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Coal Severance Tax

by Levi N. Pace

August 28, 2006

What is a severance tax? How important a revenue source is it for Utah and other Western states? Who ends up paying for it? This article explores issues related to this tax on natural resources, including a brief review of the status of coal and the severance tax in Utah.
 
State governments commonly assess severance taxes on companies that extract natural resources, particularly oil, natural gas, and coal. Individuals and businesses that ‘sever’ natural resources from the land make a profit by using up the irreplaceable natural wealth of a state. The tax is intended to compensate present and future citizens for that loss. Severance taxes may also encourage conservation and judicious usage of natural resources.[i] But to a mining corporation, taxation means reduced profits. Indeed, this tax on business could weaken incentives for the natural resource based industries and hurt their competitiveness on the nationwide market. Like other taxes, the severance tax has its pros and cons. Ultimately, someone must pay the price.
 
But who pays the price for the severance tax? States often favor severance taxes over alternative sources of government revenue because much of the severance tax burden is transferred out of the state. ‘Exporting’ the tax burden is achieved, for example, if a relatively small portion of the oil pumped from an oil-abundant state is used in that state or if out-of-state companies own oil production.[ii] This general scenario applies to many states, accounting in part for its prevalence and importance (see Figure 1). In 2004, all but 15 states reported income from severance taxes. In the same year, state severance tax revenue averaged $127 million—or approximately five percent of total state tax revenue—in the 35 states that operate severance tax laws.[iii]

 
As noted, Utah receives a considerable amount of revenue from severance taxes, all of which goes directly into the general fund. From 1996-2000, severance tax revenue averaged $21 million per year (nearly 1.5 percent of the general fund). In contrast, the average doubled for the subsequent five years to $42 million per year (2.5 percent of the general fund). In 2005, severance taxes were the third leading contributor to the general fund at 3.6 percent, following the insurance premium tax (3.7 percent) and the sales and use tax (88 percent).[iv]
 
For nearly 70 years, Utah has collected severance tax revenues. In 1937, the state imposed upon mines a one percent tax on net proceeds from the sale of metallic ores: gold, silver, copper, lead, iron, uranium, and other valuable metals. In 1956, the one percent severance tax was also applied to oil and natural gas production. This rate was raised to two percent in 1959 and again doubled to four percent in 1984. In contrast, the severance tax rate for metallic ores was not affected until 1988, when it was increased to 2.4 percent, and 1990 when it was adjusted to 2.6 percent. Collections have varied considerably through the years depending on, among other things, fluctuating prices for these goods. It should be noted that the definition of net proceeds changed over time, as well as the specification of exemptions. Coal and lumber have never been subject to a severance tax in Utah.[v]
 
Coal stands out as an anomaly in its exemption from severance taxes in Utah. It is a hydrocarbon like oil and natural gas and is mined like the metallic ores, all of which are taxed in Utah. Most of the other Western coal-producing states collect a severance tax coal (see Figure 2). Of these states, it was not determined whether Arizona and Washington (the states with the least amount of coal production) have a coal severance tax.
 
Utah produces a considerable amount of coal. Of 27 coal-producing states, Utah was fifteenth in output in 2004, and thirteenth from 2000-2003.[vi]Coal production has expanded considerably over the past few decades, with the exception of a recent decline in production, from which the industry seems to have recovered (see Figure 3). A similar taxation of coal in Utah would be consistent with the treatment of other natural resources and would likely produce a considerable amount of revenue.

On the other hand, several claims are made supporting Utah’s current tax policy on coal:

• Above average costs of production and transportation already place Utah at a competitive disadvantage among other coal-producing states.
• Much of the coal mined from Utah’s soil is used to generate electricity for Utah customers, who would end up paying most of the tax.
• Tax revenue generated may not justify the administrative cost of assessment[vii]
• The political clout of special interests may represent a non-economic defender of current tax policy, since all of Utah’s coal comes from Carbon, Emery, and Sevier counties.[viii]

We will briefly consider the first two claims.
 
First, is production and transportation of coal more expensive in Utah than in other states? Underground coal mining is more expensive than surface mining, but the price of underground coal is also higher due to its preferred qualities. Utah mining is entirely of underground coal. In addition, a 2000 study shows that Utah was able to sell its coal at an average price of $17.56 per ton, which was $0.54 higher than the average price received by underground coal producers in other Western states.[ix] In addition to the high quality of Utah’s coal, employee productivity in underground mines was about 6.8 tons per labor hour in Utah for 2004, compared to 9.5 tons per labor hour in Colorado (the highest in the West) and a mere 1.6 and 2.9 tons per labor hour in Montana and Wyoming, respectively.[x] Regarding transportation costs, Figure 4 illustrates that in 2004 Utah had below-average transportation (delivery) costs compared to other western states. Corresponding 2000 statistics are similar.[xi]

 

The second claim suggested that energy from Utah coal is bought mostly by Utah customers. Where does Utah-mined coal end up? Forty percent of the coal produced in Utah is sold to other states for a variety of uses. Most of what is left is used within the state for electric utilities,[xii] which run almost exclusively on coal.[xiii] Furthermore, it appears that just over one third of Utah-generated electricity is sent to other states.[xiv] Considering the 40 percent of Utah coal sold out-of-state, a severance tax on that portion of coal output would likely not be paid by Utah consumers. Data indicates the out-of-state sale of electricity may account for an additional 20 percent of Utah coal that is ultimately paid for by out-of-state customers. Perhaps a severance tax on coal could be mostly exported beyond state borders, especially if different rates are assessed based on the use of the coal. On the other hand, one might question whether the tax could, in fact, be passed on to consumers instead of being absorbed by coal mining and electricity generating companies, some of which are Utah companies.
 
The severance tax represents an important source of state general fund revenue and an important policy issue for Utah, as well as for many other states with considerable natural resource endowments. This introductory case study of Utah coal illustrates some of the relevant arguments for and against levying a severance tax, relying on some data and economic analysis. How much severance tax is appropriate on which natural resources is as complex an issue as the debate surrounding personal or corporate income taxes. Discussion of the severance tax has emerged intermittently in the Utah legislature, resulting in policy that affects industry, government and its sovereign constituents.