was not in our report, but uploaded here are some of my notes from the event.

One thing that I stressed at the event was that the state should not overreact to the OPEB liability by completely pre-funding it. As the chart below shows, both the House and Senate legislation would fully fund the OPEB liability by FY 2028 and FY 2030 respectively, while our two biggest pension plans would only have a funding ratio between 80-95 percent.

So, why shouldn’t we fully pre-fund the OPEB liability? Although it seems counter intuitive, there are several good reasons.

First, unlike pensions which are a legal and moral obligation of the state, retiree health care is not. The PEIA board can take it away tomorrow with little recourse (no collective bargaining) from public employees.  Therefore, it makes little sense to fund the OPEB liability at a higher rate than our state’s pension liability.  Secondly, many experts argue that 80 percent funding is sufficient for public pensions because states and localities, as ongoing entities, can use tax revenues to make up a shortfall if necessary. Here is what a recent GAO report said:

“Many experts and officials to whom we spoke consider a funded ratio of 80 percent to be sufficient for public plans for a couple of reasons.  First, it is unlikely that public entities will go bankrupt as can happen with private sector employers, and state and local governments can spread the costs of unfunded liabilities over up to 30 years under current GASB standards.  In addition, several commented that it can be politically unwise for a plan to be overfunded; that is, to have a funded ratio over 100 percent. The contributions made to funds with excess’ assets can become a target for lawmakers with other priorities or for those wishing to increase retiree benefits.” 

Instead of aiming for 100 percent funding by FY 2030, the state should aim for 60 to 80 percent funding by FY 2040. This will put us way ahead of most states and will also free up millions of dollars that can go toward many of the state’s more pressing economic problems, such as having the least educated (formally) workforce in the country.

Lastly, to paraphrase Donald Rumsfeld, there are a lot of known unknowns regarding the Affordable Care Act.  For example, the ACA provides subsidies up to 400 percent of the federal poverty level for individuals and families who purchase insurance in the health exchange. It is possible that some public workers – especially those that perform physically demanding work – will have to retire before they reach age 65. Therefore, they could receive a better deal by purchasing health coverage in the exchange than taking the retiree health subsidy provided by PEIA.

For example, the average early retiree (age 55-64) pays about $252 a month or $3,024 annually toward his or her PEIA health insurance. Based on the Consolidated Retirement Board Calculator, he or she would have an annual annuity of $25,000 based on a final salary of $50,000. Assuming no other sources of income, he or she would be eligible for a health exchange subsidy at 250 percent of the federal poverty level ($27,075 for a single person in 2010) and pay $2,315 or about $700 less than PEIA.

Currently, between 30 to 40 percent of retiree health care costs are non-Medicare retirees in PEIA. If our state proceeds with a strong exchange and the ACA remains intact, it might be better to phase out the retiree health subsidy for early retirees instead of capping the amount for all retirees. This could drastically reduce the OPEB liability without harming most retirees. As the table below shows, both the House and Senate plan (McCabe plan)) would require that retirees pay on average between 65 and 69 percent of their pension income toward purchasing health insurance in FY 2030 compared to less than 10 percent today.

The table below highlights the share of health care premiums that retirees would pay under both the House and Senate (McCabe Plan) bills. As you can see, retirees would have to pay on average about 80 percent of their health care premiums – which would effectively end the retiree benefit. If the state decided to cap the retiree subsidy to the normal rate of government growth instead of arbitrarily capping the subsidy, it would provide more of a benefit to retirees while not crowding out other government spending.

Given the fragile nature of the OPEB liability and the possibilities regarding health care reform, it makes much more sense to take a more judicious approach to solving the OPEB problem. As shown above, there are solutions to addressing the OPEB liability that do not require drastically reducing health care benefits for retirees or hurting our state’s ability to make the important public investments it needs to make in educating our workforce.