Myths and facts: Is Oklahoma’s 1-percent tax on horizontal drilling a tax credit? No, it’s a low tax rate on a productive behavior

May 15, 2014

[Advocates for raising Oklahoma’s gross production tax from the current 1 percent rate to 7 percent on horizontal and deep-well drilling for oil and natural gas have made questionable claims about the nature of the tax, the effects of energy drilling on Oklahoma’s economy, and the relationship between taxes on drilling and funding state government. This is one in a series of posts in which we present the facts.]

Myth: Oklahoma’s current gross production tax of 1 percent on horizontal and deep-well drilling for oil and natural gas is a tax credit, not a tax rate.

Facts: In 1994, Oklahoma lawmakers established a tax rebate that, while not technically a rate reduction, effectively lowered the gross production tax rate on horizontal oil and natural gas wells from 7 percent to 1 percent during the first two years of a well’s production. Later, lawmakers extended the rebate to the first four years of production, or until the operator recouped their initial costs invested in a well, whichever came first. Upon drilling a well and paying the tax on the well’s production, an operator would submit paperwork to the Oklahoma Tax Commission and receive back the rebate amount. This structure was regularly scheduled for sunset review every three years — meaning, every third year, the state Legislature was required to decide whether to keep the structure in place.

In 2010, lawmakers established that what had, until that time, been a tax rebate would, going forward, be a literal reduction of the gross production tax rate on horizontal and deep wells from 7 percent to 1 percent for the first four years of a well’s production. The structure remained on a sunset review schedule, with July 1, 2015 being the next opportunity for sunset.

There is a clear difference between tax credits and tax rates. With tax credits, the government controls the government-taxpayer relationship. It’s easier for the government to pick winners and losers in an economy by doling out tax credits to a selected few than by applying a simple, low tax rate across the board.

Some suggest that, by charging a 1 percent tax rate on production from horizontal and deep wells while simultaneously charging a 7 percent rate on vertically drilled wells, the state of Oklahoma is still picking winners and losers. There is some merit to this thinking. By no means, however, does this necessitate a 600 percent increase in the tax rate on horizontal and deep wells. It would be just as logical, if not more so, to instead reduce the rate on vertical wells, in order to bring parity to how the gross production tax is applied and set a low tax burden on private-sector job creators. This is especially true if the goal of policymakers is to grow Oklahoma’s economy.

Indeed, a long-term, ever-growing body of academic research indicates that tax rates, particularly taxes on work and production, have an impact on economic development, job growth, and the ability of state governments to fund the services taxpayers want.

On this note, a proposal from some of Oklahoma’s energy industry leaders would set the state’s gross production tax rate on all new wells – horizontal, vertical, deep or otherwise – at 2 percent. As a result, all new oil and natural gas wells drilled in Oklahoma would be taxed the same.

Consider that, over the past decade, Oklahoma’s total state government spending has hit all-time highs each year, without fail, even through two recessions. And Oklahoma’s total state tax collections have hit record highs each of the last two years and are on pace to do so again this year. During this time, Oklahoma’s gross production tax rate on horizontal and deep wells remained effectively at 1 percent, and private Oklahoma energy drillers created tens of thousands of high-paying jobs for breadwinners in Oklahoma families across the state.