Dotzenrod: ND erred badly by cutting oil tax
On Jan. 1, North Dakota's oil extraction tax dropped from a rate of 6.5 percent to a new lower rate of 5 percent. That change may seem small, but the loss in revenue to the state is around $11 million a month or $132 million a year, using a North...
On Jan. 1, North Dakota’s oil extraction tax dropped from a rate of 6.5 percent to a new lower rate of 5 percent. That change may seem small, but the loss in revenue to the state is around $11 million a month or $132 million a year, using a North Dakota oil price of $25 a barrel.
Most states carefully guard their mineral resource income. So why would the North Dakota Legislature voluntarily reduce the tax on oil and forgo state revenue that is quite significant?
The price of oil was dropping during the 2015 legislative session. If the decline continued, the “trigger” provisions of the out-of-date, pre-fracking, pre-horizontal drilling law from 1987 would require the state’s 6.5 percent oil extraction tax to drop to an effective rate of near 1 percent.
This old, conventional-well-era law provided that if oil prices began to average below a pre-determined “trigger” price (of around $55 a barrel), then the tax rate would plummet.
Conversely, if oil prices rose above the “trigger” price, then the 6.5 percent oil extraction tax would return.
If left unchanged, these “trigger” provisions would provide a dramatic cut in taxes to the oil industry and an unacceptably large loss of revenue to the state.
While these “trigger” provisions reduced the state’s 6.5 percent oil extraction tax to near 1 percent, they had no effect on the 5 percent gross production tax on oil, which generally functions as “local impact money” for schools, roads, local government and so on in the area where the oil is produced.
It became increasingly clear that the “trigger” tax break of 1987 no longer fit with today’s level of industry activity, impact and development. The move to abolish the “trigger” was supported by virtually every member of the Legislature and passed the Senate unanimously when voted on as a separate proposition in 2013 and 2015.
What made the bill (as approved in 2015) controversial was the insistence by the legislative leaders that the elimination of the 1987 “trigger” tax law had to be coupled with a permanent cut in the oil extraction tax from 6.5 percent to 5 percent.
In the closing days of the session, with only one week to consider the bill from introduction to final passage and almost no time for citizen input, it passed on a very divided vote in both chambers of the Legislature.
So, it is now law. The “trigger” is gone, and the 6.5 percent oil tax rate now is a 5 percent oil tax rate.
Eliminating the “trigger” was widely supported and needed to be done, saving an estimated $26 million a month (using a North Dakota price of $25 a barrel) of otherwise lost tax revenue. But if the oil tax rate had been left as it was, the savings would have been $37 million a month.
The $11 million difference between these two numbers is the amount of lost tax revenue due to the rate change from 6.5 percent to 5 percent.
And the effect of this cut in the oil extraction tax could be quite high because it will be in place even when oil prices rise. For example, had this cut been in effect during the 2013-15 biennium, the revenue loss would have been well over $600 million.
Over many years of activity in the Bakken Formation, even with lower oil prices, this tax cut will mean billions less for critical water projects, infrastructure development, K-12, property tax relief, higher education and the state’s Legacy Fund.
The decision to cut the oil tax was a missed opportunity for the future of North Dakota. The Legislature could have eliminated the 1987 “trigger” tax provisions and left the tax rate alone at the 6.5 percent rate approved by the voters in a statewide ballot measure in 1980.
The oil tax rates that prevailed in our state yielded the biggest oil boom in state history and made us the second largest oil producing state in the nation. Those rates placed us just below the middle of the range of the eight major oil-producing states when comparing their overall set of oil industry taxes to ours (according to Covenant Report, December 2012).
It would be hard to argue that our rates were too high compared to other states or were holding back activity in the Bakken.
North Dakota, like other oil and agriculture states, will have to make adjustments, and difficult budget decisions will be made as we work through this time of lower commodity prices.
Nevertheless, the decision of the 2015 Legislature to lower the tax on oil was an avoidable loss of present and future state revenues that certainly will limit our public policy choices for years to come.