Severance Tax Cut Would Cost Millions (Updated)

After hearing from the coal industry about their desire for cut in the severance tax, SB 705 was quickly introduced and sped through the Senate Finance Committee on Monday, and is already on 2nd reading in the Senate today. In its current form, the bill cuts the severance tax on coal from 5% to 4% starting in FY 2019, and then down to 3% starting in FY 2020. We've talked before about how a cut in the severance tax is unlikely to benefit the industry much, and certainly not to the extent that they claim. Now that there is an actual bill, we can make an estimate of its fiscal impact.

The bill's severance tax cut is phased in over 2 years, dropping to 4% in FY 2019 and to 3% in FY 2020, for a total rate reduction of 2 percentage points. It's important to note that the state already has reduced rates for thin seam coal of 2% and 1%, depending on seam thickness. SB 750 does not change that, so the rate reduction would only apply to coal produced in seams thicker than 45 inches. In FY 2017, the thin seam rate reduction was worth $40 million. Also important to note is that the state's 5% severance tax rate is technically two rates, a 4.65% rate for the state and a 0.35% rate for local governments. SB 750 keeps the local rate the same, so the bill actually lowers the state rate from 4.65% to 2.65% over two years.

With all of that being said, let's try to estimate the fiscal impact of the bill. The state's share coal severance tax revenue is projected to be about $206 million for FY 2019 and $213 million for FY 2020. 

SB 750 would reduce the state's share of coal severance tax revenue by about $53 million in FY 2019, and $109 million in FY 2020 and about $110 million/year after that. And while the 0.35% local rate is unaffected, coal producing counties also receive an additional distribution of 5% of total coal severance tax revenue. Lowering overall revenue by $110 million would cost those counties $5.5 million in lost severance tax distributions.

Of course, this analysis assumes that coal production would be unaffected by the tax decrease, but that's a pretty safe assumption. Multiple studies have show coal production is largely unaffected by changes in severance tax rates, with tax cuts causing large declines in revenue far outweighing the only minor increases in production. And, as we've pointed out before, West Virginia already has lower taxes than our main competition in coal production, and tax cuts will do little to change our productivity challenges and the threat to coal from low natural gas prices.

So while the coal tax cut will do little to help the industry, the revenue lost could do some real harm, West Virginia is in the midst of a substantial budget crisis, and has been neglecting investment in areas like education, infrastructure, and our workforce for years. Year after year of budget cuts have taken their toll, and more tax cuts will only make future cuts more likely. And while the Coal Association report (dubiously) claims that a severance tax cut will create 1,800 jobs, as I've pointed before, the spending cuts the revenue loss would likely force would offset any economic gain. Large spending cuts at the state level would likely lead to job losses in both the public and private sector. For example, based on the previously linked report, roughly $50,000 in tax revenue supports 1 public sector job. If revenue falls by $110 million, that would equal a loss of 2,200 jobs, more than the severance tax cut is alleged to create.



Just minutes after this post was published, the Senate amended SB 705 to include natural gas in the tax break along with coal, and the tax break would start one year earlier in FY 2018. Total natural gas severance tax revenue (both state and local shares) is projected to be $104.3 million in FY 2018 and $109.3 million in FY 2019.

SB 750 would reduce total natural gas severance tax revenue by $23.7 million in FY 2018 and $49.7 million in FY 2019 and over $61 million/year by FY 2021. Of that reduction, local governments would lose $6.1 million/year and the state would lose $54.9 million/year.

With the new start date, SB 705 would reduce state coal revenue by $51.5 million in FY 2018, and $105.6 million in FY 2019, and about $110 million a year after that. Counties would lose $5.5 million/year.

The total loss for the state when fully enacted would be about $159 million/year while local governments would lose about $11.6 million/year.


***UPDATED 3/10/16***

While the bill the cut the severance tax on coal has been turned into a study resolution, much to the chagrin of some in the coal industry, Ted and I decided to take a close look at the Coal Association's study on the benefits of the severance tax cut. One of the most egregious omissions from the study was a lack of any revenue estimate, as well as not evidence to support the claim that a three-percent cut in the severance tax would result in a three-percent increase in production. But even taking that assumption at face value, a three-percent cut in the severance tax would still costs hundreds of millions of dollars, even with a three-percent increase in production. 

Estimated Impact of Reduction of Coal Severance Tax from 5% to 2% using WV Coal Association Study*

Estimated Coal Production at 5% Severance Tax: 90 million tons
Estimated Coal Production at 2% Severance Tax (3% Increase in Production): 92.7 million tons
Estimated price of coal in WV: $50 per ton
Estimated price of coal in WV if Severance Tax Reduction (5 to 2%) savings lower price: $49 per ton

Current Law estimated coal production value in WV: $4.50 billion
Reduced severance tax estimated coal production value in WV: $4.54 billion

Estimated coal severance tax collections under current law (5%): $225 million
Estimated coal severance tax collections under reduced severance tax rate (2%): $90.8 million

Estimated lost revenue under 2% coal severance tax: -$134 million

**At $50,000 per 1 job, $134 million in state and local expenditures = 2,680 jobs
WV Coal Association estimate of job gains from severance tax reduction = 1,864 jobs

Estimated net jobs from severance tax reduction = -816 jobs

*This simple exercise is not definitive but is meant to provide a simple explanation of how even using the findings contained in the WV Coal Association study are fundamentally flawed since it fails to consider how severance tax reductions would impact state and local expenditures. The above assumes 90 million tons of coal production in a given year in West Virginia with an average price of $50 per ton. The current spot price for steam coal in West Virginia is $42.25 per ton in Central Appalachia and $48.60 per ton in Northern Appalachia.

The average price of US metallurgical coal exports was $85.65 per ton between July and September of 2015.

It is unclear what share of total coal production in West Virginia is metallurgical coal, but a large share of it is produced in thin-seams which already receive a reduced severance tax rate of 2 and 1 percent. WV Coal Association study:

**The multiplier used ($50,000 in state expenditures per job) is a conservative estimate based on several studies. A 2009 study by the Economic Policy Institute estimates that each direct public sector job cost about $70,000 with an indirect multiplier of 0.5% per private sector jobs, which is about $46,000, cost per job.

A study by Harvard University economics professor Daniel Shoag finds that $35,000 of state spending generates one job.

In a more recent study by Shoag, he finds that during an economic recession "every additional $22,011 of spending contemporaneously creates one job."

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