How the Marcellus Boom Masked West Virginia's Tax Cut Problems
Earlier this week, the state's monthly revenue report was released, which keeps track of the various taxes that make up the state's General Revenue Fund. For October, the General Revenue Fund was up $5 million over the estimate, a pretty good month. This was largely due to severance taxes, which came in at $38.1 million or almost $10 million over the October estimate. Less impressive was the corporate net income/business franchise tax revenue, which came in at $8.4 million, $134,000 below estimates. For FY 2015, the state is expecting to collect $201.5 million in corporate net income/business franchise tax revenue, which (excluding the bad year of 2012) would be the lowest amount since 2004.
It's no surprise that the state's business tax revenue has been lackluster, with the series of business tax cuts enacted since 2006. The tax cuts have dramatically reduced revenue, to the tune of $205 million in FY 2015. While these tax cuts have caused their fair share of budget problems in recent years, West Virginia hasn't had the major budget problems of tax cutting state's like Kansas and North Carolina, which are facing massive budget shortfalls.
After several rounds of budget cuts, West Virginia is still facing a $126 million shortfall in FY 2016, a gap of about 2.6% of the base budget. But West Virginia's tax cut induced problems could have been much worse, if it weren't for the Marcellus boom and the resulting rise in severance tax revenue.
Right around the time West Virginia started its business tax cuts, natural gas production in the state took off, in a rather fortunate coincidence. Natural gas production in West Virginia increased from 231 billion cubic feet in 2007 to 718 billion cubic feet in 2013, an increase of 211%. As a result, even as the coal industry struggled, severance tax revenue took off. Between 1999 and 2004, severance tax revenue grew at an average annual rate of 4.4%. Between 2004 and 2014, that growth rate grew to an average of 10.2% per year, as severance tax revenue grew to nearly $500 million. Moving forward, the State Budget Office projects that revenue growth will return to its pre-boom rate of about 4% per year, as coal's decline catches up with gas's gains.
The growth in severance tax has neatly coincided with the shrinking of the state's business tax revenue. For the past 15 years, revenue from the severance tax and the corporate net income/business franchise tax have combined to make up about 15% of the state's general revenue, a share that has been fairly stable. But each tax's contribution to that share has changed dramatically. In FY 2005, the split was pretty close to half, with the CNI/BFT making up 8.5% of general revenue, and the severance tax accounting for 7.5%. While while the severance tax grew, business tax cuts took their toll, and by FY 2015, the CNI/BFT's share was down to 4.7%, while the severance tax's share was up to 11.1%. The decline in business tax revenue was almost completely masked by the increase in severance tax revenue.
Without the extraordinary growth in severance tax revenue making up for the lost business tax revenue, the state's budget pictures would have looked very different. Since 2008, West Virginia general revenue fund has averaged a balance of $32 million, albeit with shortfalls since FY 2012 that have necessitated budget cuts the past three years. So, up until FY 2012, the severance tax has done a pretty good job of covering up the losses from the business tax cuts, and West Virginia has avoided major budget pain.
Just how much of a difference did the Marcellus boom make? Let's assume that instead of its extraordinary 10% per year growth from 2004 to 2014, that the severance tax maintained its pre-boom average growth rate of 4.4%. This scenario shows what the effect of the business tax cuts would have had on the state budget, has there not been a natural gas boom to bail us out.
In this scenario, West Virginia goes from having an average general revenue balance of $32 million from FY 2008 to FY 2015, to an average annual gap of -$135 million. Instead of fiscal troubles creeping up on the state in FY 2012, they would have started right off the bat, as soon as the tax cuts took effect. And these gaps still include the budget cuts that West Virginia did have to make, so in reality they would have been even larger. For example, while in this scenario, FY 2011 has a positive balance, it includes $115 million in budget cuts that were replaced by stimulus funds that year. Without the extra growth in severance revenue, West Virginia would have been short over $1 billion since FY 2008. This means not only would there have been no deposits in the rainy day fund that during that time (which may have stopped further business tax cuts), but even larger spending cuts then we have seen since Fy 2012 would have been needed.
Not only did the natural gas boom help cover up some major budget problems that West Virginia's business tax cuts could have caused, it also covered up some the lack of economic growth that the tax cuts were supposed to create. After the tax cuts were enacted, then-Governor Manchin highlighted them in his FY 2010 budget message, pointing out that the Cato Institute called them, "probably the most pro-growth tax reforms of any state." And while our "business tax climate" increased from 34th in 2007 to 21st in 2015, the business tax cuts haven't done much to promote growth.
West Virginia's private-sector job growth since the end of the recession has been middle of the pack, relative to our neighboring states, coming in at 5.4%, behind Kentucky and Ohio (both of which, by the way, have worse "business tax climates").
But, just like with West Virginia's revenue, take away the natural gas boom, and West Virginia's job growth looks less impressive. When looking at non-mining private-sector job growth, West Virginia comes in last place among our border states, with growth falling from 5.4% to 4.8%.
The same thing happens to our GDP growth. While tax-cut enthusiasts like to tout West Virginia's 5.1% GDP growth last year as evidence that our tax cuts are working, without the growth in the natural gas industry, our GDP growth would have been negative. And even with the 3rd-highest GDP growth last year, West Virginia ranked dead last in job growth, losing almost 7,000 jobs.
West Virginia was told we badly needed tax reform to spur economic development, and that with it we would be, "in a better position to compete regionally with Pennsylvania and Virginia." We got our tax reform, and unless tax cuts put natural gas underground, we have little to show for it. Instead of competing regionally, we're lagging behind all of our neighbors, instead of growing the rainy day fund, we're depleting it, and instead of making the investments that do matter for economic growth, we're worrying about where to cut next.