How Pa. can get severance tax right

Perhaps Gov. Wolf and the Pennsylvania legislature should take a break from their budget and tax battles and spend some time in Norway. Or keep the costs down by visiting North Dakota instead.

Both Norway and North Dakota are model petro-powers. Both sit atop massive oil resources and yet they have devised ways to avoid the common "resource curse" that so often afflicts major producers of nonrenewable energy like oil, gas, and coal.

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The Drake Well, near Titusville, Pa., often cited as the nation's first commercial oil well.

Indeed, North Dakota, which boasts the largest Norwegian American population of any state, formally borrowed and put to use a bunch of Nordic ideas. All were aimed at securing reasonable amounts of revenue from extraction for the public good but not becoming so dependent on those sources that they would succumb to the inevitable boom-and-bust cycle.

For Pennsylvania, this is familiar territory. Prices hit $10 per barrel within one year of the Titusville oil discovery in January 1861. But those prices plunged by 99 percent, to a dime a barrel, one year after that.

The Keystone State has been living with some form of boom-and-bust ever since. And it has never quite figured out what to do with severance taxes, a common tool used in 35 other states to capture some of the value from a resource that is permanently being extracted for commercial use.

In the North Dakota case, the state operates two overlapping severance taxes that have captured 11.5 percent of the gross value of extracted oil. During the recent legislative session, it reduced that rate to 10 percent, but with triggers that would increase the rate as the price of oil increases.

The taxes produce considerable revenue - $2.5 billion in fiscal 2013, the year North Dakota was ranked second among the states in oil production. This is more than 10 times what Pennsylvania captured in the same year - when it was No. 2 among states in gas production - from its non-tax impact fee, set at an effective rate of 1 or 2 percent.

So North Dakota captures fair amounts of revenue that Pennsylvania leaves on the table. But it has also taken significant steps not to follow the resource curse playbook and blow it all at once.

Instead, North Dakota amended its constitution five years ago to create a Legacy Fund. This is a formal trust fund that captures 30 percent of the annual tax haul and sets it aside for long-term investment.

Only portions of the fund can be spent in each legislative session and any initial expenditures are delayed until 2017. Proponents wanted to allow time for the principal to grow and serious study of spending options to occur.

The idea here was permanence, preparing North Dakota for inevitable production declines and long-term needs. Republicans and Democrats in the state generally agree on the merits of the trust fund, and it was endorsed by a large margin in a ballot proposition.

The parallels with Norway are really quite strong, including its world-class sovereign-wealth fund that is setting aside and investing oil money to address the Norwegian equivalent of Social Security. Extract now, don't spent it all at once, and think longer term.

Imagine if Pennsylvania had set up a severance tax and trust fund in the 1860s. Or during any of its subsequent booms of oil, coal, and gas production. Neighboring West Virginia has been kicking itself for dropping the ball on its own long-term extraction of fossil fuels. In 2014, it created a much smaller version of the Legacy Fund, while beginning to consider expansion options.

Instead, Pennsylvania is locked into another ugly battle over this issue. The governor wants a tax and wants to spend it now. The legislature does not want a tax and is looking for ways to cut other taxes to encourage more drilling. Industry is threatening to move to Ohio if a tax is created, even though that state's Republican governor - presidential aspirant John Kasich - has made a major severance-tax increase a top issue in Columbus.

Harrisburg isn't Oslo or Bismarck. But as the latest severance-tax standoff continues, it should be noted that other oil and gas superpowers have found ways to sustain a viable tax regime and extended production. They have also found ways to use it not only for short-term bounty but longer-term needs.


Barry G. Rabe is a public policy scholar at the Woodrow Wilson International Center for Scholars in Washington and a professor at the Gerald R. Ford School of Public Policy, University of Michigan.

brabe@umich.edu