What Really Happens When You Cut Taxes On Oil Companies (Updated)

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An oil pump in the wilds of Alaska.

Tax cuts are often spoken of as an unalloyed good in American politics. But the state of Alaska is learning the hard way those cuts — especially when they are for taxes on oil companies — don’t always deliver as promised.

Alaska is the only state with neither a state income tax nor a state sales tax. For revenue, it relies entirely on federal funding and various taxes on oil production in the state. Back in 2013, the oil taxes were altered by legislation passed under former Governor Sean Parnell (R). The logic of the bill — which flattened the tax rate, thus cutting the tax burden for high-dollar oil profits and raising it for low-dollar profits — was that it would spur renewed oil industry activity in the state. But that expected economic ferment has not materialized. And now, as the price of oil drops lower and lower, Alaska’s state budget is falling well into the red.

“[I]n recent years taxes on oil production have covered more than half the total budget ($13.5 billion including federal funds and capital projects) and 90 percent of the state’s discretionary spending ($6.5 billion to run agencies and schools),” the Washington Post reported on Wednesday. “Now, with prices under $70 a barrel, the budget deficit could balloon to more than $3 billion, about half of the state’s discretionary spending level.”

According to work in mid-2014 from Alaska’s Institute of Social and Economic Research (ISER) — when the revenue hole in the oil tax was anticipated to be $2.1 billion for this year — the overwhelming majority of the drop was due to the change in oil prices. Whether the old or new tax regime will bring in more revenue is disputed, but another ISER study projected that, under the most likely assumptions for future oil prices and production costs, the old structure would’ve brought in about $1.3 billion more revenue over the next five years.

Newly-installed Governor Bill Walker — an independent who quit the Republican Party to run a joint-ticket campaign with Alaska’s Democrats in the recent midterm elections — supported a referendum to undo the tax cut, but it was narrowly defeated by voters back in August. Walker also supported taking up the expansion of Medicaid — the joint federal-state health insurance program for the poor — that’s on offer under the Affordable Care Act. Parnell had resisted the move, citing cost concerns.

In November, Walker told the Alaska Dispatch News that “he doesn’t plan to offer changes to the tax structure this session. But he plans to monitor whether the tax is having the desired effect of more oil in the pipeline and increased industry investment.”

According to previous reporting from the Dispatch News, oil production in Alaska has actually been slowly declining ever since the late 1980s, when it peaked at 2 million barrels per day. Advocates for the oil tax cut had insisted the policy change would reverse that trend. But new state projections at the start of 2014 anticipated a continued decline to 312,000 barrels per day by the end of the decade, from 531,000 barrels per day in 2013.

In a way, Alaska’s tax cut was an attempt to fight forces far bigger than the state or its policymakers could possibly control. Since oil from Alaska works just as well as oil from Russia, the Middle East, or Venezuela, the price of oil is determined by the global market. And the fact is, global oil production has not been able to keep pace with the growth in global demand for sometime.

There can be blips like the current price drop, thanks to things like the North American boom in shale production, or decisions by the Organization of the Petroleum Exporting Countries — a cooperative organization and economic cartel of Middle Eastern, South American, and African states — to flood the market with supply to move prices. But oil is a physical resource, and there’s only so much of it under the ground, and supplies will inevitably become ever more difficult to maintain as producers drill for more nontraditional reserves. Meanwhile, enormous populations in China and India especially are attempting a mass movement into the global middle class — and unless the world can engineer a mass move onto renewables and electric vehicles, and soon, their appetite for oil could grow massively.

That means, long-term, it’s still about supply and demand, and oil is just going to become harder and harder to come by.


An earlier version of this story did not make clear how much the tax change versus the oil price drop contributed to the revenue hole, and the piece has been updated for clarity.

Specifically, the first ISER analysis found that the alteration to the tax structure likely only accounted for four percent of the then-anticipated $2.1 billion oil revenue drop. Furthermore, according to that same study, “if current trends continue — if costs continue to rise faster than oil prices — the new tax could produce more revenue.”

However, the amount of revenue the new tax structure would bring in versus the old one is inherently difficult to predict, because it depends on a number of variables. Not only does the oil price matter, but the costs of production can also be deducted from the tax liability. And the later study out of ISER pointed out that current trends production costs likely won’t continue, and were instead driven in 2014 by several large one-off projects in Alaska. Using production costs from Department of Revenue assumptions, it’s likely the old tax structure would have brought in $1.3 billion more than the new one over the next five years — a gap of roughly 12 percent.

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