Oklahoma on Oil: Big Tax Breaks and Low Returns to Local Governments

Summary Findings

• Oklahoma currently has a low effective tax rate compared to peer states. The state’s effective tax rate on unconventional oil production is 3.3 percent, the lowest of seven peer oil-producing states(see Figure 1 below).
• Oklahoma’s low effective tax rate results from a four-year production tax incentive that reduces the tax rate for newly completed horizontal wells from seven to one percent. Oklahoma is one of only two oil-producing states reviewed in this study with an active holiday incentive for oil (the other is Montana).
• But distributions are delayed by up to 22 months from the start of production by the tax incentive. Distributions are only made to county governments and school districts, leaving cities with few direct revenues to manage impacts associated with drilling and related population growth.
• The amount returned to local governments equal to one percent of gross production is second lowest among the seven states in this study. Revenue is also distributed only to jurisdictions that host production, leaving out adjacent cities and counties that experience impacts (see Figure 2 below).

Figure 1. Comparison of Production Tax Revenue Collected from a Typical Unconventional Oil Well

Figure 2. Comparison of Distribution of Production Tax Revenue from a Typical Unconventional Oil Well

Background

Unconventional oil is extracted from tight shale formations using horizontal drilling and hydraulic fracturing technologies. The focus on unconventional oil is important as horizontal drilling and hydraulic fracturing technologies have led a resurgence in oil production in the U.S. Unconventional oil plays require more wells to be drilled on a continuous basis to maintain production than comparable conventional oil fields. This expands potential employment, income, and tax benefits, but also heightens and extends impacts on communities and public costs.

State and local governments levy different types of production taxes, at different rates, and offer a complex array of exemptions, deductions, and incentives. The various approaches to taxing oil and natural gas make comparisons between states difficult, although not impossible. This report applies each state’s fiscal policy, including production taxes and revenue distributions, to a typical new unconventional oil well over ten years of production. This allows for a comparison of how states tax oil extracted using unconventional technologies, and how this revenue is distributed to communities over time.

To provide a simple framework for the comparison, we assess state production tax policies on four criteria: the amount, time, location, and predictability of revenue distributions to local governments where extraction and associated impacts occur. We also provide a summary of the methods and data used to compare state fiscal policies.

The various approaches to taxing oil make comparisons between states difficult, although not impossible. To compare states, we apply each state’s fiscal policy, including production taxes and revenue distributions, to a typical unconventional oil well. This allows for a comparison of how states tax oil extracted using unconventional technologies, and how this revenue is distributed to communities.

We hope these data and resources will be useful to states and communities with unconventional oil development that are trying to mitigate the short-term impacts of oil extraction while making investments in long-term economic development opportunities.