A Citizen’s Guide

While House Resources took testimony this morning from BP and ConocoPhillips, Senate Judiciary debated the merits of net and gross taxes. The talk went straight to the heart of the tax debate.

We’ve heard over and over that the goal is to get a fair share of revenue from the resource without discouraging investment, but it’s sometimes unclear whether fair share refers to government take (a percent of income) or simple dollar figures.

Revenue Commissioner Pat Galvin explained that the real and expected shortfalls from the PPT weren’t caused so much by the tax model not working, but more by using a faulty assumption about costs.

“It was an error in an assumption about reality,” he said. Specifically, it cost a whole lot more to produce a barrel of oil than expected, so even if the state got the government take it expected, it got less cash.

Here’s where it comes to the net vs gross debate. With a gross tax, which is mostly based on price and production (and not company costs), the state would have an easier time projecting revenues than under a net. But what is gained for the state in terms of stability is lost by the companies. Under a gross tax, a company’s effective government take could be much higher or lower depending on costs, and that could knock projects off the drawing board. You’d get the dollars you expected, but not the government take — or the investment climate.

“That was a trade off that we didn’t want to make,” Galvin said.

There were a few other interesting things. Galvin talked about a learning curve for the state and oil companies regarding the PPT. Companies probably asked for all the credits and deductions they could, he said, “Most likely we’re going to bring some of those back.” (He suggested that companies will soon offer their own estimates for how much money the state will get under PPT.)

At one point, Sen. Bill Wielechowski asked Galvin to explain how a 35 percent tax could provide a better investment climate for a company than a 25 percent tax. Here’s how I understand it:

When a company with existing production invests in a new project, the value of the tax deduction they get is greater if the tax rate is higher. (It would still be paying the higher tax on existing production.) The company would pay more tax once production started on the project, but because of the value of having money now instead of later, the value of the higher tax deduction early on outweighs the cost of the higher tax rate later (in terms of net present value).

“So it’s good for us to raise taxes?” joked Sen. Hollis French.

“In certain circumstances,” cautioned Galvin.

The committee is back at it this afternoon.