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Testimony on California Severance Tax

by Mason Gaffney, 1981

(Typed from notes, 22 April 94)

California State Assembly, Revenue and Taxation Committee, Wadie P. Deddeh, Chairman.

Interim Hearing, Oil Severance Taxation, AB 1597 (Bates, Berman, Floyd, Kapiloff; also Senators Greene and Sieroty)

15 Oct 1981, 1:30-4:30 PM, Los Angeles, State Building #1138, 107 S. Broadway, Los Angeles

Introduction

AB 1597 would impose tax at rate of 6% of gross wellhead value "for the privilege of severing oil." The tax would be in addition to the property tax, and to any yield tax imposed in lieu of an "ad valorem" (meaning property) tax.

Proceeds would go into a school fund.

1. Assumptions
   1. A state severance tax on oil is constitutional. That is stare decisis. Various such state taxes have been challenged as bearing on interstate commerce. The U.S. Supreme Court resolved this most recently in Commonwealth Edison Company v. Montana, 2 July 1981. Montana imposed a severance tax on coal, at a rate of 30%. Most of the sales were to out of state buyers like the plaintiff: Commonwealth Edison is a large utility in Chicago. However, Montana buyers are also subject to the tax so it was ruled not to violate the Commerce Clause of the U.S. Constitution.¹

      In addition, much or most of the tax is not shifted forward at all, but is borne by owners of coal lands in Montana. It is almost certain that Commonwealth Edison is one of those owners: most consuming utilities do acquire their own energy reserves.² This may be the real reason behind their lawsuit.

      Sometimes the argument is made of an implied contract, or moral obligation, not to raise taxes above existing levels, because purchasers are "innocent," and bought in the faith taxes would not rise. However, no California owner can reasonably claim to be "innocent" of the possibility such a tax might be imposed at any time. The severance tax is legal, and adjudicated, and has long been imposed in all other states. Major owners are sophisticated investors. All major companies have tax departments and legal staff. They are in the business of taking risks; one such risk is that of higher taxation.³

      150 years ago, most of California was either public domain or in old Spanish grants. Spanish land grants routinely reserved mineral rights for the crown, on the "regalian principle."⁴ Land from the U.S. public domain was granted to individuals for the primary public purpose of developing agriculture, irrigation, and towns. Minerals were included mainly by oversight. Their early discovery was a windfall; their value at modern levels is the acme of a series of windfalls. If they were on the OCS (Outer Continental Shelf) the U.S. Government would still be the owner, auctioning off exploration rights for high prices. Riparian owners along the coastline were never given title to offshore minerals; by analogy, it seems only accidental that overlying landowners were given special rights to underground minerals. Accordingly, public sentiment in this country, and in most others, has long viewed mineral rights as being peculiarly affected by a public interest.

   2. A tax must have a public purpose. There are new, high, legitimate demands on the California State Treasury. It is ground between the lower millstone of Prop. 13, causing localities to require more State funds; and the Reagan Administration in Washington, cutting back on national revenue-sharing.

      Before and independent of Prop. 13, there was and remains a need to supply a higher share of school funding from the State level, as mandated in the Serrano decision in California, and reinforced by similar decisions rising in other states (e.g. the Rodriguez case from Texas).

   3. There is a large taxable surplus, or rent, in California oil and gas that is privately owned. Rent has been characterized as "fat in the private sector." It is private income in excess of that required as an incentive to evoke production.
      1. Most of the fields were brought in, and remained producers, at much lower prices than those now obtained for the product.

      2. Many fields have recently been acquired by large, wealthy international major oil firms, at high prices. Mergers and acquisitions at high valuations are clear evidence of high rents. It is the surplus in lands that attracts wealthy outside buyers.

      3. The rent of California oil and gas is currently untapped for public purposes. California is the only major mineral-rich state lacking any form of state severance tax.

      4. Some California oil and gas is publicly owned, and is known to yield large surpluses to the public. The State owns its "tidelands," the strip of coastal land inside the three-mile limit. Outside that limit, the Federal government sells leases for high prices, even in deep water and with limited competition among a few major buyers. It seems to follow that upland oil, privately owned, yields surpluses too.

      5. Oil and gas extractors as a group show much higher profits per employee than any other major industry. They receive something like 40% of all profits in the Fortune 500, with only 10% ⁵ of the employees. High profits per employee are a sure indicator there is high rent.

2. There is a case for higher taxation of energy deposits.
   1. Before Prop. 13, California had used its property tax in lieu of a severance tax, to get public revenues from oil and gas. California stood alone among oil-producing states in having no severance tax. On the other hand, it stood almost alone among the 50 states in having an effective property tax on oil and gas in situ.

      California's property tax was effective because the State Board of Equalization in Sacramento maintains an office of specialists to give professional aid to localities needing to assess reserves of oil in situ. The head of that office, Robert Paschall, testifying before the Alaska State Legislature,⁶ stated from his California experience that it is as feasible to assess the value of oil reserves as any ordinary parcel of real estate. He stated that the uncertainty regarding the physical quantity of oil in the ground is considerably less than the kinds of uncertainty that bear on the price of any other real estate: concerns about the future price of the product, and costs of production. With oil and gas, besides, the time horizon is shorter; and there is only one highest and best use to consider.

      Accordingly, California before 1978 got substantial revenues from its localities' property taxes levied on reserves of oil and gas. Mr. Paschall later consulted in the Appalachian States, and has told me that California is a hundred years ahead of those states in assessing hydrocarbons for property tax purposes. It assesses oil and gas accurately, while they fail to assess coal - a much easier job, technically - accurately. The difference is political, or worse. Mr. Paschall says his life was threatened.

      In 1978, of course, Prop. 13 changed all that, lowering our property tax rate to 1/3