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Where Are We on the Wolf Severance Tax Proposal?

severance tax

Charles A. Schliebs
Managing DirectorStone Pier Capital Advisors, LP

 

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What are the prospects for Tom Wolf’s proposed severance tax after losing the first round with the Pennsylvania legislature? Charlie Schliebs evaluates.

When we published our last issue of our company newsletter in July of last year, we were simply waiting for the 2015-16 Pennsylvania budget to be approved by Governor Wolf before publishing the next issue, in which we planned to explain how the key budget compromises were made and what they meant for the shale gas industry, not only in Pennsylvania but also in adjoining states.

Well, we waited, and we waited, and we waited, and things were really never solved. Instead, the Governor lost on all accounts (shale gas severance tax and otherwise) and all the cans were kicked down the road for another try with the 2016-17 budget due at the end of this month, June 30, 2016. What happens next with the 2016-17 budget? Well, let me offer some observations.

Initially, everyone seemed to predict that, once again, the June 30 deadline would not only be missed, but also that an actual budget would again go months thereafter before being approved. But, a couple things happened to potentially change our view of this prediction.

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Pennsylvania State Capitol

First, we tried to get various leaders in the legislature to speak at the important Northeast Petrochemical Construction Conference to be held in Pittsburgh on June 27-28, 2016. Uniformly, all House and Senate leadership said they had to be in Harrisburg at that time since they expected a budget to be submitted and approved on or before June 30. The response was so uniform that we made some inquiries.

It appears that there is so much public disenchantment with the hardships that a late budget caused last year that both Democrats and Republicans are focused on making sure there is a timely approved budget. Of course, we are not sure such a result will occur, but we have heard it enough that there may be some truth in it. We certainly hope it works out that way, as long as Governor Wolf does not get his solution to all budget problems—higher taxes without even exploring alternatives.

Specifically, where are we on the Wolf severance tax proposal? For a complete summary of all the versions of severance tax proposals from Governor Wolf in connection with the last budget, see our earlier post here. For his 2016-17 budget effort, Gov. Wolf has come up with yet another poorly researched proposal for a severance tax singling out shale gas to the exclusion of all other natural resources: 6.5%, with the impact fee going away.

What Gov. Wolf and so many do not realize is that when prices are really low, as they are now, the existing impact fee actually raises more money that a price-based severance tax. If only Governor Wolf had long ago accepted a proposal to adopt his proposed 5% severance tax with the Impact Fee as a credit, he would have had the higher revenue levels under low gas pricing, while benefitting from the full 5% tax when prices rebounded to higher levels.

But, no, that would have involved work such as straightforward analysis and perhaps having constructive discussions with the oil and gas industry as well as those legislators who recognize the industry’s value to the Commonwealth, and Governor Wolf made it clear he was going to do no such things.

Governor Wolf’s many misrepresentations during Round One of the budget battle in 2015 (see the earlier referenced materials) have created a situation where no one in Harrisburg trusts him with financial figures, not even his own party stalwarts. There is way too much bobbing and weaving, without sufficient specificity, always leaving him room to maladroitly maneuver around the numbers.  But for the recognition by both parties that the budget deadlock needs a solution by June 30 if at all possible, the negative feelings among the Governor and so many of his constituencies would seem to make a legitimate negotiated compromise once again unlikely. So, where do we go from here?

For the new budget year of 2016-2017, Governor Wolf has proposed a 6.5% severance tax, with a credit for the impact fee (borrowing the impact fee credit idea from my advice to him and the advice of many others).  However, as is often the case the Devil is in the details.  I find that very few supporters, or frankly critics, of Governor Wolf’s severance tax proposal, who have actually read the report on Governor Wolf’s revenue proposals for the new budget year.

Let’s see what the state government’s own Independent Fiscal Office (“IFO”) has to say about Governor Wolf’s continued claim that his tax is “right in the middle” of other states’ severance taxes.  [The IFO is roughly analogous to the Federal Government’s nonpartisan Congressional Budget Office, providing nonpartisan analysis to the General Assembly as the CBO does to Congress.]

The April 20, 2016 Analysis of Revenue Proposals FY 2016-17 from the IFO is mandatory reading for anyone having an opinion, or wanting to have an opinion, on any proposed severance tax in Pennsylvania (start reading on page 10).  As regular readers will recall, when IFO reviewed Governor Wolf’s previous proposal, it projected that the Wolf proposal would result in the highest severance tax in the nation. This time, after a thorough analysis, the IFO concluded that “…the analysis finds that the total lifetime ETR [estimated tax rate] for Pennsylvania is the highest among comparison states” [emphasis supplied].  Those comparison states are Arkansas, Louisiana, Ohio, Oklahoma, Texas and West Virginia.

Severance Tax

Anyone who believes that we should take the approach of Governor Wolf is either not understanding the IFO report, not reading it, ignoring it, or simply wants to make sure that Pennsylvania’s position in minimized as deposits in Ohio and West Virginia become more of a focus, and the newest estimates show dramatic shale reserves in other states like Colorado.

The IFO analysis is too detailed and nuanced to set forth in its entirety here, but please consider studying it carefully before taking any position on the severance tax topic.

As mentioned elsewhere in this issue, we are seeing companies exit Pennsylvania for neighboring Marcellus / Utica states, and other basins as well.  Yes, the gas is here and it is not going anyplace, but it can be drilled last.  Perhaps, someday soon, Governor Wolf will realize that.

P.S. In my previous article here, I generally used “Wolf Administration” in lieu of “Governor Wolf” because the actions of the Wolf Administration in connection with the severance tax did not square with most of what I thought I knew about Tom Wolf, his intelligence and thoughtfulness, and his common sense and historical effectiveness in business.  As a member of his Transition Team, I tried to be optimistic, and tried to believe that as a political neophyte he may simply be taking some very bad advice from poorly selected subject matter experts.  Sadly, I can no longer give him that benefit of the doubt.

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