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Save California, Tax Oil

By Saad Asad

Facing a $16 billion shortfall, Gov. Jerry Brown of California passed a budget that makes significant cuts to programs for low-income families and puts tax hikes on the November ballot. Excluded from this rancorous debate was the passage of an oil severance tax, law in states as conservative as Alabama and Sarah Palin’s Alaska.

Oil severance taxes are merely taxes on the extraction of oil. Since the economic activity generated from drilling is only temporal, Californians deserve restitution for the non-renewable energy extraction in the state. A modest tax on California oil extraction could generate up to $380 million. These revenue gains could have helped avoid cuts to child-care subsidies for low-income families ($64 million) and the Healthy Families program ($80 million) during a recent round of budget cuts.

An oil severance tax would only be a small hit to oil companies. Consider  the recent profits of California’s major oil companies: Chevron pulled in first quarter profits of $6.47 billion, and Exxon a staggering $9.45 billion. CEOs of these corporations received $35 million and $25 million in total compensation for 2011, respectively.

Because the price of oil is set at the world market, the tax will not be passed on to consumers but will be held by the local producers. Though the introduction of an oil severance tax could lead to a short-run reduction in supply, this reduction will not increase prices at the pump. California is already an oil importer, so the current price already reflects these transportation costs.

Critics argue this tax would reduce current production and discourage new drilling, forcing more oil to be imported and reducing the economic activity generated by oil companies. However, research carried out for Wyoming’s legislature suggests that oil production is highly inelastic in regards to changes to production taxes (i.e. a severance tax). The report finds that, “a production tax rate increase is shown to decrease early period exploration effort, affect little change in reserve additions and future production, and substantially increase discounted tax revenue. Policy implications of this outcome suggest that state officials may consider raising production tax rates as a way to increase revenue while risking little in the way of loss to future oil activity.”

A University of Alberta study confirms this inelasticity, staging “the simulations are consistent with prior studies in that they reflect insensitivity of oil production volumes with respect to even comparatively large production tax rate changes.” Headwaters Economics, an independent research firm, claims that price is the ultimate driver of oil production in a state, not tax structure.

Another criticism of oil severance taxes is that aggregate state revenues will decline due to decreases in property tax (via devaluations of land) and income tax liability (via decreased profits). A RAND study disputes this point and argues that property taxes would fall 6 cents per dollar for every dollar collected by the severance tax, and the net revenue for every severance dollar raised would be between 84 and 99 cents.

Despite its positive benefits, oil firms have consistently prevented a severance tax from passing via the legislature or the ballot box. Gov. Pat Brown attempted to pass a severance tax in 1959 but failed, as did then Assemblyman Antonio Villaraigosa in 1995. Proposition 11 in 1980, also an attempt, failed 55%-45%. More recently, oil firms defeated Proposition 87 in 2006 by spending $93 million, the most expensive ballot in state history (for perspective: both sides of the same-sex marriage Proposition 8 battle spent a total $70 million).

If California wants to pass an oil severance tax, it needs legislators tough enough to stand up to the vigorous oil lobby. Though the campaign may be tough, it is necessary if the state wishes to save programs for low-income Californians and prevent budget cuts to K-12 or higher education.

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