1. Changing Alaska's Oil and Gas Production Taxes: Issues and Consequences Matthew Berman Professor of Economics Institute of Social and Economic Research University of Alaska Anchorage Presentation to International Association for Energy Economics Alaska Chapter April 20, 2006 Institute of Social and Economic Research

2. Why does Alaska need to change its tax system? Alaska’s effective production tax rate has declined by nearly 50 percent since 1993 and continues to decline. Oil companies expect the legislature to change taxes, and want to see what the changes are before committing to a gas pipeline financing agreement with the state. Current tax structure unsuited to today’s conditions. Governor Murkowski’s proposal: Profit-based Production Tax (PPT) Institute of Social and Economic Research

3. Three big questions about oil and gas taxes 1. How much is the government take? 2. How does the fiscal regime share risk? 3. What is the nature of the relationship between government and industry? There is no such thing as a perfect tax. Every alternative involves tradeoffs. Institute of Social and Economic Research

4. How much is the government take? State’s roles: as resource owner, the state collects lease revenues such as royalties; as sovereign, the state has powers of taxation. Fiscal regime: the overall structure of revenue sources from lease payments and taxes. Institute of Social and Economic Research

5. Alaska’s take from the oil industry has been declining Most state revenues historically have come from royalties and production (severance) taxes. Institute of Social and Economic Research

6. Alaska’s take has averaged between 30 and 40 percent of wellhead value in most years. But it has been declining recently. Non-recurring revenues, such as lease bonuses and legal settlements, have raised significant revenues. Institute of Social and Economic Research

7. The proposed PPT would increase the take at high oil prices and reduce it at low prices. At real world oil prices below $20, the state would lose money. This occurred nearly 30 percent of the time during the past 45 years, including two years out of the past ten. Institute of Social and Economic Research

8. Comparing Alaska to other states Alaska has a reputation as a high tax state. That used to be the case, but is no longer true. Institute of Social and Economic Research

9. Tradeoff: Higher government take increases likelihood of adverse effects on business decisions But... not all taxes are equal. Some ways of taking revenue have bigger effects than others. Institute of Social and Economic Research

10. International comparison of selected petroleum fiscal regimes, ranked by attractiveness to industry PPT would improve Alaska’s international competitiveness ranking compared to the current tax system without reducing government take. Institute of Social and Economic Research

11. How does the fiscal regime share risk? Tradeoff: achieving more equitable sharing of risk between government and industry increases the complexity of revenue measures. Progressivity: the degree to which revenue increases as a proportion of income as income rises. Institute of Social and Economic Research

12. Relative progressivity of different lease payments and taxes Institute of Social and Economic Research

13. Alaska has relied mainly on regressive revenues When oil prices rise, the state take as a percentage of wellhead revenue actually falls. Institute of Social and Economic Research

14. Distribution of revenue from oil sales: PPT vs. current state severance tax, at lower oil prices Institute of Social and Economic Research

15. Distribution of revenue from oil sales: PPT vs. Current state severance tax, at higher oil prices Institute of Social and Economic Research

16. Examples of expected cash flows and investment returns under the current and proposed tax systems Institute of Social and Economic Research

17. The PPT with investment tax credit defers revenues as it redistributes investment risks Institute of Social and Economic Research

18. What is the nature of the relationship between government and industry? Tradeoff: closer relations permit more flexibility in adapting the fiscal regime to changing conditions, but at a cost to transparency in government. Administrative distance: the degree to which industry and government participate in setting the terms of the fiscal regime. Institute of Social and Economic Research

19. Administrative distance of industry-government relations Institute of Social and Economic Research

20. Major changes in Alaska’s oil and gas fiscal regime since 1973 -- moving toward less administrative distance Institute of Social and Economic Research

21. Effects of a standard deduction The governor’s bill would give each company tax-free oil production. Institute of Social and Economic Research

22. Effects of a standard deduction... (continued) The graph shows the effects of the governor’s bill. Different versions have different effects, but would still tax different companies at different rates. Institute of Social and Economic Research

23. Combined effects of deductions and credits Different versions have different effects, but each may cost the state as much revenue as would a 5 percent reduction in the base tax rate. Institute of Social and Economic Research

24. Unresolved questions as the legislature debates and modifies the administration’s proposed PPT 1.Should the tax contain a large standard deduction? Should we move from taxing oil from different fields at different rates to taxing different companies at different rates? 2.Should different regions of different types of oil be taxed differently? Cook Inlet oil? Heavy oil? 3.Should natural gas be included in the PPT? If so, should it have a different tax rate? 4.Should a transitional deduction be included? 5.Should the tax include a progressive rate structure, and increase at high oil prices? 6.Is the PPT too complicated? Will we just bring on endless litigation? Institute of Social and Economic Research

25. Recommendations 1. The PPT is an improvement over the current production tax. The state could easily raise its percentage take to the level of the early 1990s by simply changing the Economic Limit in the ELF formula from its current level of 300 barrels per day per well to a more realistic level of 100 barrels per day. But by changing to a tax on net income instead of gross revenues, the state would better share risk with oil companies and cause fewer adverse effects per dollar of revenue collected. Alaskans should anticipate disputes and litigation if the PPT is implemented. But the state has weathered these before. Institute of Social and Economic Research

26. Recommendations... (continued) 2. Don’t expect too much. The PPT should not be viewed as an opportunity to increase the state’s take from its oil and gas. Oil prices are more likely to fall from their current levels than rise. In the long run, the state take from the PPT may be no more, and possibly less, than it is now. Alaska’s experience with a major oil tax overhaul in 1981 suggests that it is impossible to know exactly how much revenue will change when the basis for taxation shifts. The PPT will not solve the long-term problem of the fiscal gap caused by declining oil production. No oil tax can. Institute of Social and Economic Research

27. Recommendations... (continued) 3. Keep it simple! Switching to a tax on net income automatically adjusts for differing ability to pay among different investments. The more complicated the bill becomes, with attempts to treat different income and operations differently, the more opportunities for disputes and litigation. Beware of unintended consequences of special provisions, which, once enacted, become very difficult to remove. The gas pipeline contract, not a broad tax bill, is the place to special provisions related to North Slope gas development. It is better to keep tax rates low and the tax base large. Institute of Social and Economic Research