A Severance Tax on California Oil?
GroundSwell, July-August 2006]
California has long been and remains a major oil-extracting
state. It is the largest gasoline consumer by far, at the highest
prices. Its fields were yielding up hydrocarbons not long ago when
oil was at $10/bbl or less, and natural gas was a drug on the
market. There is much economic rent there. And yet California is the
only state, major or minor, with no severance tax.
This November voters will turn thumbs up or down on Prop. 87, a
severance tax measure. Besides the usual suspects, its backers
include some leading venture capitalists from Silicon Valley, with
interests in greentech. Two of the leading contributors are Vinod
Khosla (Sun Microsystems) and John Doerr (Kleiner Perkins Caulfield
Alaska, as is well known, distributes a generous social dividend
annually from its oil revenues, and also keeps building a Heritage
Fund for the future. Alberta does the same. Less known are the
heritage funds of smaller producers Wyoming and New Mexico. All
three of these U.S. states are red, bright red, on the current
political map. And yet their representatives in Washington have
urged Congress and the Administration to follow their lead in
rebuilding Iraq (not long ago, when that was a dream rather than a
nightmare), and to export the idea to various African and other
nations where we might sway policies. Colin Powell, when Secretary
of State, took them seriously. They seem unconcerned that such an
idea might blow back on us and influence U.S. policy. Its
an anomaly that a cynic i.e. a reasonable observer of
politics -- can only explain by postulating that these red state
reps knew their idea never had a chance, while they played to neocon
fantasies. If someone has a more upbeat idea, Im listening.
In California the last time anyone pushed hard for a severance tax
was 1981, when Jerry Brown was still Governor. Certain California
local governments had been taking healthy revenues from oil fields.
Californias State Board of Equalization had been doing an
outstanding job of helping counties assess oil fields for property
tax purposes (showing, among other things, that it can be done).
Prop. 13 (1978) had cut off most of that property tax revenue, so it
was a good time to get some back. The effort failed, but one major
backer, Bill Lockyer, is now our A.G., a traditional rung up the
ladder to the top.
Georgists are of mixed minds on severance taxation. Some oppose it
as being a tax on production, and prefer a property tax based on
assessed value. Others say that extracting a natural deposit is not
the same as production, and assessing underground values is
impracticable anyway. There are elements of truth in both views. The
following is an attempt to sort them out and come to a firm
recommendation. The gist of it was written for the California State
Assembly Committee on Revenue and Taxation.
PROP. 87 would impose tax at rate of 6% of gross wellhead value "for
the privilege of severing oil." The tax would be in addition to
the property tax, and to any yield tax imposed in lieu of an "ad
valorem" (meaning property) tax.
Proceeds would go into a fund to promote greentech energy (the
1981 bill was earmarked for schools).
A. A state severance tax on oil is constitutional. That is stare
decisis. Various such state taxes have been challenged as bearing on
interstate commerce. The U.S. Supreme Court resolved this in
Commonwealth Edison Company v. Montana, 2 July 1981. Montana imposed
a severance tax on coal, at a rate of 30%. Most of the sales were to
out of state buyers like the plaintiff: Commonwealth Edison is a
large utility in Chicago. However, Montana buyers are also subject
to the tax so it was ruled not to violate the Commerce Clause of the
In addition, much or most of the tax is not shifted forward at
all, but is borne by owners of coal lands in Montana. It is almost
certain that Commonwealth Edison is one of those owners: most
consuming utilities do acquire their own energy reserves. This may
be the real reason behind their lawsuit.
Sometimes the argument is made of an implied contract, or moral
obligation, not to raise taxes above existing levels, because
purchasers are "innocent," and bought in the faith taxes
would not rise. However, no California owner can reasonably claim to
be "innocent" of the possibility such a tax might be
imposed at any time. The severance tax is legal, and adjudicated,
and has long been imposed in all other states. Major owners are
sophisticated investors. All major companies have tax departments
and legal staff. They are in the business of taking risks; one such
risk is that of higher taxation.
150 years ago, most of California was either public domain or in
old Spanish or Mexican grants. Spanish and Mexican land grants
routinely reserved mineral rights for the crown or its successor, on
the "regalian principle." The U.S. Government accepted and
validated all such grants, with their conditions, at the Treaty of
As for the U.S. public domain, Congress granted lands from it to
individuals and corporations for the primary public purpose of
developing agriculture, transportation, irrigation, and towns.
Minerals were included mainly by oversight. Their early discovery
was a windfall; their value at modern levels is the acme of a series
of windfalls. If they were on the OCS (Outer Continental Shelf) the
U.S. Government would still be the owner, auctioning off exploration
rights for high prices. Riparian owners along the coastline were
never given title to offshore minerals; by analogy, it seems only
accidental that overlying landowners were given special rights to
underground minerals. Accordingly, public sentiment in this country,
and in most others, has long viewed mineral rights as being
peculiarly affected by a public interest.
B. A tax must have a public purpose. There are new, high,
legitimate demands on the California State Treasury. It is ground
between the lower millstone of Prop. 13, causing localities to
require more State funds; and the Administration in Washington,
cutting back on national revenue-sharing.
Before and independent of Prop. 13, there was and remains a need
to supply a higher share of school funding from the State level, as
mandated in the Serrano decision in California, and similar
decisions in other states.
C. There is a large taxable surplus, or rent, in California oil
and gas that is privately owned. Rent has been characterized as "fat
in the private sector." It is private income in excess of that
required as an incentive to evoke production.
1. Most of the fields were brought in, and remained producers, at
much lower prices than those now obtaining.
2. Many fields have recently been acquired by large, wealthy
international major oil firms, at high prices. Mergers and
acquisitions at high valuations are clear evidence of high rents. It
is the surplus in lands that attracts wealthy outside buyers.
3. The rent of California oil and gas is currently untapped for
public purposes. California is the only major mineral-rich state
lacking any form of state severance tax.
4. Some California oil and gas is publicly owned, and is known to
yield large surpluses to the public. The State owns its "tidelands,"
the strip of coastal land inside the three-mile limit. Outside that
limit, the Federal government sells leases for high prices, even in
deep water and with limited competition among a few major buyers. It
seems to follow that upland oil, privately owned, yields surpluses
5. Oil and gas extractors as a group show much higher profits per
employee than any other major industry. They receive something like
40% of all profits in the Fortune 500, with only 10% of the
employees. High profits per employee are a sure indicator there is
6. There has been talk that Kern County oil is played out, and of
low quality. Yet, Philip Anschutz, legendary wildcatter and
leasehound, in 1999 completed the costly Pacific Pipeline connecting
Kern County oilfields with refineries in El Segundo and Wilmington.
II. There is a case for higher taxation of energy deposits.
A. Before Prop. 13, California had used its property tax in lieu
of a severance tax, to get public revenues from oil and gas.
California alone among oil-producing states had no severance tax. On
the other hand, it almost alone had an effective property tax on oil
and gas in situ. Only a few counties benefited, but one of them was
the largest, Los Angeles.
California's property tax was effective because the State Board of
Equalization in Sacramento maintains an office of specialists to
give professional aid to localities needing to assess reserves of
oil in situ. The head of that office, Robert Paschall, testifying
before the Alaska State Legislature, stated from his California
experience that it is as feasible to assess the value of oil
reserves as any ordinary parcel of real estate. He stated that the
uncertainty regarding the physical quantity of oil in the ground is
considerably less than the kinds of uncertainty that bear on the
price of any other real estate: concerns about the future price of
the product, and costs of production. With oil and gas, besides, the
time horizon is shorter; and there is only one highest and best use
Accordingly, California before 1978 got substantial revenues from
its localities' property taxes levied on reserves of oil and gas.
Mr. Paschall later consulted in the Appalachian States, and has told
me that California is a hundred years ahead of those states in
assessing hydrocarbons for property tax purposes. It assesses oil
and gas accurately, while they fail to assess coal -- a much easier
job, technically -- accurately. The difference is political, or
worse. Mr. Paschall says his life was threatened.
In 1978, of course, Prop. 13 changed all that, lowering our
property tax rate to 1/3 or so of its previous level, while also
rolling back and freezing assessed valuations of property.
B. Most of what Howard Jarvis and Paul Gann said and published, in
advancing their Prop. 13 in 1978, was about abating property taxes
on homes, both owner-occupied and rented. Neither they, nor other
advocates, said anything about abating property taxes on deposits of
oil and gas in the ground. It is fair to infer that there was no
voter intent to untax oil and gas. Such tax relief was, from the
voters' view, incidental and unintended: it slipped by in the heat
of the moment and general ignorance of relative values involved.
This is relevant because the courts, in interpreting voter intent,
rely on language used by proponents during elections. There is no
evidence that voters intended to relieve oil and gas. Their minds
and visions were directed elsewhere, and they fell for it. It
follows that the voters' intent would not be violated now were we to
use severance taxes to tap the rent surplus from California's
C. Ownership of oil and gas is highly concentrated, so any tax on
this industry will have progressive consequences.
D. Beneficial ownership of the shares of the international major
oil and gas corporations that own much of California oil and gas is
routinely concealed, but much of it is known to be distributed
nationwide, and worldwide. Thomas Mellon Evans, for example, is
headquartered in New York; Jean Paul Getty was an expatriate
resident in England; Philip Anschutz lives in and works from Denver,
having no California residence or address; Texaco is in Houston;
Chevron in Chicago; shareholders are everywhere. The rents are
therefore spent, in large part, elsewhere. Tapping those rents for
public purposes means spending the money in California instead, thus
improving our balance of payments and our economic base.
E. Recent price hikes, and ongoing deregulation, are bringing
huge increases in wealth to owners of California oil and gas.
F. California derives no revenue from Federal OCS lands, for they
are outside the State's boundaries. It is possible that if the State
puts in place a working, active tax-gathering mechanism for upland
oil and gas, it can be adapted to the tricky job of taxing offshore
extraction through a "first-use" tax.
G. There is a State gasoline tax. Some of this is shifted
backwards, to sellers. However, it fails to tap much of our mineral
rents, for at least three reasons.
1. The real value of the State gas tax has fallen over many
decades now, because of "reverse bracket creep." That is,
it is a "specific" tax, so much per gallon, rather than ad
valorem. So it fails to keep up with inflation. On an ad valorem
basis it is now much lower than it was 90 years ago. In 1920,
incredible as it seems, it was our largest source of State revenue.
2. The tax bears the same on gas from high cost wells as from
low-cost wells. Thus, it cannot begin to tap the economic rent from
the low-cost wells. It may be a tolerably good way to tap the
taxable surplus from some of the highway users, to the extent it is
shifted forward to them. It is no way at all to tap rent from
low-cost producers, even to the extent it is shifted back to
producers: it hits the high-cost fields as hard as the low-cost
3. The State subsidizes gasoline consumption by building and
policing and maintaining and replacing its huge highway network. The
gasoline tax falls short even of paying for that.
III. Some voice concern that a severance tax would simply be
shifted forward to California consumers, and therefore be
regressive, like a retail sales tax. The concern is unfounded in
this case. The severance tax comes out of the surpluses now received
by equity owners of the natural resource: it is largely a tax on
rents from the natural resource in situ. Let us explain why.
There are four conditions that let producers shift a tax forward
to consumers. These are:
The first three of these conditions are not met in this case, as
we will now see; the fourth is only partially met. Let us look at
them one at a time.
A. World demand for oil is sensitive to price; it once proved to
be quite so. That is why there was an oil glut, and sinking prices
following the initially successful Arab Oil Embargos, and in spite
of OPEC's strong hold over world production.
To be sure, following these successes Americans foolishly let
suburban sprawl run wild again, so now demand is elastic from a
higher base. Clearly Americans collectively, represented by their
governments and intellectual leaders, need to take permanent
measures to curb sprawl and the excess demand for fuel that it
generates. This calls for shock therapy, such as we have
sought to impose on Poland and Russia. Natural scarcity has just
administered the shock to us. We must respond by throwing out the
pro-sprawlers and re-compacting our settlements. Pro-sprawlers, or the
road gang, are a highly organized lobby led by oil firms, auto
firms and dealers, cement and asphalt firms, civil engineering
firms, certain law firms, various allied firms, and (tragically)
certain universities and think tanks whose personnel dance to their
B. Supply is fairly inelastic
1. California was a major producer long before the Oil Embargo, at
a much lower price level than that prevailing today. Much of our
production is not, therefore, from fields that are marginal at
today's higher prices. California is not primarily an active margin
of new exploration and production, like the Overthrust Belt that was
brought in by high prices. California does extract a good deal of "heavy,"
low-quality oil. This fact is often cited in opposition to severance
taxes. For two reasons, this is not a reason for opposing this tax.
a. The extra refining cost needed for heavy oil takes place "after
the Christmas-tree (wellhead)." The severance tax is imposed on
the value of oil at the wellhead, thus exempting any value-added
after the Christmas-tree.
b. Heavy oil is dirty oil. Refining it pollutes air severely, so
it should pay a special tax as a pollution charge. (Economists call
this a Pigovian charge, after A.C. Pigou, a British
economist and advocate.) In this case, it would actually make more
sense to impose the severance tax on value-after-refining. PROP. 87
might be faulted for having too narrow, rather than too broad a
base, in this special case. In general, though, it would work better
to impose a Pigovian pollution charge on its own merits separately.
It should be tuned to pollution damages, rather than value-added in
With increased awareness that global warming is real, and a
problem, the case for taxing combustion, and the fossil hydrocarbons
that fuel it, is now so strong that many people would favor
severance taxes for this reason alone.
Some oil is now being extracted using costly advanced recovery
techniques, like steam injection. This is another matter, because
these costs are undertaken before the Christmas tree, and add to
wellhead value, the tax base. It is against our interest to
discourage advanced recovery by taxing the values it conserves.
Objective facts are needed concerning the relative importance of
this special cost factor. Where oil revenues are 95% consumed by
costs of extraction, there is little net rent remaining to tax at
Evidence cited above suggests that the marginal portion of
California oil and gas production is not so great as to make most
California production untaxable. It is only traditional, in any
industry it is proposed to tax, for industry speakers to exhibit
marginal firms and marginal lands as though they were typical. These
are the "widows and orphans" of every tax debate, advanced
to distract attention from the high taxable surpluses received by
the more rentable (rent-yielding) fields.
2. The basic resource is supplied originally by nature, not man.
Like other forms of land, it comes in a fixed quantity.
Most oil has a low "elasticity of production." That is,
marginal variable costs of O&M per unit are low relative to the
value of the unit. In economese, the marginal product of the current
variable inputs is low relative to their average product. That
implies you could cut back on O&M by, for example, 10%, and by
so doing lower output only by, say, 2%. This is at the other extreme
from a labor-intensive operation where lowering the labor input by
10% would lower output by 9% or even 10%. The difference is because
oil to some extent produces itself, with minimal help from man: this
is why oil in the ground sells for such fancy prices.
The points above may be expressed equally well in terms of costs
per barrel of oil. Costs/barrel are simply the reciprocal of
value-of-product/unit of input. The above reasoning says that the
costs of squeezing out the marginal barrel, and converting it to
high-quality oil, may be high, while the average cost per barrel
(including the low-cost barrels) remains much lower.
C. Only a little of world supply comes from California. In fact,
only part of California supply comes from California: much comes
from Alaska. The middle east and Latin America stand ready to move
in were California prices to rise much. Hugo Chavez is more than
eager to supply American demands, and only doctrinaire bigotry would
bid us refuse him. Albertas fabled tar sands, containing more
reserves than Saudi Arabia, have at last come on line. The giant
machines needed are made in Milwaukee, abating any balance of
payments problem. Thus, even if world demand were inelastic, demand
for California oil would be highly elastic.
D. The proposed tax (severance) does hit marginal production. We
will see (IV, infra) that this fault would be considerably offset by
a drop in private royalties. These, like the severance tax itself,
are a variable cost. They are based on units-of-production, and have
the same disincentive effects as the severance tax. Private lessors,
anticipating the severance tax, would offer about that much less to
landowners in the form of royalties.
The remaining faults of a severance tax may be corrected by
modifying it, as will be shown, to allow deduction of some costs.
IV. The severance tax does have some disincentive and
anti-conservation effects on producers. However, these are only
moderate compared with excise taxes on other bases. This is owing to
the nature of the resource, and the institutions of the industry.
A. It is the nature of oil and gas fields to yield very high
returns, with little variable cost, in a few "bonanza"
years, followed by a long "tail" of dwindling yields over
many years or decades. Then finally they go on a "stripper well"
basis at the end of a long cycle. During the bonanza years, a 6% tax
on yields has little effect. During the stripper years, it is
possible and, in some jurisdictions, routine to lower severance tax
If the explorer for oil finds nothing, it is no matter. If he does
find something, revenues are so much greater than variable costs
that a severance tax has little impact. After production declines,
variable rates may be renegotiated, and often are. It is generally
feasible to distinguish the bonanza years from the stripper years,
as a practical matter.
B. Much oil and gas is produced by lessees who have negotiated
payment packages with private, public, or aboriginal landowners.
Part of the payment is always a "royalty" element. Like
the severance tax, the royalty is a share of well-head value. The
lowest royalty rates are 1/8, or 12.5%, more than double the
severance tax rate proposed in PROP. 87.
Such rates have been standard since the beginning. In the last 50
years they have risen well above the old standard of 1/8. In Saudi
Arabia they have long since risen above 50%, with no noticeable
disincentive effects. Many other private and public lessors,
following the Saudi lead, have broken out of the old mold (imposed
and long enforced by a unified group of major lessees) and raised
royalty rates to high levels. Alaska, for example, takes a royalty
from Prudhoe Bay, plus a 12.25% severance tax, plus a transit tax on
use of the Trans-Alaska Pipeline, plus a tax on profits of oil
In such perspective, the 6% severance tax proposed in PROP. 87
seems trivial as a variable cost. The existence and prevalence of
high royalty rates within the industry itself, voluntarily
negotiated by private parties, indicates that they do not regard
variable charges on production as significantly aborting economic
Where a severance tax does drag down the rate of extracting oil,
the loss is not total. Deferring is not destroying or aborting. The
power of falling water, if not used today, is lost forever. Oil is
different: less now means more later. Mis-timing may indeed result
in substantial net economic losses, considering the time value of
money. I do not minimize such losses, which most people, and even
petroleum engineers, undervalue. However, many conservation-minded
people, including some inside the industry, make the case that such
deferral is a net social gain. One of its benefits is alleged to be,
and may actually be, that slower extraction rates increase the total
quantum ultimately recovered. On such grounds, engineers have
traditionally referred to a slow rate, that maximizes ultimate
recovery while disregarding the time-value of money, as the Maximum
Efficient Rate, or MER.
On balance, tax-induced deferral is a net social cost. However, in
the larger context, tax-induced drag offsets subsidy-induced
acceleration of extraction rates, and is not obviously, on balance,
a net social loss. For example the depletion allowance
of the Federal income tax, which still applies to stripper wells, is
a kind of negative severance tax, i.e. a subsidy to
rapid extraction. It is at tax rates much higher than the 6%
severance rate we are considering here.
C. In negotiating new leases on private land, lessees would
probably offer lower royalties than now, in light of anticipated
severance taxes to fall on the lessee. Lessors would have to accept
them. Thus the variable charge imposed by the State would probably
be offset by lowering the variable charge paid to lessors.
It is true that lessors would then have lesser incentive to
produce, but their incentives are hardly relevant. In the standard
lease, production rates are determined by lessees. Lessors' incomes
are almost purely parasitic, and useless as incentives. The standard
lease terms simply recognize that lessors serve no economic
function. The State might tax their royalties 100%, with little
There are other possibilities, which lawyers writing the fine
print in leases will want to cover, but we will leave the elegant
variations to them. In general, lessees subject to future taxes
might lower either the royalty rate, as above; or the "bonus
bid" paid up front. If they lower bonus bids it is another
social gain, because it tends to ease entry into the industry, and
increase competition. Thus, either way the market goes, imposing the
new tax would lead to an offsetting gain.
D. It is an interesting question how a new severance tax would be
split between lessees and lessors under existing lease contracts. It
seems most likely that existing contracts, if not simply silent on
the matter, provide that a royalty owner receiving X% of wellhead
value would also bear X% of the tax; and also that contracts that
are silent would be interpreted in that same manner.
With incentives in mind, it would be most desirable to structure
the proposed severance tax so that it would all come out of
royalty-owners' shares, and none out of lessees' shares. This would
eliminate disincentive effects on extraction rates, since royalty
recipients have no control over such rates.
With distributive consequences in mind, however, the matter is not
so clear. It is possible that lessees as a group are fewer, and
wealthier, than royalty-recipients as a group. Facts are needed on
concentration of ownership. A full-scale study is called for.
Ownership of resources, and of corporate shares, are both
traditionally shrouded in secrecy. Indeed, proposing and carrying
out such a study might be more of a public benefit than the proposed
tax itself. Perhaps the most politic way to proceed is first to
impose the tax at a high rate, on the assumption that ownership is
highly concentrated; then let those taxed press, if they will, for a
study of the concentration of ownership. Of course, that assumes an
administration not dominated by the industry, something we have not
seen for a while.
E. Intergovernmental relations.
1. The severance tax, like many other state taxes, would be
deductible from the Federal income tax bases, both corporate and
individual. Thus, from the State view, its disincentive effects are
partly abated by an added contribution from Washington. In this
respect it is superior to the most likely alternative state taxes,
on retail sales. These are not deductible.
2. Federal income tax treatment of income from minerals,
especially oil and gas, is generally very lenient on the taxpayer.
In tax lingo, this tax source is "unpreempted." There is
vast "tax space," a vacuum this or any State might
This answers the concern that might be raised about any tax on
minerals, however structured: will it erode motives to find new
mineral sources through exploration? The U.S. Congress is so
unreasonably generous in this regard, the rents are there for the
State to take.
F. Refiners and distributors.
Most of the oil industry is vertically integrated, so shifting a
tax from one stage to another is mostly arbitrary, determined by
internal transfer pricing policies. To the extent that competition
prevails, however, tax incidence depends on the relative supply
elasticities. Whichever stage of production has the most inelastic
supply conditions will bear most of any tax. In this case, for
reasons given, elasticity of supply of oil and gas in situ is
probably less than that of refining services. As to distribution
involving pipelines, these operate everywhere under quasi-monopoly
conditions, mostly in vertically integrated form. Questions of
shifting are primarily institutional, depending on the facts and
agreements of each case. There is no general simple theoretical
answer to the outcome in such cases.
In one sense a drag on extraction rates may benefit refineries.
They may save capital by building less capacity, and using it over a
G. Air pollution
A severance tax has been advanced as a surrogate for a Pigovian
pollution charge. It is not a good surrogate, in general, because it
only slows down the flow of California oil. Unlimited foreign oil
lies in wait to replace it.
On the other hand, see comments on heavy oil, supra.
V. The severance tax may be improved by allowing certain cost
The idea of a severance tax is to tap the rent from oil and gas.
Rent is the value given by nature, before man adds value. Ideally, a
severance tax would be imposed not at the well-head, as now
proposed, but at the well-foot, before the costs of lifting. There
are several standard approaches to allowing cost offsets, to move
from simple wellhead value to something approximating what we may
call a true or pure severance tax. I will mention three.
The net proceeds tax has something in common with an income tax,
but with important differences. The ordinary income tax is in personam
(human or corporate), so funny things may happen en route to the tax
base. For example, overhead from headquarters in Houston or New York
may be over-allocated to a California field, wiping out much of its
net income. The net proceeds tax avoid this. It is based on the facts
of particular fields or deposits, regardless of the owners' other
circumstances. Only expenditures in situ are deductible.
- A. Sliding rate based on flow. The idea here is that low-cost
(high-rent) wells flow faster than high-cost (low-rent) wells, so
the tax rate rises with the flow per well. This is clearly an
approximation based on an incidental attribute of most low-cost
wells, rather than low cost itself. Like any approximation, it
will give results that only approximate a sought-for outcome. In
some cases it will be far off target.
B. Use of rate classes, based on known standard recovery
techniques. Under this system, wells are divided discretely into
those using primary, secondary, and tertiary techniques. Oil
from steam injection, a costly advanced technique, would be
taxed at the lowest rate; modern gushers, if any, at the
highest. The workability of the system depends in part on there
being no "gray areas" between the standard recovery
techniques. Its even more general weakness is that it is based
on distinguishing among techniques, rather than the natural
resource to which applied.
C. Redefining the tax base to exclude costs of extraction.
This is getting to the "well-foot" basis of valuation
cited above. The common American term for this tax base is "net
proceeds." It is used in Nevada, Idaho, Utah, and South
Dakota. It has eloquent expositors in Australian economists Ross
Garnaut and Anthony Clunies-Ross, who have helped implement the
system in Papua-New Guinea.
The theoretical purist may prefer some scheme for perfect
allocation of overhead to specific fields, for otherwise such
overhead is not recognized as a legitimate cost. There are practical
reasons, however, for preferring the net proceeds-in-situ approach.
1. Local tax authorities are not equipped to audit the books and
evaluate the allocations made by multinational firms, nor would the
firms want them to;
2. There are strong sociological, anti-trust, and local reasons
for embedding some bias against large, absentee owners;
3. It is widely believed that almost all large American firms
would gain by cutting their administrative overhead. In addition,
field operations are more purely productive. Some of the
expenditures of central offices are for machinations that may
benefit the firm at the expense of the public good.
Any of those modifications of the severance tax will lower the tax
base. The lost revenue may be more than regained, however, by
raising the tax rate. This, indeed, is a major purpose of removing
non-land costs from the tax base: it allows the Treasury to tap more
of the pure surplus from low-cost fields, without jeopardy of
aborting production from high-cost fields, or marginal production
from all fields.
A tricky question with taxing net proceeds is that of when to let
capital costs be deducted. The subject deserves more time and space
than available here; the writer has addressed it elsewhere.
Rent has been informally defined as "fat in the private
sector." To tap rent for public purposes there are two
requirements. First, the tax base must be a source of rent; second,
the tax itself must not abort or destroy rent. Oil and gas are
indeed a source of rent. The severance tax would abort only a minor
share of it, and this flaw may be remedied by modifying the tax to
allow reasonable cost deductions. These would permit raising the
rate to secure more of the rent from low-cost fields.
Editor's note: For GroundSwell space reasons, the above
article's footnotes were not published, but they are available on
request from the author.