Economy Colorado Severance Tax
Anthony Milne 800628757 September 13th 2007
When examining the state of Colorado's severance tax, many different issues arise that relate to possible changes in its structure and general function. Recently, the issue of the Colorado severance tax has become a growing subject of debate and concern among taxpayers and government officials alike. The tax is imposed upon nonrenewable natural resources that are removed from the earth. Specifically, to the income from gross oil, both crude and condensate, as well as natural gases like coal bed methane and carbon dioxide. This tax is essentially meant to compensate present and future citizens for the loss of irreplaceable resources that add to a state's natural wealth and as the revenues of this tax have greatly increased over recent years so has the controversies surrounding it. Questions surrounding Colorado's severance tax can be separated into two main concerns, one being the basic notion of a new tax and/or tax structure imposed on the basis of increased revenues and efficiency, while the other issues are related to revenue distribution concerns. Both of these angles shine a light on the possibility of a new severance tax or altering the structures of that in place. This paper will serve to examine the different concerns related to Colorado severance tax and their possible solutions while attempting to make a case for changes to the collection and revenue distribution structure of the current tax. One major issue that must be considered when examining the Colorado severance tax is the distribution of its revenues. The tax revenue collected from the income of oil and gas produced in Colorado is supposed to be used to reimburse local governments for purposes such as fixing damaged roads caused from the drilling trucks, helping build new
schools overwhelmed by the arrival of industry workers and their families, or to expand city sewer systems and other public related projects. 1 The State Severance Tax Statute 39-29-101 explains this idea as follows: It additionally is the intent of the general assembly that a portion of the revenues derived from such a severance tax be used by the state for public purposes, that a portion be held by the state in a perpetual trust fund, and that a portion be made available to local governments to offset the impact created by nonrenewable resource development.2 The present argument in regards to this matter is that the tax revenues are not being distributed in a way that governments and public entities are being fully reimbursed for the cost of natural resource harvesting impacts. In recent presentations to Colorado Legislative Council's "Interim Committee to Study the Allocation of Severance Tax and Federal Mineral Lease Revenue", county commissioners, mayors, school administrators, housing authority members, road and bridge supervisors, human service workers, and private citizens from all areas of Colorado made unanimous arguments that the tax revenues were not providing for services needed, especially in rural areas of the Western Slope where the largest oil and gas boom has taken place.3 The chart below illustrates how the severance tax revenue is distributed with revenues being divided in half, with half going to the State Trust Fund and the other half to the Local Impact Fund. From there, The Department of Natural Resources receives half of the State Trust Fund monies and the other half goes into a perpetual fund that loans money to Colorado Water
1) Robinson, Leslie. "Do Severance Tax Deductions Cost Taxpayers?" Colorado Confidential 30 July 2007. 7 Sept. 2007 <http://www.coloradoconfidential.org>. 2) Robinson, Leslie. "Caution: You are Entering the Severance Tax Distribution Maze." Colorado Confidential 29 Aug. 2007. 7 Sept. 2007 <http://www.coloradoconfidential.org>. 3) Robinson, Leslie. "Do Severance Tax Deductions Cost Taxpayers?" Colorado Confidential 30 July 2007. 7 Sept. 2007 <http://www.coloradoconfidential.org>.
Conservation projects. Currently, The Local Impact Fund is divided, as the image below displays, with eighty-five percent going to The Department of Local Affairs grant projects and fifteen percent distributed directly to the local governments. Recently, arguers for an increase of funds to local governments received some support with the passing of House Bill 1139 in that this bill will increase the direct distribution to local governments to thirty percent of the Local Impact Fund in 2008.4
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Despite this increase in the direct distribution, it is not likely that it will be enough to satisfy the costs of local governments in energy development communities. This is the case for both reasons of substitution and the sheer magnitude related to the development related costs. First, simply adjusting the percentage of the Local Impact Fund monies to direct distribution does not add to the LIF as a whole and taking away from local grant projects may counteract the benefits of this substitution if not have an even worse affect.6
Second, and even more significantly, is the idea that even if this substitution does help
4&6) Robinson, Leslie. "The Politics of the Oil and Gas Severance Tax." Colorado Confidential 25 July 2007. 8 Sept. 2007 <http://www.coloradoconfidential.org>. 5) Severance Tax Direct Distribution Discussion. Department of Local Affairs. Denver: Colorado State Government, 2007. pg.3. 8 Sept. 2007 <https://dola.colorado.gov>.
local communities, the amount still may not be enough. In a document circulated by Department of Local Affairs Director Susan Kirkpatrick in the spring of 2006, the projected capital-improvement and infrastructure needs for energy impacted counties, towns and special districts of the next twenty years would be around twenty-three and a half billion dollars. And although this is a number that is a rough estimate with a large margin for error, the common consensus of town, city and county affected by energy development is that further measures will be needed. 7
Another issue in the same vein as the revenue distribution, is that related to state receipts from federal mineral leases back into the state and energy communities. The basic problem in this case is a matter of the distribution structure as related to complexity. The chart below shows the route of federal funds and how they pass through a series of complex state statutes that affect the direct distribution to local governments.
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7) Robinson, Leslie. "Billions and Billions Needed to Mitigate Energy Impacts." Colorado Confidential 6 Apr. 2007. 8 Sept. 2007 <http://www.coloradoconfidential.org>. 8) Severance Tax Direct Distribution Discussion. Department of Local Affairs. Denver: Colorado State Government, 2007. 5. 8 Sept. 2007 <https://dola.colorado.gov>.
Colorado distributes its federal mineral leasing revenues, which hit $144 million last year, through a multi-tiered, spillover formula. As the amount of money collected from the federal government hits benchmarks, the revenues spill into three tiers with different spending mechanisms. Between the formula's three tiers, the federal dollars flow to the state education fund, energy-impacted counties and cities, the Colorado Water Conservation Board, local school districts and the Department of Local Affairs.8 The complexity of the system and its use of dollar amounts rather than percentages is the cause of inefficiency as well as the need for lawmakers to step in every few years for adjustment. Representative Bernie Buescher of Grand Junction said that the system is so convoluted that he doubts any small reforms could yield meaningful results. "I, for one, would rather throw this whole thing out...We ought to come up with one method that finds some consistency and some understanding," says Buescher. 9 And although this issue is a small blip on the radar that of problems with Colorado severance tax, it is consistent with the idea that some problems surrounding the tax may be operational and do not call for a completely new tax or tax rate but rather some organizational changes.
One observation about the Colorado severance tax is that if its operational problems were remedied, then its monetary issues may be solved. This idea is apparent in a recent Colorado State Performance Audit in June of 2006 where the Department of Revenue reported that possibly millions of severance tax dollars have not been collected because of collection and auditing issues. 10 The audit concluded that neither the
8&9)Robinson, Leslie. "Caution: You are Entering the Severance Tax Distribution Maze." Colorado Confidential 29 Aug. 2007. 7 Sept. 2007 <http://www.coloradoconfidential.org>. 10) Symanski, Sally. Performance Audit June 2006. Colorado Department of Revenue. Denver: Colorado State Auditors Office, 2006. pg.50. 8 Sept. 2007 <http://www.state.co.us/gov>.
Department of Revenue nor the Colorado Oil and Gas Conservation Commission have adopted adequate controls to ensure the accuracy of oil and gas production data. As well as the notions that "The Colorado Department of Revenue lacks a process for systematically ensuring all individuals and entities required to file severance tax returns are doing so, that the severance tax audit selection process does not provide adequate audit coverage, audit work plans lack all of the necessary components for verifying that taxpayers have paid the proper tax and are in compliance with state law, and that The Department of Revenue has not effectively managed its resources to provide reasonable assurance that the State is receiving the severance taxes it is due". 11 The audit created six recommendations to the Department of Revenue and the Colorado Oil and Gas Conservation Commission about ways to improve and ensure the way the tax is imposed, collected and monitored. Currently, all six of the recommendations have been accepted by their recipients but it is yet to see what affect they will have. The hope is that these improvements will lead to the collection of potentially millions of dollars in owed taxes that will help to serve the distribution and allocation problems discussed previously.
Another popular operational issue related to that of the current severance tax is the fact that Colorado's Ad Valorem tax deductions could be altered or removed in the interest of generating more revenue. Colorado has a unique Ad Valorem tax rule that allows oil and gas producers to deduct eighty-seven and a half percent of their assessed payments to local governments from their severance tax due the state. The only other state to offer Ad Valorem policies is Kansas but at a much lesser rate of one to two percent. The policy is not popular among the supporters of severance tax and
11) Symanski, Sally. Performance Audit June 2006. Colorado Department of Revenue. Denver: Colorado State Auditors Office, 2006. pg.48. 8 Sept. 2007 <http://www.state.co.us/gov>.
the increase of its revenues on the basis that the deductions are essentially allowing for companies to deduct from their money owed the state because they pay tax to local governments. Garfield County assessor John Gorman was quoted telling severance tax committee members that "I don't understand the concept of Ad Valorem tax deductions...It would be similar to me deducting local sales tax from the total state sales tax I pay".12 The State Auditor's report referred to previously addresses this issue with the statement that: The Department of Revenue's taxpayer information system does not track ad valorem credits taken against severance taxes. Therefore, we were unable to determine the actual amount of the ad valorem credits claimed on oil and gas severance tax returns. However, due to the ad valorem tax credit, the majority of oil and gas tax filers do not have a severance tax liability. Rather, the majority of severance tax filings result in taxpayer refunds.13 This statement piggybacks on the argument that these deductions do not make sense with the notion that the energy companies are not accountable for their ad valorem deductions. In numerous cases, the state auditor's office also noted that when and if the department does an audit of an oil and gas producer's severance tax documents, more often than not, the auditor has found producers have over estimated their ad valorem discounts. It is hard to justify a system in which energy companies are not only receiving unreasonable tax deductions, but also overestimating these deductions and receiving vast amounts of money while costing the Colorado government millions of dollars a year in tax revenues. Superintendent of the Rifle area school district, Gary Pack, summed up the
12) Robinson, Leslie. "Do Severance Tax Deductions Cost Taxpayers?" Colorado Confidential 30 July 2007. 7 Sept. 2007 <http://www.coloradoconfidential.org>.
13) Symanski, Sally. Performance Audit June 2006. Colorado Department of Revenue. Denver: Colorado State Auditors Office, 2006. pg.51. 8 Sept. 2007 <http://www.state.co.us/gov>.
issue perfectly when he asked the question, "Why is Colorado giving millions of dollars in severance tax revenues back to the energy companies?"14 Along with the Ad Valorem tax deductions, another structural issue of popular debate is that of the severance tax "stripper" well exemptions. Unlike the ad valorem credit that reduces the amount of severance tax due, Colorado law exempts the taxation of certain oil and gas productions known as stripper wells. These stripper wells refer to a type of oil or gas well which produces fifteen barrels or less of oil or ninety thousand cubic feet or less of gas per day for the average of all producing days during the taxable year. 15 According to Department of Natural Resources personnel, the purpose of the exemption is to maximize recovery from a well or a field by encouraging producers to continue using a well even when the economic incentive for doing has declined. Yet, according to the 2005 mineral production data from the Colorado Oil and Gas Conservation Commission, nearly half of Colorado's thirty thousand wells produce oil and or gas at levels below the exemption level of severance taxation. This data has shown that fifteen million barrels of oil and about one hundred and forty billion cubic feet of gas would have been exempt severance from taxes in 2005. Using the average price for these minerals during that period, the Colorado Oil and Gas Conservation Commission estimates that nearly nineteen million dollars was exempt from severance taxation last year. 16 When considering a tax exemption for smaller less economical natural resource producers, it is hard to argue that the exemption requirements should be set a level where nearly half of all producers would operate
14) Robinson, Leslie. "Do Severance Tax Deductions Cost Taxpayers?" Colorado Confidential 30 July 2007. 7 Sept. 2007 <http://www.coloradoconfidential.org>. 15) Colorado. Taxpayer Service Division. Department of Revenue. Severance Tax Information for Owners of Any. Nov. 2006. 9 Sept. 2007 <http://www.revenue.state.co.us>. 16) Symanski, Sally. Performance Audit June 2006. Colorado Department of Revenue. Denver: Colorado State Auditors Office, 2006. pg.45. 8 Sept. 2007 <http://www.state.co.us/gov>.
severance tax free. The last of the policy issues to be discussed in this paper is that relating to coal. Considerable flaws of the severance tax as related to coal come from the policies of coal production tax credits and exemption policies. In regards to tax credits, the issue can be considered, on the basis of lost revenue alone. Current severance tax procedure allows for a fifty percent credit against the standard coal tax rate of fifty-four cents per ton when coal is produced underground. Accordingly, using coal production data maintained by the Department of Natural Resources for the year 2005, one finds that at a fifty percent credit rate with approximately twenty-one million taxable tons of coal being produced underground, that the total value of the credit or taxable revenue lost would have been nearly six million dollars.17 Furthermore, Colorado severance tax policy states that no tax shall be imposed on the first three hundred thousand tons of coal produced in each quarter of the taxable year. This adds up to 1.2 million tons of coal per mine that is not subject to severance taxation equaling about $648,000 dollars in taxes per mine that is not collected by the state. Using the same 2005 DONR data listed above, it is estimated that 10.8 million tons or around four million dollars are not collected because of these exemptions. 18 The final issue to consider with regards to the Colorado severance tax is its most prominent control feature--the actual tax rate. When considering whether Colorado's severance tax rate is at a level in which it can be considered a good and fair tax, it is important to consider other states severance taxes in comparison. Colorado's tax system based on gross income of crude oil, natural gas, carbon dioxide. Oil and gas is composed
17) Pace, Levi N. "Coal Severance Tax." Center for Public Policy and Administration 2 (2006). 11 Sept. 2007 <http://www.cppa.utah.edu/>. 18) Symanski, Sally. Performance Audit June 2006. Colorado Department of Revenue. Denver: Colorado State Auditors Office, 2006. pg.45. 8 Sept. 2007 <http://www.state.co.us/gov>.
of two percent for $25,000 dollars, three percent for $25,000 to $100,000 dollars, four percent for $100,000 to $300,000 dollars, and five percent for anything over $300,000 dollars comes out to a total rate of approximately 5.7 percent. This 5.7 percent when compared to other state severance taxes is quite low. For example, Oklahoma levies 7 percent, New Mexico 9.4, Wyoming 11.2, and while Utah only sports a 4.5 percent rate, its is actually higher than Colorado's because of Colorado's property tax credits. When looking at these figures, one finds that Colorado certainly has room to increase its tax rate without undercutting its competitive position with its oil and gas producing neighbors. Presented even further in a more monetarily positioned way, the difference between Colorado and Wyoming's severance tax revenue is almost exclusively a result of Wyoming's higher tax rate and added up to nearly six times the amount of Colorado's in 2004. 19 Even further more, when considering Colorado's ad valorem tax structure and the ability to let producers subtract property taxes from severance tax, the credits transform the nominal 5.7 percent rate into one that yields only two percent or less. Another way to look at possibly changing the severance tax would be to again lean on the concept of simplicity; rather than change the rate, simply change how it is imposed. Because natural resources are very volatile industries and goods, and that it has also been suggested by federal legislation that it may be optimal for different tax rates to be applied based on different market conditions, in the interest of simplicity it may be better to impose tax on a different unit than gross income. Again pulling from the examples of other states with California, Indiana, and Ohio, as well as the Colorado severance tax on coal, one reasonable idea would be to charge tax on a per amount produced basis. This idea may have a simplifying effect in that if rates did need adjusting,
19) "Colorado Levies Low Severance Tax Rate." Denver Post 2 Apr. 2007. 11 Sept. 2007 <http://www.denverpost.com>.
they could be done so less often and with a necessary simplicity with reference to the voter approval needed under the TABOR amendment. 20 Considering all of issues discussed above, it is obvious that there are grounds for a change to Colorado severance tax, as well as a lot of different ways to change it. Under the impression that any modifications to Colorado's severance tax would warrant major legislative action and moreover, the fact that any changes resulting in a net tax gain would require a statewide vote in accordance with TABOR, it is obvious that all issues necessitate careful consideration. The final portion of this paper will serve to briefly opinionate what possible changes to Colorado severance tax should be made. First off, it is the opinion of this author that in order for Colorado to benefit most greatly from severance tax it should serve to accomplish two things. The first of these requirements, is the currently controversial issue of providing enough funds to local governments that they are able to offset the impacts on their communities created by nonrenewable resource development.20 The second of the requirements is that Colorado serves to maximize its severance tax revenue without needing to change its severance tax rates. Therefore it is the position of this paper that Colorado does not need a new severance tax but rather make changes to the current system. Beginning with the first requirement of providing local governments with means to offset energy development impacts such as road damage and school crowding, two possible solutions come to mind. The first of these solutions is to change the revenue distribution structure at the state level. As explained earlier, House Bill 1139 recently passed to increase the percentage of the Local Impact Fund going directly to local
20) Symanski, Sally. Performance Audit June 2006. Colorado Department of Revenue. Denver: Colorado State Auditors Office, 2006. pg.51. 8 Sept. 2007 <http://www.state.co.us/gov>.
governments from fifteen to thirty percent starting in 2008. Yet, with estimated amounts for developmental impacts expected to reach billions of dollars in the next two decades, as well as large amounts for lobbying by numerous local communities, it is safe to assume that even more drastic changes may be necessary. Given these circumstances, three possible remedies emerge. The first is to further increase the percentage of the LIF that goes to local governments. But as stated earlier, this may serve to harm the local governments as much as it helps them in that by increasing direct allocation, grant funds must be reduced. That said this same sort of process leads to the next possible solution; changing the percentage of severance revenues received by the Local Impact Fund and the State Trust Fund to favor the LIF. Currently, the distribution is cut in half between the LIF and the STF, and shifting the percentage in favor of the LIF would serve to allocate more funds to local governments both directly and through grants. And although it must be noted that this transition would of course shift funds away from the State Trust Fund and henceforth the Perpetual Fund as well as the Department of Natural Resources Operational Account, one might argue that because there are numerous channels by which the State Trust Fund receives money where as virtually the entire Local Impacts Fund is supplied by state and federal severance tax revenues, the latter should receive precedence in this case. But if it is not desirable for these distributions to be changed, then a third possibility may be better suited. The third possibility would be to simply increase the collected revenue of the severance taxes and in turn increase the amount of money the local governments receive as a result. This would increase revenues without increasing the actual severance tax rate, which is the second requirement put forth as a
necessary action; therefore the following suggestions will serve as possible solutions for both requirements. In order to increase the severance tax revenues of the Colorado government without increasing the actual rates that the tax currently applies, certain severance tax policies and systems as mentioned previously must be modified. The first of these systems is that dealing with collections and processing of severance tax returns. Because of the capacity for the current systems to lack immense amounts of information and resources necessary to proficiently monitor, collect, and audit the allocation and payment of severance tax, this system must be improved. The 2006 State Auditor's report of severance tax give two relevant suggestions of how to solve these issues. First, the Department of Revenue should attempt to improve controls over processing severance tax returns by:
"(a)following up with taxpayers who do not submit required supporting documents with returns, (b) entering all critical data from returns and supporting documents, (c) implementing additional math edits to match information from supporting documents to that reported on returns and to recalculate the tax liability owed, as well as penalties and interest due, (d) establishing more rigorous review procedures for returns that exceed the Department's internal threshold for refund requests, and (e) seeking statutory change to allow enforcement of the withholding requirement in cases where the producer fails to withhold and submit the statutorily required 1 percent of gross income from interest owners on a quarterly basis." (21)
And second, the Department should investigate more effective ways to collect oil and gas severance taxes owed to the State. By attempting the preceding improvements, it is virtually guaranteed that the state will both issue tax and collect money that it is owed and was previously not receiving for one reason or the other. Another important way to increase severance tax revenue would be to rid the
21) Symanski, Sally. Performance Audit June 2006. Colorado Department of Revenue. Denver: Colorado State Auditors Office, 2006. pg.55. 8 Sept. 2007 <http://www.state.co.us/gov>.
severance tax of its Ad Valerom tax structure. By eliminating this system of giving tax credit for the majority of property tax paid, the severance tax revenue would increase substantially along with actually allowing the actual severance tax rates to operate at the levels they are meant to. On the same note, would be the removal of the "stripper" wells tax exemptions. By removing these exemptions the severance tax would serve to increase its income by amounts in the millions per year while also serving to properly tax nearly half of Colorado's energy resource producers. As with the property tax credits, it would also be a possible scenario to simply lower the requirements at which these exemptions are given in order to increase the amount of firms that must pay. Either way, the decrease or total annihilation of these exemptions serve the wanted result. A final beneficial change to the severance tax is the idea of administering the tax at the producer level rather than the interest owner level. Taxing to the interest owner level makes auditing severance taxpayers difficult and labor-intensive. A single oil or gas well in Colorado may have many interest owners and each owner is only responsible for reporting a percentage of the gross income making it difficult to verify that the total amount of oil and gas produced by a well has been reported and the appropriate taxes paid. To ensure this degree of verification, auditors must audit the tax returns for every owner of the well, making for large amounts of work. Processing such a high volume of refunds is administratively burdensome and costly for the Department of Revenue, and thus, the State. By requiring only producers to file returns for and pay severance taxes is one option for simplifying the severance tax and for significantly increasing administrative efficiencies. It is estimated that taking this route will decrease the number of returns the Department of Revenue receives from
approximately 7,800 to fewer than 100 each year. Producers could then allocate the severance tax among interest owners leading to more efficient processing costs for the State as well as eliminating the collection and tax imposition problems mentioned earlier with the currently incapable system. In conclusion, it is the belief of this author that although a completely new severance tax is not in order, major modifications should be made to the structure and policies of the current tax. As previously stated, any of these changes may be hard to come by considering that TABOR labor requires a statewide vote for any net gain in tax revenue and all but one of the suggestions given are in the interest of increasing this revenue. Also, it must be stated that this paper does not take into consideration the relationships between the state government and the energy producing companies, or the interests of the energy companies as individuals beyond the rationale that state government should act in its best interests and that the policies suggested are by no means astray or can be considered harsh in comparison to other states with similar severance tax issues.