With the possibility of another oil tax fight looming, the House Resources Committee began a week of hearings Monday on the state’s oil tax regime and related tax credits.
Last year, House Resources gutted a proposal from Gov. Bill Walker to overhaul oil and gas tax credits. The legislature later passed a version of the bill that almost exclusively focused on Cook Inlet, yet had a larger fiscal impact than the House Resources version.
House Resources is a much different committee in the ascendancy of the House Majority Coalition.
Former committee Vice-chair Mike Hawker (R-Anchorage) and Co-chair Ben Nageak (D-Barrow) are gone. Hawker retired, while Nageak lost a close primary to Rep. Dean Westlake (D-Kotzebue) that was ultimately decided in the courts.
Westlake, now House Resources Vice-chair, is one of five freshman legislators on the committee.
House Resources Co-chair Geran Tarr (D-Anchorage) said a review of oil taxes and credits would bring those members up to speed, with the possibility of an oil tax bill on the horizon.
There have been six changes to oil taxes in the last twelve years, prompting Tax Division Director Ken Alper to call it “The Volatile Period” in a presentation.
The State’s cash liability in tax credits is estimated to be about $900 million in Fiscal Year 2018. Meanwhile, the State barely has enough left in the Constitutional Budget Reserve (CBR), its main savings account, to cover next year’s $3 billion deficit, excluding the bulk of those credits.
Doesn’t that indicate that tax credits must be part of a fiscal plan, House Resources Co-chair Andy Josephson (D-Anchorage) asked Alper during Monday’s hearing.
“About two-thirds of our budget is coming out of our savings right now,” Alper responded. “The closer the CBR gets to zero, the more concerning it is because we really do need that money for a crisis. What if there’s a big earthquake or something and we need to come up with $1 billion on the fly?”
In a press conference Monday, the Senate majority reiterated that its solution to closing the fiscal gap involves budget cuts, a government spending limit, and use of the Permanent Fund investment earnings. An income tax and oil tax credits do not factor in their plan.
“There is an overarching view of this caucus- it’s informal, but as you talk to people in their offices and in the halls- most people don’t believe it’s a good idea to start looking at taking people’s money away from them before we have addressed our own spending problems,” said Senate President Pete Kelly (R-Fairbanks). “Taxes seem to be a mechanism to fund a government that we believe is already too large.”
Two years ago, Kelly said during a Senate Finance hearing that government spending in the 1990s was so strict it “created a pent up demand[.]”
Yet Monday, Kelly praised those actions in the context of limited revenue:
A structural deficit is probably more desirable than taxing the people of Alaska to fill every little gap that’s in the budget because the budget’s too big. If you have a structural deficit — it should be smaller and it should be further into the future — if you have that, then everyone’s always managing to that structural deficit, to that cliff that may be out there somewhere in the future. We saw that in the ‘90s, and we saw quite disciplined spending in the ‘90s because of that.
The Walker Administration argues that structural deficits create uncertainty in the oil industry — still the source of two-thirds of State revenue — because companies do not know if the State will be able to pay tax credits. That uncertainty could change future investment behavior.
If the legislature does not act on a fiscal plan, Commissioner of Revenue Randall Hoffbeck has told Senate Finance the administration will introduce another oil tax bill.
Brief History of Oil Taxation in Alaska Influences Mood for Change
During the fairly steady period from 1978 to 1998, the State’s oil revenue averaged about 32 percent of the wellhead value, or the value of the oil after deducting costs like transportation.
But in 1998, the growing number of wells drilled on the North Slope began to influence the Economic Limit Factor (ELF) until, by 2005, most fields, including Kuparuk, were paying less than one percent tax, Alper told House Resources.
Gov. Frank Murkowski changed the ELF calculation so that so-called satellite fields were taxed at the same rate as Prudhoe Bay. The Alaska Supreme Court upheld this move in December, saving the State $500 million plus interest.
The legislature introduced the first oil tax credit the following year with the Petroleum Production Tax (PPT). That regime was a switch from a gross tax, which tends to have a flatter curve, to a net profits tax, where the returns to the State are worse at low prices but improve with higher price.
When PPT resulted in $800 million less revenue than expected in its first year, the legislature passed Alaska’s Clear and Equitable Share (ACES) in 2007.
To encourage small producers, ACES established credits for repurchase, paid in cash to companies in development or early production phases before they generate a tax liability.
These cash credits are unique to Alaska, Alper said.
Tax credits are used throughout the world in a number of different circumstances, not just in oil and gas. Generally, they’re understood to mean something you could use to offset your taxes. And when these were first written, that was the way they were understood; you would earn a credit, and then you would hold it. Then, at some point, you would owe taxes, and you would use it against your future liability. All of the credit certificates that are in-hand can be used indefinitely for that purpose. Alaska took a relatively unique step in going beyond that in saying, “We, the State, will buy them back from you at face value, subject to available funds.” That changed the playing field substantially.
The State doubled its cash credit obligation in 2010 with passage of the Cook Inlet Recovery Act. Alper noted the bill was the product of a gas supply emergency.
“At the time, the concern was brownouts. The concern was full-on supply shutdown that could greatly harm Southcentral Alaska,” he said.
The legislature phased out those Cook Inlet credits last year through HB 247.
“We no longer need these credits to ensure that the lights stay on in Anchorage,” said Alper.
In 2013, the legislature abandoned ACES in favor of SB 21. The bill added more tax credits to those under ACES, while reducing the tax rate at higher prices.
At current prices, Alper said SB 21 results in about $100 million more revenue than ACES would, but the combination of available credits can drop a company’s liability below the four-percent minimum tax established in the bill. A company’s tax burden can actually drop to zero.
If legislators consider an oil tax bill, Alper suggested they do something to fix this phenomenon, sometimes called “piercing the floor.”
“You’re taking a non-renewable resource from the ground and you’re paying the sovereign — as opposed to the landowner — you’re paying the sovereign, the State, for the privilege of removing something that only gets to be removed once. There’s a school a thought that says that should always be something. It should never be zero,” said Alper.
“As far as the State is concerned, one of the challenges in the low-price environment is under a net system, there are these other deductions that help the industry a little bit more because they’re still able to deduct their transportation costs, as well as their operating and capital expenditures. So that gives them some protection at low prices that we do not have because of the way the net system is set up,” Tarr told committee members.
Legislators Wonder When Gov. Walker Plans to Pay Off Credit Liability
ACES established a statutory formula for depositing money into a fund from which tax credits are paid.
Alper said that until last year, the legislature has consistently made the appropriation for credits open-ended.
“The reason it’s much more of an issue before us now is, as the revenue has reduced, the credit obligations have not [reduced] nearly as rapidly, so they become a much bigger component of our shrinking revenue pool,” he said.
Last year, Walker proposed spending $1 billion out of savings to pay off the credits, but that proposal was tied to use of the Permanent Fund earnings reserve and tax increases.
“When those measures didn’t pass, the fiscal note was not funded, either,” said Alper.
Walker vetoed the credits down to the $30 million recommended by the formula. This year, he has proposed the minimum payment of $74 million.
“What the governor has done in the most recent budgets is to say, ‘While we’re still in extremis here, let’s just use the statutory number. Let’s not pay more than we have to. They don’t lose value. They don’t go away. Companies could use them to offset their future taxes… And when funding is available, we’ll pay for them,’” Alper explained.
Senate Resources Chair Cathy Giessel (R-Anchorage) said Monday that Walker’s veto and his FY 2018 budget are building a debt the legislature otherwise addressed first with SB 21 and last year with HB 247.
“The governor continues to make policy with a veto pen,” she said. “It’s created a situation of having a credit card debt that we’re not paying off, and so interest is increasing. It’s building. We want to fix that, but we can’t fix it unless the governor agrees to work with us.”
Alper told House Resources the cash credit liability is not a “debt.” There is no interest, though the credits retain their face value. If the State keeps paying the minimum, it will owe $1.6 billion in FY 2026.
“Kicking these credits ten years down the road, it seems like they’re not really doing much good for the people they’re intended to do good for,” Rep. Chris Birch (R-Anchorage) told him.
Alper acknowledged that for the first time companies are beginning to discuss buying and selling the credits among themselves, rather than wait on the State to pay.
“I am not a fan of the tax credits,” Birch told Alper, but he added, “We have offered up tax credits, and there’s a liability for tax credits. When do we propose to pay the tax credits, assuming that we have the obligation? I’m kind of reminded of Robert Service: ‘A promise made is a debt unpaid.’”
“My expectation to the question when are they going to be paid? As soon as the legislature and the governor are comfortable that we’ve resolved the underlying fiscal situation to where we know we’ll have the money to pay them,” Alper replied.
Even though there is a formula for the credits, Alper reminded legislators that everything is subject to appropriation.
“There’s no requirement to appropriate anything at all,” he said.
Without more revenue, the State cannot afford to pay oil tax credits, and oil is not forecast to provide the revenue boost the State needs. Oil companies relying on tax credits are going to need help from the State in the form of a long-term fiscal plan.
A symbiotic relationship is the only thing that will save the State and the industry.