Can Papa Oil Save Us Again?

Did Oil Taxes Cause the Problem? Can They Fix it?

Medium Grind – News and Analysis

Last week Rep. Les Gara (D-Anchorage) received a response to a list of questions he’d sent Tax Division Director Ken Alper back in January. Gara issued a press release Thursday with his interpretation of Alper’s response; Monday Gara’s HB 326 was introduced. The bill is an oil tax revision that Gara describes as an attempt to contribute to a more balanced and fair fiscal plan.

In the release Gara described Alper’s response as an “analysis,” and the document spurred some angst in the Capitol for at least a few minutes. It was mentioned at Thursday’s House majority press availability. House Speaker Mike Chenault (R- Nikiski) lamented that the Department of Revenue was somehow able to provide analysis to minority member Gara, but that the department had been slow rolling responses to majority questions from committee members this session. In fairness to Alper and Gara, the letter in question was sent Jan. 16, and the questions relate to the current oil tax structure. The questions majority members are asking this session relate mostly to Governor Bill Walker’s budget and fiscal proposals that are new in the Legislature this year. It’s also probably fair to describe Alper’s response as answers to some questions, rather than an analysis. That said, the new bill spins yet another twist into this year’s fiscal debate, albeit the most familiar twist of all.

The point of introducing an oil tax bill at this late juncture, Gara said, is to ensure everything is on the table during the budget and fiscal debates dominating this legislative session.

“If you’re going to ask people in the state to give up a big portion of their dividend, which is what some people are doing,” Gara said, “we have to put everything else on the table too, so we can talk about it. So things can be balanced.” It’s the talk of dividend reductions, along with further operating budget cuts, that weigh most heavily on Gara’s mind.

 

How Much Wood Does This Woodchuck Chuck?

So, in terms of getting more economic logs on the fire that keeps government services steaming along, how does Gara’s bill stack up? As with any oil tax ... it depends. Net profits taxes are impacted by myriad moving parts and spinning gears. But whether it’s net- or gross-based, all oil taxes are most dramatically impacted by price and production. You don’t need Grinder News to tell you price and production aren’t exactly enjoying their halcyon days right now. Under any of the state’s three previous oil tax regimes, or under Gara’s proposal, we’d still be right here in the hole we’re in.

At current prices Gara’s bill earns about zero more dollars over the current tax structure or over Governor Bill Walker’s modest proposal to raise the minimum tax to 5 percent, instead of the current 4 percent. As a point of reference, the current tax structure has a base tax of 35 percent, but when oil prices fall below about $70 per barrel the minimum tax rate kicks in. Raising the minimum tax means the state earns a bit more at lower prices. Gara’s plan would raise the minimum, but it would also make it progressive, so that as oil prices increase, the tax rate follows them, from 5 percent at the bottom of the scale to 10 percent just before the crossover point where the base profits tax kicks in. More on the structure later, but at current oil prices (around $30/bbl) that wouldn’t move the needle at all, and even at something like $70/bbl it would raise about $300 million additional. The Department of Revenue’s 2016 forecast is $56/bbl, and oil is currently around $30/bbl and has dipped as low as $26/bbl in 2016.

Another provision of Gara’s bill is to make the base profits tax somewhat progressive again, as it was under ACES. Gov. Sean Parnell’s SB 21 established a flat base tax rate of 35 percent. Gara’s bill would range between 20 percent and 35 percent, depending upon the price of oil, but there is a more significant difference. Current law sets the base rate at 35 percent, but that is a nominal number – basically a starting point that is never actually paid by the producers. First they take their qualified deductions, which are basically transportation costs and qualified capital expenses. That reduces the amount of taxable earnings – effectively reducing their tax rate. The rate after deductions is the effective rate. Under current law for everything defined as “new oil” companies can also take advantage of something called the Gross Value Reduction, which basically reduces their taxable amount by 20 percent. It means, for instance, that at between $90 and $100 per barrel instead of paying 35 percent tax a producer only pays about 19 percent. Gara’s bill would do away with the GVR after four years.

One other important change Gara’s bill makes is something Walker is also seeking to do. Right now the state offers a net operating loss credit to companies that do not make a profit in Alaska for a given year. The intent was to help out explorers and small producers who were spending money to find oil and to begin bringing it into production, but that were not yet earning money in Alaska. The assumption was the three majors were not likely to lose money in Alaska. There is evidence this year that at least one of the majors is, in fact, losing money here. If they take the NOL credit it could cost the state real money. It’s a serious problem that needs to be resolved this session.

The challenge is you can’t have a net-based tax without deductions. Even if Gara’s high-end rate is 35 percent, companies will have to be allowed to deduct for transportation costs and qualified capital expenditures. One of the advantages of a gross-based tax is that it basically takes three things into account: How much oil comes out the end of the line; how much is that oil worth; how much of a cut does the state get?

Any net-based structure, no matter how smart you are, is going to be more complex, and it’s going to rely on a fair amount of subjectivity. What is a qualified capital expense? What is actually “new oil” vs. faster production of the old oil? Which credits incentivize wise capital investment and more production? The list is almost endless, and every answer changes the way the tax works – and every administration is likely to answer at least some of the questions differently.

 

Can Oil Save Us Again?

Gara said he wants to put everything on the table, including the notion that the producers shouldn’t get away with what he says is paying zero taxes. One of his arguments is that under the current system oil would have to nearly triple in price before the state started making any real money. Under his own bill oil would have to more than double in price before measurable revenues are earned, and at the forecast price of $56 per barrel, which may be less when the new forecast is released, his bill does little more than the governor’s proposal relative to the $3.6 billion fiscal gap. For those first four years while Gara’s bill maintains the GVR calculation it doesn’t even perform significantly better at higher prices.

All that aside, it’s not Gara’s fault, any more than it’s the fault of Parnell’s SB 21, or really the fault of the major producers. Oil prices are low, and production in Alaska continues to decline. The primary stated goal of SB 21 was to encourage capital investment to generate more production. It would presumably do that by creating a more attractive tax climate in relation to other provinces. Whether or not that philosophy was legitimate is no longer relevant in the current economic climate. At these prices the last thing Alaskans should want is increased production – why dump a finite resource into a poor market? Fortunately, that’s the last thing producers are likely to want to do, too. The point is there simply isn’t a tax structure that can make oil save us in this market.

Where Gara is likely right is that changes to SB 21 are needed, and that oil is not likely to be $30/bbl forever. The GVR might have been a reasonable idea at one time, but it was only initially intended to apply to explorers and small producers who would bring legitimately new oil into the mix. The major producers balked at that notion, claiming most of the “new oil” would come from existing fields. They won and got in on the GVR action. That leaves the Department of Natural Resources the difficult task of figuring out which oil would have been produced anyway, and which oil is actually the result of the GVR. No matter how you slice that, Alaska is likely giving a huge tax break on oil that should be taxed fully.

The problem is, while Alaska’s oil tax structure needs some changes, most of them won’t do anything to contribute to the current revenue shortfall trouble. The governor has legislation to reduce oil and gas tax credits, and that’s where the money’s at in the short term. Updating the decades-old credit structure in Cook Inlet alone could produce hundreds of millions in revenue for the state. Changing the tax structure, which traditionally takes a long time and generates intense battles, won’t produce any meaningful results until, and unless, oil rebounds to somewhere above $75/bbl again, and that’s not likely in the near future.

The Myths That Wouldn’t Die

Finally, HB 326 is more evidence that legislators across the gamut seem to be struggling to accept the new paradigm. Gara said the Legislature has always set oil taxes for the current world, and that he wants to address the future, but he couldn’t say what he thought the average price of oil might be over the next five years. That’s not surprising, nobody’s ever gotten that right. It was really high in 2009, he said, and now it’s really low. It’ll be high and low in the future, too.

“If oil is $1 a barrel it’s not going to be the primary source of revenue,” Gara said. “If oil goes back to 2009 prices and we get back to over $120, $130 a barrel, which isn’t going to happen in the near term, but if that happens again we should be able to generate surpluses and put money into savings and put money into schools and money into the university, which has been cut to shreds, and put money into job training.”

And that’s one myth. It’s the idea that basing Alaska’s fiscal structure on the volatile oil market will always balance out and benefit us in the end. Gara said he’s open to other ideas, and that he wants all legislators to get outside of their ideological boxes, but his statement above is unclear. If oil is not going to be Alaska’s primary source of revenue at low prices, then what is? It’s the question Democrats have always been hesitant to answer, likely because whether we like it or not, some restructuring of the Permanent Fund to stabilize the fiscal boat is really the biggest piece of the solution. It’s hard to know how many of the minority Democrats are in that place. Minority Leader Chris Tuck, (D-Anchorage) still does not reply to requests for an interview, so it’s hard to gauge where the caucus stands on the big picture. Tuck and Gara appeared together at the House minority press availability this morning. Gara talked about his bill; Tuck talked about the need for revenues across the board. Both talked about the futility of massive cuts. In an interview Gara said cuts along the lines of Governor Walker's proposal are reasonable. When asked what their plan would be neither of them, nor Guttenberg nor Rep. Scott Kawasaki (D-Fairbanks) could offer specifics.

The other myth is spoken from the other side of the aisle. Some majority Republicans still recite the epic tale of the giant government that ate Alaska. Sen. Pete Kelly (R-Fairbanks) and Rep. Tammie Wilson (R-North Pole) are the leading voices in the chorus. They’re not willing to talk about revenue measures until the colossus of red tape is cut down to the right size – whatever that might be. The problem is there’s almost nothing left to cut. There are a few efficiencies to be found here and a redundancy or two to be sliced there, but it’s peanuts for a state budget hungry for steak and potatoes. They point to the fact that Education and Health and Social Services still have lots of money in their budgets, but that doesn’t necessarily mean it’s wasted money. In fact, most of it is formula driven and would require statutory changes to reduce it – I don’t see any such bills in the mill. As evidence that cuts can be made Kelly continues to point out that the Legislature cut megabucks from state operations last year and “nothing happened.” Earlier in the week he pointed out that only 37 state workers were laid off. That’s technically true, but it’s a mischaracterization of the facts. There are 600 fewer state workers today than there would have been without those budget cuts. To the credit of the various departments and agencies they were able to avoid more layoffs by encouraging some people to retire and by not filling positions vacated by many others. This year they’ve asked many state workers to take unpaid furloughs to reduce costs in yet another effort to avoid layoffs. Reductions in the workforce, whether from government or from the private sector, ripple through the economy, so it could be argued that something has happened, but we just haven’t all felt the brunt of it yet.

So, while Democrats argue for oil tax reform and against cuts and Republicans argue against oil tax and for cuts, the real problem continues to hang over the Legislature like an anvil. Alaska’s problem, contrary to popular opinion, is not loose spending. The real problem is that the state has gone too long trying to balance its books on a volatile and declining commodity. If the Democrats are right and oil rebounds in some exciting new way, it will be a temporary party, like it always is, but with declining production the parties will soon become shadows of their former selves, and the cleanup will get harder and harder. If the small-government Republicans are right we’ll soon live in a utopia where the government no longer tells you how many salmon you can catch – and no longer provides law enforcement, education or roads maintenance ... or dividend checks.

There are some truly moderate and pragmatic people in the Capitol. As much as they’d prefer not to, they’ve come to grips with the notion that it’s going to take a broad-based approach to fill the budget gap, and that just about ever sector of the state is going to feel some of the pain. How many of them there are and whether or not they can prevent another train wreck at the end of this session is yet to be seen.