Comparing Severance Tax Proposals
Yesterday, the West Virginia Center on Budget and Policy posted an analysis of the “compromise tax plan,” that is thought to be the foundation for budget negotiations between the Senate and the governor. Overall, the plan would reduce state revenue by $114.8 million. While most of the revenue loss comes from reductions in income tax rates, changes to the severance tax also result in large revenue losses.
The compromise tax plan would replace the state’s five percent severance tax on natural gas and coal production, with a varied rate tied to the price of coal or natural gas. The proposal in the compromise plan is similar to proposals made by the governor during the legislative session, with one major difference. While the governor’s proposals were largely revenue neutral, the compromise tax plan would result in a major loss of severance tax revenue.
First, let’s look at what the changes mean for natural gas. The governor’s proposed changes to the natural gas severance tax have been looked at in this post analyzing SB 415. The governor’s proposal would have natural gas severance tax rates ranging from five percent for when the price of natural gas is at or below $3.00/MCF up to 10 percent when the price is at or above $9.00/MCF. While the bill potentially doubles the severance tax on natural gas, it is unlikely to have much of an impact, as the Tax Department notes in its fiscal note of the bill, natural gas prices are projected to stay below $3.00 in the foreseeable future.
While the severance tax rate for natural gas under the governor’s proposal starts at five percent and goes up, the rate under the compromise plan starts at five percent and goes down. Under the compromise plan, the severance tax rate for natural gas would only reach five percent if the price of natural gas was above $9.00/MCF, and the rates go all the way down to 2.5 percent when the price is at or below $3.00/MCF. As the Tax Department’s analysis of the governor’s proposal showed, natural gas prices are expected to stay below $3.00/MCF for the next several years, meaning that the severance tax rate on natural gas would be cut in half. This would reduce severance tax revenue from natural gas in FY 2018 from $110.9 million to $55.4 million, a loss of $55.4 million.
Similar differences exist between the governor’s proposed coal severance tax tiers and those in the compromise bill. SB 478 is the governor’s proposal for coal severance taxes. The proposal would have coal severance tax rates ranging from 3.5 percent for metallurgical coal when the price of met coal is at or below $50/ton, up to 10 percent for when the price of met coal is above $200/ton. For steam coal, the rates would range from 3.5 percent when the price of steam coal is at or below $30/ton, up to 10 percent for when the price of steam coal is above $100/ton.
According to the fiscal note for SB 478, the tiered rates would not likely have a major impact on revenue. The current prices for steam and met coal would keep the severance tax rate at five percent, with a chance of a small rate increase for met coal. That is not the case under the tiered rates in the compromise tax bill. Under the compromise tax plan, steam coal priced at between $40 and $50 per ton would be taxed at a rate of 2.5 percent, half the current rate of five percent. This would reduce severance tax revenue from coal in FY 2018 from $153.4 million to $76.7 million, a loss of $76.7 million.
As the fiscal note for SB 478 notes, metallurgical coal in West Virginia qualifies for the thin seam reduced rate. According to figures from the Tax Department, approximately 18 percent of coal’s production value in the state is mined from seams 37 to 45 inches thin, and 13 percent in mines from seams less than 37 inches thick. Under the compromise tax plan, thin seam coal less than 37 inches thick, priced between $75 and $85 per ton would be taxed at a rate of 1.75 percent, 0.75 percent higher than the current rate of 1.0 percent. Thin seam coal between 37 and 45 inches thick, priced between $75 and $85 per ton would be taxed at a rate of 2.25 percent, 0.25 percent more than the current rate of 2.0 percent. This would increase revenue in FY 2018 from $15.0 million to $19.4 million, an increase of $4.4 million.
Overall, while the governor’s proposal for severance tax reform was revenue neutral, with the possibility, while remote, of increased revenue in the future, the proposal in the compromise tax plan results is in effect a major severance tax cut. Severance tax revenue would decline by about $131 million in FY 2018.
Cutting the severance tax is almost never a good idea, and does little to benefit the state. The severance tax is highly exportable, meaning that it is paid for by out-of-state consumers. A model of the incidence of Texas’s severance tax found that 62 percent of the state’s severance tax is exported, with Texas residents only paying for 38 percent of the tax. According to the EIA, West Virginia produces more than 5.5 times as much energy as its residents consume, meaning that the vast majority of the state’s severance tax is exported out of state. So in turn, the vast majority of savings from cutting the severance tax are also exported out of the state.
The severance tax has also shown to have little impact on jobs or mineral production. In fact, with its five percent severance tax rate, last year, West Virginia set an all-time high for natural gas production, even in the face of collapsing prices. Severance taxes mean even less for the rest of the state’s economy. The Tax Foundation does not include the severance tax in the State Business Tax Climate Index.
With its current budget problems, the last thing West Virginia should be doing is lowering its severance tax on natural gas extraction given our state’s looming budget crisis. Instead the state should be ensuring that we are adequately taxing our non-renewable minerals to help diversify and grow our economy.