State tax policy and oil production: The role of the severance tax and credits for drilling expenses

Abstract

Abstract State Tax Policy and Oil Production: The Role of the Severance Tax and Credits for Drilling Expenses This paper describes state tax structures facing the oil industry in the United States and simulates effects of changes in severance tax rates when a credit is allowed for drilling expenses. We calibrate the Hotelling model developed by Pindyck (1978) to examine how taxes and subsidies at different stages of the resource exploration and production phase alters the behavior of oil producers and thus impacts on exploration activity, additions to the reserve base and production of energy. In our model, returns to exploration are subject to diminishing returns, but additions to the reserve base reduce the cost of production. The calibration model with data from U.S. oilfields is used to show effects of alternative tax and subsidy policies on drilling and production, the tax revenue accruing to states as well as on the time path of drilling expenditures and resource production. 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. Also, they suggest that a drilling expense credit may cost more than the incremental severance tax revenue obtained. These results may be useful in evaluating recent tax policy changes in Alaska as well as on national energy tax policy in light of recent interest in stimulating drilling for new reserves. These findings may also support recent policy interest in the Obama Administration towards repealing percentage depletion allowances given to non-integrated oil and gas firms and other tax preferences all of which are projected to raise federal tax revenue by more than $30 billion between 2010 and 2019.

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