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Fracking Tax Issues and Logistics

Hydraulic fracturing is being touted as a revenue bonanza for the 35 states that have shale gas potential, but it's not without its issues.

AP/David Smith
New revenue streams are seemingly few and far between. That's one reason so many states have been considering online gambling -- and now, fracking. Hydraulic fracturing -- one of Governing's issues to watch for 2012 -- is being touted as a revenue bonanza for the 35 states that have shale gas potential. A survey by the nonprofit, nonpartisan Resources for the Future (RFF), which conducts independent research on energy and natural resources, reports that of those 35 states, 23 have severance taxes (also known as excise taxes on natural resources) that would apply to gas captured through fracking.

Ohio is one of those states, and its governor, John Kasich, recently proposed raising the tax to pay for an income tax cut. In the next few paragraphs, I'll break down the issues surrounding the fracking tax.

The value of fracking: To get a sense of how much money we are talking about, I pulled revenue estimates for fracking in Ohio and New York state. I should caution that all estimates be taken with a grain of salt as projections vary depending on the political position of the reportee. Regardless, each state is looking at a lot of money. A June report from the libertarian Manhattan Institute looked at what fracking would be worth to New York if and when that state ends its current moratorium: $11.4 billion in economic output and $1.4 billion in tax revenues.

In Ohio, a state rich with fracking potential thanks to the Utica and Marcellus shale formations, the left-leaning Innovation Ohio estimates that if fracking is allowed to go forward, oil and gas drillers will realize at least $85.9 billion over the lifetime of the natural gas wells. Based on estimates of the amount of oil within Ohio's shale, the industry could reap an additional $130 billion to $550 billion from its production. In terms of revenue, that means Ohio could net between $666 million and $1 billion over the next five years through the new oil and gas tax structure under consideration.

How a fracking tax works: States use a severance tax on the extraction of shale gas. That is, the tax is applied to all natural gas that is severed from its source. In 18 states, the severance tax is a percent of the market value of gas; in five, it is in dollars-cents per cubic feet. According to the RFF survey, the percent of tax that states apply ranges from a low of 1 percent to a high of 9 percent. For cents per cubic feet, most are around 2 cents. Ohio's rate is 2.5 cents per cubic feet -- which converts to a 1.1 percent severance tax at today's gas prices, according to Madeline Gottlieb, a research assistant at RFF. By way of comparison, West Virginia and Michigan impose a 5 percent tax on oil and natural gas; Texas, 7.5 percent. Innovation Ohio estimates that if Ohio were to raise its severance to the equivalent of 5 percent, it could generate $1.7 billion in new revenue over the next decade. If it raised it to 7.5 percent, that figure jumps to $2.5 billion.

The sway of Impact fees: In addition to new severance taxes on fracking, Kasich's proposal is likely to include an impact fee -- money companies would pay to fix the roads their heavy trucks and equipment damage in Ohio's rural towns. The impact fee is likely to be based on a fee per hole drilled, with 100 percent of the proceeds staying at the local level for road maintenance. Pennsylvania and West Virginia, Ohio's closest fracking competitors, already assess such fees. Pennsylvania, which has no severance tax, sends a portion of the impact fee to the state -- in that sense the fee works like a tax.

A no-brainer to pass: Passing or raising taxes is never an easy matter, but relatively speaking, fracking is low-hanging fruit. A tax on it usually has popular support and, given the questions raised about the damage the fracking process may do to the environment, many in the industry see a tax as a way to boost fracking's appeal to the public. With a severance tax common in states where drilling has gone on for a long time, the industry is accustomed to paying it -- as long as those taxes are at the low end.

Kim Rueben of the Urban Institute's Tax Center notes that "taxing something like fracking is a way to make energy users (who typically don't live in the state) bear some of the costs of energy extraction. In theory, it seems like a good idea to tax the activity if for no other reason than to help pay for the externalities that may arise from the activity. Also, states typically tax activities that use natural resources to account for the fact that there are societal costs and also these resources may not be renewable."

Even when industry opposes the tax, the state has leverage. As Dale Butland, an Innovation Ohio spokesman, has put it: "You want to drill in shale, you have to go where the shale is and Ohio has it. It's completely implausible that these companies are going to leave billions of dollars in profits on the table if they are asked to pay the same tax rates that they already pay in Texas."

Elizabeth Daigneau is GOVERNING's managing editor.
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