Last Wednesday, the Louisiana House of Representatives Ways and Means State Tax Structure Subcommittee met for the fourth time in a series of meetings to study the tax structure of Louisiana. Previous meetings were held to discuss an overview and history of various state taxes, including sales taxes and personal and corporate income taxes. This meeting was held to discuss the severance, gas, property, and inventory taxes. For this article, we’ll begin severance taxes and cover the others in future articles.

What is a severance tax?

Severance taxes are levied on the extraction of certain minerals and other natural resources from the soil or ground and include items such as timber, oil, gas, salt, coal, stone, and sand. In recent years, these business taxes are a smaller portion of state revenue than in previous years, collecting only $302 million in the fiscal year 2021, or approximately 5% of the total state revenue. Going back to the 1960s, mineral revenues were over 50% of the state’s revenues. This decline is due to dramatic increases in taxes overall, declining prices, declining production, and a diversification of the state’s economy without oil and gas playing such a large role.

Much of the revenue from these taxes is dedicated to specific purposes. Once collected, there is a portion that is distributed to the parish governments. Still, other dedications include Atchafalaya Basin Conservation Fund, the Coastal Protection and Restoration Fund, and the Budget Stabilization Fund, just to name a few. Some people believe that the dedication of these funds to conservation projects is important, but this means that much of the revenue collected from the severance tax does not go into the state general fund to pay the expenses for the normal operations of the state. Continuing to lock up funds reduces the ability of the legislature to manage the state’s budget.

Louisiana has the highest severance tax rate on oil production of any state, except Alaska, at 12.5% of its value at the time of its extraction; however, there is a lower rate of 4% on natural gas production. Most states tax oil and natural gas production at very similar rates, but Louisiana is unique in that oil extraction is taxed at nearly three times the rate of natural gas. Figure 1 below compares the oil and gas tax rates among the southern states.

Figure 1. Oil and Gas Tax Rates Among the Producing Southern States

Generally, good tax policy consists of low rates on the broadest tax base, meaning fewer exemptions and exclusions. Louisiana has a severance tax exemption on horizontal drilling, which is generally used in shale production of 100% of taxes owed for the first two years of a well, with some limits. Louisiana is not the only state with an exemption or reduced rate on horizontal wells, but it is unique in the large exemption. There are also exemptions for less-producing wells. Over half of the potential severance tax revenue is not received due to the exemptions for horizontal drilling. The LSU Center for Energy Studies concluded in a recent study that “it is unlikely that the horizontal drilling exemption was needed to spur production in the Haynesville Shale region.”

Having such disparate taxes on two different hydrocarbons (oil and natural gas) creates economic distortions. A tax structure should be as neutral as possible so that investment decisions are made based on the economics of the cost to produce and the value of the resources, rather than the government picking winners and losers through tax structure. This can affect which hydrocarbons a producer can decide to pursue, impacting the areas of the state that are developed, which areas have more oil or more gas, and specific drilling strategies to use.

When considering reforming the structure of severance taxes, two things should come to mind: level taxes between oil and gas and implement a broad base and low rate. The disparity between oil and gas taxes creates distortions in the economy induced by the government, while the exemptions on certain types of natural gas production cause a higher rate to be maintained. Legislators should consider decreasing the disparity between the two hydrocarbons, bringing Louisiana more in line with neighboring states while also considering a reduction in exemptions on certain natural gas production. This will create a level playing field for all producers in the state, removing the implication that government picks winners and losers.