Oil and natural-gas severance taxes are typically paid to state governments by parties involved in producing or "severing" the resource from the Earth. The taxes are based on the quantity or value of the oil and natural gas produced or removed, according to the National Conference of State Legislatures. Where the revenues go is determined by the state.
How It Works
The revenue from severance taxes allows states to benefit from natural resources that exist within their borders. Not all states have severance taxes. As of 2007, 34 states had none, while 19 had severance taxes, for which collections were lower than 1 percent of total state tax collections. Oil producers pay taxes on a per-barrel basis, and natural-gas producers pay taxes on a per-foot basis. In addition, the tax rates may be graduated based on volume of production or value of the products.
Some states define value of product to mean market value in some states and gross value in others. Severance-tax rates can vary widely, according to the Mineral Web. Taxable net value or net proceeds are calculated by deducting certain items from the gross value or proceeds. Examples of such deductions include the cost of production and royalties paid. In 2007, severance taxes ranged from 1 percent for Nevada to 64.4 percent for Alaska, based on the taxes as a percentage of total state-tax collections.
States that wish to raise severance-tax rates typically face resistance from producers, who claim that higher taxes would raise prices for consumers, according to The Santa Fe New Mexican newspaper. However, that is not always true, since those prices also depend on other factors, such as supply and demand as well as market speculation.
The state government directs the tax revenues to various areas, such as schools, Medicaid, water development, local government and conservation-related issues, A state must balance its needs for funds with its desire to keep producers working within its borders to keep generating revenue. Not surprisingly, severance-tax reform becomes a bigger issue at times when the economic status of a state worsens, while oil and gas profits rise.
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