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October 9, 1981
American Emirates?
Key energy-producing states-located
mainly in the West-were heartened by a
recent Supreme Court decision upholding
Montana's right to levy a stiff "severance" tax
on coal mined there. (The name "severance
tax" comes from the fact that it is appl ied at
the production stage, as the product is
"severed" from the ground.) The decision
supports those states' efforts to use energy
severance taxes as a major source of general
revenue. But industries, utilities and other
energy consumers in the energy-resource
deficient states-mainly in the Midwest and
Northeast -were angered by the decision.
Producing states argue that severance taxes
are necessary to provide for the roads,
sewers, schools and other facilities required
to support rapid energy development-and
to ensure that some revenues are left in state
coffers followi ng the depletion of thei r energy
resources. But opponents argue that the tax
drains income from energy-poor to energyrich states, and thereby precipitates one of the
largest capital transfers in the nation's history.
Indeed, they envision the creation of a de
facto "United American Emirates" -a group
of energy-producing states whose control
over domestic energy sources leads to a
major transfer of wealth. Also, they maintain
that, because of the increased revenue from
this source, energy-producing states can
reduce other business taxes and thereby
encourage business to locate there,
facilitating further transfers of wealth. These
states, moreover, can qualify for additional
Federal payments on revenue sharing and
other programs, because the allocation
formulas sometimes reward states for their
"tax effort," the amount of revenue they raise
on their own.
The arguments against the tax bear closer
scrutiny. There is no question that severance
taxes constitute an important and growing
source of state revenue for the resource-rich
states, particularly now that domestic oil
prices have been decontrolled. It is also true
that severance-tax revenues are making it
possible for state governments to reduce
other taxes below levels that might otherwise
prevail. But the argument that such taxes are
being passed on to out-of-state customers
through higher energy prices undoubtedly
holds true only for certain energy sources.
Most of the pass-through apparently pertains
to coal and uranium, which account for less
than one-tenth of the total state revenues
derived from energy severance taxes.
Montana decision
Since 1921, Montana has imposed a
severance tax on the output of its coal mines,
including coal mined on Federal lands. In
1975, however, the state legislature voted to
raise the tax for surface-mined coal to a range
of 20 to 30 percent of the contract sales pri ce,
with the maximum applying to coal with the
highest heat content. In 1978, four Montana
coal producers and eleven of their out-ofstate electric-utility customers sought tax
refunds on constitutional grounds. The trial
court-and later the Montana Supreme Court
-upheld the tax, and the utilities then
appealed the decision to the U.S. Supreme
Court.
The uti Iities contended that the Montana tax
discriminates against interstate commerce,
because 90 percent of Montana coal is
shipped to other states under contracts that
shift the burden primarily to non-Montana
utility companies and thus to residents of
other states.Those contracts typically provide
for a pass-through of state-taxation costs to
the utilities, while fuel-adjustment clauses in
turn provide for a further pass-through of such
costs to utility customers. The utilities argued
furtherthatthetax is excessive, being unfairly
related to the value of the mine-related
services the state provides or the mine-related
costs it incurs. Finally, they argued thatthe tax
violates Federal law-namely the Mineral
Lands Leasing Act of 1 920-because it
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Opinions expressed in this newsletter do not
necessarily reflect the views of the management
of the Fpderal Reserve Bank of San Francisco,
or of the Board crf Governors of the Federal
Reserve System.
$3.7 billion in 1 980-largely reflecting the
upsurge in domestic energy prices duringthis
period. Coal revenues showed the most rapid
growth, rising from $38 million to $329
million over the period, but still comprised
only 9 percent of the total by 1980. Oil-andgas severance tax revenues-the bulk of the
total-rose from $808 million to $3.4 billion.
As a result of this growth, energy severance
taxes rose in importance as a source of state
revenue-in
1980, accounting for over onethird of Alaska's total revenues and over onefourth of Oklahoma's and Wyoming's totals.
reduces the Government's royalty payments
from output from Federally-owned land.
The Supreme Court ruled that a state
severance tax is subject to Constitutional
review even though imposed on goods prior
to their entrance into the stream of interstate
commerce. The Court added, however, that
the Montana tax is even-handed and
nondiscriminatory with regard to out-of-state
users, because it is computed at the same rate
regardless of the coal's final destination. The
Court ruled further that the question of what
constitutes an "excessive" rate is a matter for
Congress and not the courts to resolve.
Finally, it ruled that the tax does not violate
the purposes of the Mineral Lands Leasing
Act, which expressly authorized the states to
levy and collect taxes as though the Federal
government were not concerned.
The growth in severance-tax revenues occurred in the face of price controls on domestically-produced oil and gas. But revenues
may now soar, in the wake of (full or partial)
decontrol of these prices. Moreover, rents
and royalties on state-owned oil and gas
properties add even more to the total. According to Treasury Department estimates,
oil-producing states could collect $128 billion during this decade simply as a result of
decontrol. More than $100 billion of that
total would flow to just four states: Alaska,
California, Louisiana and Texas. (That accounts for Alaska's abilityto repeal its income
tax and to refund 1979 and 1980 taxes.)
Phased decontrol of natural-gas prices under
present law would yield producing states
another $50 billion, 'with immediate decontrol yielding revenues many times greater.
Risingrevenues
Only a few states are net exporters of primary
energy: Louisiana, Wyoming, New Mexico,
Kentucky, Alaska, Oklahoma, West Virginia,
Montana and Texas (1976 data). The major
oil-and-gas producing states are Texas,
Alaska, Louisiana, California and Oklahoma.
Coal resources are more widely dispersed,
with the largest producers being Kentucky,
West Virginia, Pennsylvania and Wyoming.
(Montana actually is one of the smaller
producers, with about 4 percent of the total.)
New Mexico and Wyoming produce most of
the nation's uranium.
Who really pays?
Energy resource-deficient states argue that
these taxes are shifted forward fully to
consumers; and that, since most of the
production is sold in interstate markets, most
of the tax is "exported". Butthat argument
neglects the fact that the structure of the
markets for most energy sources will not
permit a full pass-through of severance taxes
to consumers, even when the regulatory
framework is not an impediment.
Many producing states now impose
severance taxes. The Alaska legislature
recently raised that state's petroleumseverance tax from 12.25 percent to 15.0
percent, making it the highest in the nation.
Louisiana charges 12.5 percent, while other
states charge rates ranging from 7.0 percent
to 1.5 percent. In the case of coal, Wyoming
charges the second highest rate after
Montana-namely
10.5 percent-while
other states' rates range from 8.4 percent to as
little as 0.2 percent.
Indeed, producers' ability to pass on a
production tax depends largely upon the
elasticity of demand for the product in
question. The moreunresponsive the
quantity demanded is to a given change in
Tax revenues from this source have grown
substantially, from $840 million in 1973 to
2
price-i.e., the more inelastic
demand
schedule-the greater is the ability to passon
the tax to consumers through a higher price.
Severance taxes appear to be largely or fully
passed on to consumers only in the cases of
coal and uranium. A large proportion of coal
production is sold to electric power plants
under long-term fixed supply contracts which
allow for "pass-through" of increased
production taxes. Also, the high costs of coal
transportation tend to segment the national
market, reducing the competition among
producing states and making the demand
schedule relatively inelastic. The highly
concentrated nature of the uranium industry,
together with the lack of substitutes for
nuclear purposes, also suggests a full
pass-through of severance taxes.
In the case of domestically-produced crude
oil in an unregulated environment, imports
constitute a near-perfect substitute, and the
demand for domestic oil approaches infinity
-i.e., is perfectly elastic -at the landed
price for imported oil. Even in the absence of
Federal controls, domestic producers cannot
raise their price above the world (import)
price regardless of tax-related changes in
marginal costs and shifts in domestic supply.
Refiners simply will not pay more for
domestic oil than the world price, because a
virtually unlimited supply of imported oil is
available at the world price. Given the world
price, the severance tax must be fu Ily
absorbed by domestic producers-including
owners of the resource in question -through
a lower after-tax realized price. The
regulatory framework for natural gas
apparently allows for the pass-through of
severance taxes to final consumers in
interstate markets, butthe ability of producers
to fully avoid those taxes may be limited by
interfuel substitution, namely competition
from fuel oil.
These two fuels, however, account for a relatively small share of the total tax revenue
generated by energy severance taxes. For that
reason, we may question the claim that these
taxes generally result in a massive shift of
income to energy resource-rich states. Nonetheless, coal provides the greatest potential
for such an income transfer, and consequently, large energy-consuming states may
continue their attempts to limit severance
taxes on that particu lar fuel.
Yvonne levy
State Energy Severance Tax Revenues
$ Billions
o
1.0
2.0
3.0
4.0
D NATURAL GAS
1973
-C O AL
OIL AND NATURAL GAS
COAL
Wyoming
her
States
1 980
/
Louisiana
/
Other \ \Montana
States \
Oklahoma
Kentucky
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BANKING DATA-TWELFTHfEDERALRESERVE
DISTRICT
(Dollaramountsin millions)
SelectedAssetsandLiabilities
large CommercialBanks
Loans(gross,adjusted)
andinvestments*
Loans(gross,adjusted)
- total#
Commercialandindustrial
Replestate
Loansto individuals
Securities
loans
U.s.Treasury
securities*
Othersecurities*
Demanddeposits- total#
Demanddeposits- adjusted
Savingsdeposits- total
Timedeposits- total#
Individuals,part.& corp.
(Large
CD's)
WeeklyAverages
of Daily Figures
MemberBankReservePosition
Excess
Reserves
(+ )/Deficiency(- )
Borrowings
Netfreereserves
(+ )/Netborrowed
(- )
Amount
Outstanding
Change
from
9/23/81
151,894
130,986
39,286
54,459
23,039
1,534
5,715
15,193
38,834
27,002
29,311
85,287
77,182
33,918
9/16/81
215
- 206
15
19:3
11
3
11
20
-3,092
-1,039
- 477
170
189
74
Changefrom
yearago
Dollar
Percent
-
11,012
12,021
4,708
6,206
927
497
786
219
4,339
5,530
210
19,789
20,292
8,807
Weekended
Weekended
9/23/81
9/16/81
n/a
n/a
n/a
249
20
229
-
-
7.8
10.1
13.6
12.9
3.9
47.9
12.1
1.4
10.1
17.0
0.7
30.2
35.7
35.1
Comparable
year-ago
period
52
136
85
* Excludes
tradingaccountsecurities.
# Includesitemsnotshownseparately.
Editorialcommentsmaybe addressed
to the editor (William Burke)or to the author. ... Freecopiesof this
andother FederalReservepublicationscanbeobtainedby callingor writingthePublicInfonnationSection;
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