With oil prices in a rout, North Dakotans are obviously concerned about what impact that may have on the state’s budget. Governor Jack Dalrymple and lawmakers have increased spending aggressive in past bienniums, and have Dalrymple has charted a course for “ambitious” spending in the coming Legislative session next year, but if prices keep falling that’s going to impact the budget.
There will be fewer funds available for spending and tax relief, and the increases in on-going spending from previous legislative sessions are going to be harder to pay for.
One major area of concern is that North Dakota’s oil extraction tax has a price trigger. If oil falls below a certain price all sorts of exemptions from the tax kick in for oil producers (Tax Commissioner Ryan Rauschenberger has said that it would cut the current effective tax rate of 11 percent on oil production roughly in half).
But the mechanics of this can be really hard to understand. Since oil prices, and the potential fallout for tax revenues, will overshadow the coming legislative session I thought I’d share with you an explanation document prepared by Legislative Council for lawmakers (shared with me by a friendly lawmaker).
You can read the document below, which does a really good job of explaining this very complicated tax in a relatively easy to understand way.
Here are some important things to note:
How The Trigger Price Is Calculated
The trigger price was set at $35.50 in 2001 and indexed to inflation as calculated by the U.S. Bureau of Labor Statistics. It gets re-adjusted every year.
In 2014 the trigger price is $52.06 per barrel. In 2015 the trigger price is expected to rise slightly to $52.58 per barrel.
How The Trigger Gets Triggered
The tax breaks for oil production are invoked when the price per barrel of West Texas Intermediate Cushing crude oil (minus $2.5o per barrel) falls below the trigger price. What’s interesting is that the WTI per-barrel price is not always very indicative of actual oil prices in North Dakota.
Most of the time state officials use the price of North Dakota light sweet crude published by Flint Hills Resources as it is much more reflective of the actual prices here in North Dakota. The Flint Hills number runs consistently below the WTI number. For instance, in November the WTI price was $75.65 per barrel, while the Flint Hills price was almost $15 per barrel lower at $60.16.
Regardless, if the price of WTI oil minute $2.50 per barrel falls below the trigger price for five consecutive months a myriad of tax breaks kick in. What’s more, the trigger isn’t untriggered until the WTI price goes above the trigger for five consecutive months.
What Happens When The Trigger Gets Triggered
The oil extraction tax is 6.5 percent. On top of that producers pay a 5 percent oil production tax, for a combined maximum tax rate of 11.5 percent. But there are some exemptions and other loopholes in the law, so the effective tax according to Tax Commissioner Ryan Rauschenberger is more in the ballpark of about 11 percent.
If the trigger is triggered Rauschenberger says that effective rate would be roughly cut in half.
From the document below, here are the specifics:
What’s The Impact On The Economy And Tax Revenues?
The impact on the economy is hard to measure, but it wouldn’t be pretty. Lower prices mean less oil activity. Less oil activity probably means layoffs, which probably means a lot of people turning to unemployment benefits and public assistance. It also means less income, less commerce, and generally less prosperity.
The impact on tax revenues would also be ugly. It’s hard to quantify it in terms of dollars, but suffice it to say that the state got about $1.5 billion in direct oil and gas tax revenues (not counting dollars going to into the Legacy Fund, etc.), and billions more in higher sales and income tax revenues.
The state would take a hit in revenues and economic prosperity well before the trigger kicked in just in terms of oil prices depressing development activity. Once the trigger it the state would have a serious wound in its budget.
Which is why lawmakers should have gotten rid of the oil tax revenue when they had the shot.
Sadly, efforts were defeated because they were seen as too much of a sop to the oil industry.