Did SB21 Cause Our Budget Problems?

I recently saw a social media post that said something to the effect of “the reason the State is broke is because of the oil tax giveaway back in 2013.”

At the same time, I see pro-industry ads talking about how the same tax reform has led to an increase in production and all the current excitement on the North Slope.

So which is it – is SB21 the disease or the cure to our budget issues?

This question can be resolved by looking at the data. If you’re interested in what the data have to say, read on.

Did SB21 cause the fiscal crisis?

First, let’s look at why this conclusion is easy to reach. We can use the information from the Department of Revenue in its 2017 Revenue Sources Book to help. The information we want is on page 107. I’ve plotted in below to help visualize the issue.

It is very clear that State revenues declined after SB21 passed. However, correlation does not necessarily imply causation. We need to think through this a little more before we can declare cause and effect.

Data Problem

As I’ve pointed out before, the issue we are dealing with here is that we are comparing one system under one condition, to the other system under a different set of conditions.

It would be kind of like testing a new drug on people who go to the gym and then comparing the results to a control group of people who lead sedentary lifestyles. You can’t really be sure what the drug is doing and what the exercise is contributing. We call this a confounding variable. And in the case of oil taxes, it is oil price that gives us a problem.

Here is a plot of oil prices over the same period (these can be found on page 111 of the same document):

You can probably see that oil prices fell dramatically after SB21 passed. But, unless you can argue that SB21 caused the oil prices to fall, we need to pull the impact of falling oil prices out of the equation.

Data Solution

The easiest way to resolve this issue is to calculate what ACES payments would have been in 2014-2017. Then we can compare what was actually collected against that number.

Caveat

This is actually not a full resolution to the issue. While the change in tax systems did not impact global oil prices, it may have influenced the amount of production that followed. That is a question I will tackle in next week’s article.

It is also possible that companies changed their spending patterns in response to different economic incentives offered by the new tax law. If either of these hypotheses are true, accounting for them would favor SB21. For now, let’s just assume that all the production and cost levels were unaffected by the tax system and see what the data say.

Tax Calculation

Alaska’s tax law is complex. There are a lot of moving pieces and nuances. But let’s just take a high level view and see how close we can get without getting into the weeds.

The big differences between the two fiscal systems boil down to this.

  1. ACES had a 25% base tax rate with an escalator based on profits; SB21 increased the base rate to 35% and removed the escalator.
  2. ACES had a suite of “cashable” tax credits tied to spending; SB21 replaced those credits with a “per barrel” credit of up to $8 for each taxable barrel of oil that is produced.
  3. ACES had a “soft floor,” meaning that the credits could reduce the minimum tax; SB21 made that a “hard floor,” meaning that credits couldn’t reduce the minimum tax.

There are a lot of other details that changed. But at the end of the day, these 3 are the ones that account for over 95% of the revenue changes.

Comparison

Here is a plot of what I estimate the net tax payments would have been under each fiscal system, under the conditions that eventually unfolded (I’ve also included my estimate for FY18).

Note that there are some complexities here. The biggest one is related to the earning of tax credits versus the payment of them. These numbers show the tax credit as a reduction in taxes in the same year they are earned, rather than trying to guess when they will be paid.

In reality, credits get paid out over several years based on several factors. The problem with showing it that way is that credits earned under one system bleed into the other (we are currently facing this situation in real life as credits earned under ACES are yet to be purchased). To keep the comparison “fair,” I am taking a little shortcut and avoiding the payment question.

Another complication involves detailed information, which is confidential. My numbers here treat the entire North Slope as a single tax payer. In reality, separating the production and profits into individual tax payers would change the number a little bit.

But, I checked these numbers against what DOR reports as actual collections and these numbers are about 90% accurate. And the differences are mostly related to the issues of credit payments. So, while not perfect, this is informative.

As you can see in the graphic above, the drop in production taxes would have happened under either tax system.

Differences in Net Taxes

You can see that during the years of high oil prices (before SB21 passed), ACES did collect more than SB21 would have under those same conditions (SB21 has a negative value).

But, if you compare the amount of money the State collected under SB21 since it passed to what it would have collected under ACES under those same conditions, you’ll see that SB21 actually generated more revenue for the State than ACES did (holding all else equal).

However, it is worth digging in just a little bit more here to understand what this finding means. Let’s look at the components separately.

In the above graph, notice that SB21 raised more revenue than ACES in the last few years. This is due to the 35% tax rate that SB21 put in place. At the price levels that occurred during those years, ACES would only have charged a 25% tax rate.

In fact, ACES charges a lower base tax rate than SB21 at all prices in which the “production tax value” is less than $55 per barrel. That equates to a spot price (which we are all more accustom to seeing) of around $95 per barrel. SB21 will raise more revenue before credits at all prices below that price.

Difference in Credits

The big change comes from the credits. Here are the credits that would have been earned in each year by each tax system.

The driving force behind the higher SB21 collections in the last few years is the repeal of the Qualified Capital Expenditure credit. Note the relatively flat blue bars in 2008-2013 followed by an increase for the next few years? That indicates an increase in capital investment, and thus, more earned credits.

Also of note is 2016. You likely notice there is not red bar. That is because the oil price was so low that the companies lost money that year. Since the SB21 credits cannot pierce the minimum tax floor, no credits were earned. ACES did not have that provision, so the credits would have been earned regardless.

Here’s how I interpret the graphic above “If ACES had been in place in 2014-2016,  then the State would now be on the hook for even more tax credits than it is.”

Conclusions

So, did SB21 cause the budget crisis?

The answer is a resounding no.

The data does not support the assertion that the State’s budget problems are caused by SB21. We can firmly say that the current budget issues would have existed even if SB21 had not passed, or if the repeal effort would have been successful. 

It is the depressed oil prices that caused the problems we have been working through for the last 4 years. If those prices continue to improve, the State’s budget issues will become less dire under any tax system.

However, it would take significantly higher and sustained prices to solve the fiscal issues we still face. Without those higher prices, no change to the tax system can solve our problems.

But did SB21 really generate more revenue than ACES would have?

Technically, yes. But, the truth is a little more complicated.

The difference in total net revenue can be attributed to the Qualified Capital Expenditure credit that was repealed by SB21. If that credits would have been in place while the development of Point Thomson and CD-5 were being conducted, the State would now be on the hook for more credits.

But, there is a more likely scenario that would have unfolded. It is the same one that did unfold under SB21.

When the oil prices crashed, the State realized it was in a position that owed more in credits than it was receiving in taxes. When that happened, the legislature went to work on getting rid of those remaining credits.

If SB21 had not passed, or if it had been repealed, it is likely that the same scenario would have played out. By simply making changes to the credit system under ACES, rather than a complete overhaul of the tax code, we probably would have reached the same outcome.

Without the impacts of those credits, both tax systems would have generated about the same revenue (the minimum tax). So, I can’t comfortably agree that SB21 raised more tax revenue than would have been raised without it.

The data to date cannot confirm an assertion that the State’s revenue picture improved because of SB21.

But what about production?

However, SB21 was not intended to raise more taxes than ACES on a per barrel basis. The goal was to encourage more exploration and development. Those activities would eventually lead to more production, which would translate into more royalty and tax payments.

The question of whether or not that has been successful is open. I’ll explore that issue next week.

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