Croft Gasline Update #5

Note:  I and my staff will be sending these gasline updates on various aspects of the contract over the next few weeks, to give Alaskans more information about this important topic.  Please feel free to forward this to other people who you think would be interested -Eric

Locking In Taxes: 

Is it a Good Idea?  Is it even Legal?

Fiscal Certainty and the Gasline Contract

The administration is trying to sell the Alaskan people on the need to lock in tax rates for 30 years (oil) or 45 years (gas).  The argument for gas is, our project is too risky without a guarantee of how much (or how little) the state’s share will be.  The argument for oil is, once we figure out how much money the oil companies are making from our gas, we may try to get it back by raising oil taxes. 

The term they use for a long-term tax freeze is “fiscal certainty.”  That’s certainty for the oil companies, not for us.

What Alaska’s Constitution Says

Article 9, section 1 reads, “The power of taxation shall never be surrendered. It shall not be suspended or contracted away, except as provided in this article.”  The only exception are listed in Article 9, Section 4.  In addition to government, church, and non-profit property, “other exceptions of like or different kind may be granted by general law.”  It is this sentence on which the Governor and Attorney General rests their arguments.

“General law” means a statute, whether it is passed by the legislature, by the people through the initiative process, or via a court ruling.  This is a legal definition, and is supported in context by the three uses of the term in our constitution.

The Administration’s Argument

Last month at the beginning of the governor’s gasline “school”, the Attorney General made a presentation justifying the Governor’s authority to lock in tax rates via contract.  He based much of his argument on the looseness of the constitutional language, as well as industrial incentive laws passed in 1957 and 1968.  He argued that these laws provide precedent, and the Contract clause of the US Constitution (Article 1, Section 10:  No State shall...pass any Law impairing the Obligation of Contracts) would prohibit any future legislature from changing the terms once ratified in the contract.

In general, the historic incentive bills empowered government to grant ten year tax breaks for certain new industrial activities.  The breaks were available to anyone who made investments that met the criteria.

The attorney general used four cases in other states to establish the principle that governments can contract away the right to tax under certain circumstances.

Summary of Senator French’s Memo

My colleague Hollis French wrote a 26-page memo that thoroughly debunked the administration’s claims.  He went through ten years of opinion on the specific subject of a stranded gas contract.  All of it said the same thing:

• In 1997, Assistant Attorney General Jack Griffin (now with ConocoPhillips) wrote, “although the legislature may allow the executive to reflect those exemptions in a ‘contract,’ that ‘contract,’ like the general law upon which it is based, will be subject to an implied condition that future legislatures may amend or repeal it.”
• In 1998, Attorney General Bruce Botelho, in analyzing the Stranded Gas Act, wrote that “they legislature may expressly provide that the contracts fiscal terms are binding only so long as no future legislature decides to exercise the taxing power in a different way.”
• In 1998, the legislature’s chief attorney Tam Cook, in reviewing the then-draft Stranded Gas act, wrote “I do not think it is possible for the state to give up its power to repeal the exemption and impose the tax in the future.  Any contract that has that effect will probably be void as against public policy.”
• In a May 2006 memo, legislative attorney Don Bullock wrote, “in my opinion a contract provision limiting the level of a tax is more likely than not contrary to art. IX, sec. 1 and is not within the exceptions in art. IX, sec. 4.”  In a subsequent memo, he said that a shorter time limit or a “reopener” period would not make a difference.  “Contracting away is contracting away, regardless of the length of the contract.”

According to Senator French’s analysis, Alaska case law also supports this position.

• In 1985 the North Slope oil producers sued the state to invalidate the “separate accounting” oil taxation system that was in place at the time.  They argued that the tax amounted to a change in the terms of their lease contracts.  The court held for the state, saying, “the state could not and did not, contract away its power as a sovereign to tax income earned in the state.”
• On the other hand, a 1962 lawsuit challenging the special tax provisions of a state development corporation failed.  The court held that the tax exemptions were valid under the general law clause.  By extension, if the next legislature had chosen to eliminate the corporation, they could have.

Senator French then specifically rebutted the claims in Attorney General’s memo.

• From reading the minutes from the constitutional convention, article IX section 4 was meant to encourage new industry to come to Alaska.  “We did feel that there would possibly be occasion and good justification in the future for such things as allowing an industry-wide exemption to encourage new industry to come in and that is the reason for the particular wording there.”
• Any Supreme Court challenge to the contract would certainly focus on the term “general law.”  A long-term contract is not general law.
• The 1968 industrial tax credit act was never challenged in court.  If the 1969 legislature had chosen to eliminate the law, nothing would have prevented them from doing so.
• Three of the four cases cited by the Attorney General are irrelevant to this situation.  In the first, a state attempted to justify a retroactive tax.  The second concerned a bond issue in which the court determined there was no surrender of authority.  The third was an opinion, not an actual case, and took place in a state without Alaska’s constitutional limitation. 
• The fourth case cited by the Attorney General retroactively allowed a fifty-year-old exemption that benefited retired public employees.  This case was contradicted by three similar cases involving public employee pensions, and is very different than the governor’s proposal to limit our taxes nearly 50 years into the future.

Senator French concluded that the only way legally to justify the terms of the draft stranded gas contract would be via a constitutional amendment.  Short of that, the courts will strike down any tax break that lasts longer than the legislature that approves it.

This is a gas contract.  Why lock in oil taxes?

The oil companies’ position, parroted by the administration, is that they also require “fiscal certainty” on oil.  The premise is, once they make all that investment, they want to be protected against the legislature raising oil prices to make up for all the concessions made on gas.

As anyone watching the PPT debates realizes, changing oil taxes in Alaska is no easy matter.  The last significant change was in 1989, 17 years ago.  And once the broken ELF is fixed, hopefully soon and hopefully with a tax on the gross, I doubt there will be any desire to take on oil taxes again for years.

Daniel Johnston, an international oil and gas expert and one of the legislature’s consultants, says that locking in taxes on oil as part of a gas contract would be unprecedented in the world.  This was supported by the Administration as recently as last year:

In a July 2005 memo, the Governor’s main consultant Pedro Van Meurs says, "Producers want fiscal stability on oil, which is currently already in production and on which no fiscal stability was granted when the oil was developed.  In other words, the producers want 'retroactive' fiscal stability on oil that is external to the contract.  I do not know of a single international case where fiscal stability was granted to petroleum that was external to the contract."

Between then and now, the administration backed down from this position.  Like many other provisions of this contract, the Governor is giving away too much.

Where else do they do this sort of thing?

In most of the world, oil and gas development occurs on government-owned land.  There are basically two types of tax system.  In most cases, including everything in Alaska’s history, the government leases mineral rights in exchange for royalties and taxes.  In the other system, now being proposed, the government participates in the project and has fixed revenues negotiated by contract.

Jim Barnes is a petroleum economist and one of the legislature’s consultants on the gasline contract.  He provided us with a table that compares which countries use each method.

With no disrespect for our friends in Kazakhstan, I believe Alaska has more in common with the countries in the left column, and don’t understand why the oil companies consider us in the column on the right.

Where taxes are fixed by contract, most governments have an important power that Alaska lacks:  oil and gas leases have firm commitments to develop the resource.  If action is not taken to bring it to market, the countries take them back.  That’s part of the reason our gas has been warehoused all these years:  its more pressing for the companies elsewhere in the world.  This is why I have been pushing for a reserves tax, to help move Alaska to the front of the line.

Instead, in the governor’s “contract to nowhere,” we specifically sign away the power we now have to take the leases back, in exchange for nothing but a promise to do more studies.  Even if they drag their feet for 45 more years, we can't take the leases back.  So we would have the worst of all worlds:  we sign away our right to tax, but get no promise to develop in return.  That’s why this contract actually strands our gas.

There are really only two questions here:  can the state lock in oil and gas taxes, and should we.

On the first question, the bulk of what I’ve read says that no, we can’t.  Not without changing the constitution.  If we try, it will end up in court, and will likely be overturned.  But more important, moving forward with a contract that is doomed to be shot down would unnecessarily delay the project.

On the second question, everything I’ve read, seen, and heard says no, we shouldn’t.  The gas is economical.  This project is one of the most profitable in the world.  There are several groups willing and able to build the line without tax giveaways or giving up state sovereignty.  The oil companies have been dragging their feet for a generation, and they shouldn’t be rewarded with a sweetheart deal that will cost Alaskans billions and still doesn’t guarantee we get a pipeline.  How about a little fiscal certainty for us?