Severance Tax 101: How Texas, North Dakota, and Alaska Have Come Out Ahead

Since the 2008 stock market crash, most states have seen devastating decreases in tax revenue because of upticks in unemployment, declining consumer spending on nonessentials, and the loss of corporate taxes. State responses to this decreased revenue have included closing tax loopholes, considering moving to a consumption-only tax base, and being more stringent regarding who qualifies for social programs.

A few states, however, have not only taken the Great Recession in stride, but have come out ahead. Due in large part to the severance tax, Texas, North Dakota, and Alaska have all done well during the last seven years. These states’ natural reserves of crude oil and their willingness to allow companies to extract it from the ground have provided a cushion of state revenue funds.

What Is the Severance Tax?

The severance tax is charged to anyone who extracts, produces, or has a royalty on the extraction of nonrenewable resources such as crude oil, natural gas, condensate, and carbon dioxide from the ground. This is an additional tax on top of any federal or state income taxes owed on oil and gas.

Severance Tax Shares of Texas, North Dakota, and Alaska State Revenue

Thirty-six states impose severance taxes, and the National Conference of State Legislatures notes that in 2010, this tax accounted for $11 billion in revenues. Here’s a look at how the tax has positively affected Texas, North Dakota, and Alaska:

• Texas: Texas has no personal income tax but does impose a sales tax (6.25 percent statewide, and up to 8.25 percent when including taxes assessed by local municipalities), yet statistics from the Pew Charitable Trusts reveal that state revenue increased by 9 percent between 2008 and the end of 2013. Severance taxes account for just 3 percent of total tax revenue collection for the state, according to “Wealth of States” (p. 66).
• North Dakota: North Dakota has seen the most impressive boost in tax revenue of all the states since 2008, coming in at an overall 119.4 percent increase at the end of 2013. Severance taxes account for 19.1 percent of total tax revenue collection (p. 66).
• Alaska: While Alaska has actually experienced a considerable decrease in tax revenue since 2008 (down 59.9 percent by the end of 2013), it’s still in an impressive position compared to other states. This is thanks to an oil and subsequent tax boom, which gave it a sizable income buffer with which to run itself. Since Alaska has no state sales or income tax, “Wealth of States” notes that a whopping 44 percent of state tax revenues come from severance taxes alone (p. 66).

How States Use Severance Funds

States use the funds they collect from severance taxes in a few different ways. Because oil and gas production can damage public resources, such as roads, most states set aside part of their severance tax revenue to repair and maintain these areas. Production can also damage the environment, so funds might go toward environmental cleanup projects. The rest of the money typically goes into the state’s general fund to pay for normal functions of the state government, such as social programs, police protection, and education.

It’s clear that Texas, North Dakota, and Alaska are positioned better than other states because of their ability to collect a sizable severance tax. To keep up this success, the trick is for these states to not become too dependent on a boom-or-bust tax revenue dictated by supply, consumer demand, and fluctuating prices.

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