Rep. Gara with former Governor Jay Hammond in 2004	Oil Tax Reform: Making Sense Of The Proposals Being Discussed in Juneau

Oil tax reform has taken center stage this year in the Legislature. In this newsletter I'll explain the good, the bad, and the ugly about this debate, and how the state may have lost over $1 billion in one weekend this February.

Any discussion of this subject should start with the basic premise that former Governor Jay Hammond used to always remind people about – Alaskans own Alaska's oil, and we lease it in a form of partnership for private oil companies to produce and sell. But with oil companies on pace to earn over $7 billion in after-tax profits on their Alaska production – roughly 80% more than the state of Alaska will receive for our share in oil revenue – it's clear that we've become a junior partner in this relationship.

According to the international oil and gas experts we've heard from, Alaska's share of this oil is smaller than the share most governments in the world receive. Alaska also provides a higher rate of return to oil companies than in most places in the world.

By not doing anything about this revenue sharing imbalance we're jeopardizing our ability to improve our schools, strengthen our communities, and save money for the future. Former Governor Hammond also used to remind me that the Alaska Constitution requires that we provide the "maximum benefit" for the public from our oil and other resources. We're not doing that. This February, the Governor also conceded that the current tax system shortchanges Alaskans, and legislators from both parties are now engaged in debate on this issue.

This newsletter lays out some of the main issues being discussed, some of my concerns, and some context for what you see in the paper and may hear in the coming weeks. It is lengthy but I hope you might read on. In this newsletter I'll address:

A fair oil tax should do two major things. First, it should provide a fair share of revenue for the public. Second, it should leave healthy enough profits to attract investment, development, and exploration by oil companies.

In 2004, Former Governors Jay Hammond and Wally Hickel joined with me, Senator Hollis French (D-Anchorage) and five other legislators to call on the Governor and legislators to review Alaska's outdated oil tax system. Loopholes in current law allow many large fields to pay a 0% Production Tax, no matter how high the price of oil goes. This doesn't make sense.

Legislators and the Governor are discussing a change in the weakest parts of our oil tax structure – the Production Tax, and the Economic Limit Factor, or ELF, which has the effect of allowing many companies pay a 0% Production Tax on many new and existing fields.

The intent of Alaska's Production Tax, when it was last amended in 1989, was to lower the 15% Production Tax on marginal and older fields that were not very profitable. However, it has resulted in a 0% Production Tax on a half dozen large fields that rank among the largest 100 fields in the country. The tax on these fields remains near 0% no matter how high the price of oil. This is one of the major flaws of the current tax, and is the reason many of us have called for its reform for the past three years.

We are currently considering replacing the outdated "Production Tax" with a profits-based tax, which folks in Juneau are calling a "Production Profits Tax" or PPT. The intention is that the state should receive a larger share of the value of oil as prices and oil company profits rise. Conversely, when oil is not profitable, the tax intends to protect companies from excessive taxes that might deter investment and production. The bills being discussed also include various credits and deductions aimed at providing incentives for new exploration and development.

In early February, Governor Murkowski's oil consultant began pitching a 25% Production Profits Tax, and a 20% investment credit system. The renowned consultant, Dr. Pedro Van Meurs, stood with the Governor and said this 25% tax would make Alaska "very competitive" and "quite attractive" for future investment. As February progressed, the Governor delayed the formal release of this 25% tax proposal.

On February 21, after a weekend meeting with oil company executives, the Governor introduced his bill proposing a 20% tax instead of 25%. Before February 21, the Governor was adamant that the tax should go into effect on January 1, 2006. His filed bill delayed the implementation of the new tax to July 1. Lowering the tax rate meant a loss to the state of roughly $600 million in annual Production Profits Tax Revenue, and the delayed implementation date cost the state an additional $500 - $600 million.

Many people thought the Governor's original tax proposal was already a bit too modest, and when he reduced the amount the state will receive by over $1 billion after a meeting with oil company executives, I think he did the state a disservice.

5. What Tax Rate Is Fair?

Experts hired by the Legislature have stated that taxing oil companies at a 25% rate, and increasing the rate as prices rise, is the best approach. This will both maximize long-term revenue and lead to a healthier investment climate than Alaska provides today.

The Legislature's lead consultant, international oil expert Daniel Johnston, also testified that since existing fields are so profitable, it would be fair to tax those fields at a slightly higher rate than new, less profitable fields.

Profit margins on Alaska's larger existing fields are far higher than needed to encourage investment. According to Johnston, this in turn leaves the state's share lower than it should be.

These recommendations are supported by a recent analysis I requested from the State Department of Revenue, which you can find on our website here [PDF <1MB]. It shows oil company profits on existing North Slope fields will remain staggeringly high under current law, a 20%, 25%, and even a 30% tax rate.

6. Tax Credits Should Be Carefully Targeted To Spur New Production;
They Shouldn't Simply Give Away State Money

Most of us agree that tax incentives are needed when they spur new oil development. On the other hand, the state should not give tax breaks when they do not lead to additional investment. The PPT bill includes tax credits for new exploration and development expenses. These credits are most likely to attract new companies to engage in development and exploration in Alaska.

The Governor's bill, however, includes some questionable tax credits. For example, it allows every company in the state to earn its first $73 million of profit without being subject to the Production Profits Tax. Additionally, the bill allows companies to deduct the cost of investments they made over the past 5 years from future taxes. A tax break on prior investments does nothing to spur new development and exploration. Many legislators have rightly questioned these provisions.

I wrote recently on issues confronting us if we are to develop an Alaska Gas Pipeline. You can find that newsletter here. The gas pipeline debate has taken an interesting turn – one that many of us think makes little sense, and involves more bluff than substance.

Governor Murkowski is now taking the position that if the Legislature doesn't agree to a 20% tax rate, the oil companies might not build a gas pipeline and sign the agreement he's negotiating with them. On the other hand, he won't show anyone that agreement. In part, the word is that this "contract" doesn't include any firm commitment for companies to actually build a gas pipeline.

The Governor in essence is asking us to reduce the revenue share the state receives for our oil by roughly $600 million below what our lead experts have said is justified. He also refuses to show the public the gas pipeline "contract" he says he's negotiating. What we do know is that it includes flaws that are so great that the Commissioner of the Department of Natural Resources and his lead staff resigned late last year in protest.

Asking us to give away oil tax money for a gasline "contract" no one is allowed to see has been likened to the old game show "Let's Make A Deal." As stated by Sen. Gary Wilken (R-Fairbanks), "We're being allowed to see what's behind door number one, the oil tax bill, but the prize, the gas pipeline contract, is behind door number three, and we're not allowed to see that."

If you'd like more information on this bill, let us know. Documents presented in committee to date can be found at www.akdemocrats.org/ppt.

Relevant testimony excerpts from Legislature's and Governor's expert oil consultants we've heard testify can also be found here [PDF 2.5 MB]. These include: Daniel Johnston, Dr. Pedro Van Meurs, Dr. Tony Finizza, and Barry Pulliam.

As always, please call if you have any questions. I hope I can report to you in May that the Legislature has done the right thing – adopted an oil tax reform that provided a fair share of revenue for the state; closed unjustified tax loopholes; and provides fair incentives to prompt existing and new companies to invest, explore and develop oil in our state.

Best Regards,

      Les