Lessons from Alaska’s Windfall Profits Tax

Just because someone else does something stupid, doesn’t mean you should do it as well.

Most parents, at some point in time, have told their children something along these lines. I heard it from my mother and father, and I’ve said it to my children as well.

The same lesson applies to public policy.

The August 10 Seattle Times ran a piece – titled “Windfall tax lets Alaska rake in billions from Big Oil” by Angel Gonzalez and Hal Bernton – worth reading about the state of Alaska’s tax on oil companies. Alaska politicians love the tax – in fact, they recently hiked the levy – but does it make any sense in terms of sound energy policy?

The article explained: “Over the opposition of oil companies, Republican Gov. Sarah Palin and Alaska's Legislature last year approved a major increase in taxes on the oil industry — a step that has generated stunning new wealth for the state as oil prices soared.” This point is mistaken. Taxes do not generate wealth. Instead, by sucking resources away from the private sector, taxes discourage new wealth creation. Instead, taxes can generate more revenues for politicians to spend.

How does the tax work? The article explained: “The Alaska tax is imposed on the net profit earned on each barrel of oil pumped from state-owned land, after deducting costs for production and transportation, which are currently estimated at just under $25 a barrel. The tax is set at its highest rate in Prudhoe Bay, where the state takes 25 percent of the net profit of a barrel when its price is at or below $52. The percentage then escalates as oil prices rise over that benchmark. Alaska gets about $49 of a $120 barrel, not counting other fees. ConocoPhillips said that in total, once royalty payments and other taxes are added in, the state captures about 75 percent of the value of a barrel. An accounting benefit eases the sting for oil companies. They get a huge deduction on their state taxes when calculating their federal taxes.”

But a tax deduction is not a tax credit, for example. The companies only recapture a portion of the state tax on their federal tax returns. And since taxes paid in other states also are deductible, Alaska’s tax burden is still massive.

What’s been the impact on the Alaska budget? “Alaska collected an estimated $6 billion from the new tax during the fiscal year that ended June 30, according to the Alaska Oil and Gas Association. That helped push the state's total oil revenue — from new and existing taxes, as well as royalties — to more than $10 billion, double the amount received last year. While many other states are confronting big budget deficits because of the troubled economy, Alaska officials are in the enviable position of exploring new ways to spend the state's multibillion-dollar budget surplus. Some of that new cash will end up in the wallets of Alaska's residents. Palin's administration last week gained legislative approval for a special $1,200 payment to every Alaskan to help cope with gas prices, which are among the highest in the country. That check will come on top of the annual dividend of about $2,000 that each resident could receive this year from an oil-wealth savings account.”

Sounds great, right?

Well, as is always the case when taxes are increased, there are costs. It was reported: “The industry, however, warns new taxes are already discouraging future exploration and development in newer, more expensive projects needed to boost waning production in Alaska's oil patches. ‘Clearly, from the investor standpoint, Alaska has become a less attractive place to invest exploration and production dollars,’ said Marilyn Crockett, executive director of the Alaska Oil and Gas Association.”

Is this just talk?

Consider the following: “Still, oil-industry officials contend the tax already has affected investment decisions. BP Alaska, which runs Prudhoe Bay, said earlier this year that it had delayed the development in the western region of the North Slope as a result of the tax. ConocoPhillips cited the same reason for scrapping a $300 million refinery project. ‘What the tax has done is take away all the upside,’ said Doug Suttles, president of BP Alaska. The U.K.-based oil company paid more than $500 million in taxes to Alaska last quarter — far more than it earned in profits from Alaskan oil, according to Suttles. Investment dollars are flowing instead to places that have a better return, like the massive deep-water projects offshore in the U.S. Gulf of Mexico, where ConocoPhillips said the government take equals less than 50 percent of the barrel. In July, BP announced it would begin developing the Liberty oil field, a $1.5 billion project expected to yield 100 million barrels of oil, located on federal lands in Alaska. If the project had been located in state lands on the North Slope, ‘I don't think we'd have been able to make that investment,’ Suttles said.”

Alaska politicians can try to justify this formidable tax in all kinds of ways, but the economic realities of high taxes on energy production cannot be wished away. It’s straightforward: Higher taxes on energy production serve as a restraint on and disincentive to energy production.

Federal elected officials, as well as state lawmakers in energy rich states like Alaska, should be focused on how they can remove governmental barriers to energy production, such as reducing tax and regulatory burdens. Federal and state taxes – especially a tax as exorbitant as Alaska’s oil tax – should be targeted for reduction.

The lesson from Alaska is not that the federal government can impose a windfall profits tax with impunity. Instead, the lesson is, like mom and dad said, when others do something stupid, don’t do the same thing.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council