Ohio Governor Proposes “Frack Tax” — But Concerns Lie Ahead

An article in the Cincinnati Enquirer today discusses the proposal of Ohio Governor John Kasich to create a new “frack tax” — a severance tax (a tax on the extraction of a nonrenewable resource) on the sales of oil and gas — that Kasich estimates will raise around $413M by 2017. The Governor, however, is proposing to use this new revenue to offset a proposed cut in individual and corporate income tax.

Of course oil and gas industry representatives claim this tax could result in less investment in oil and gas production in Ohio. This threat is almost certainly without merit, given the potential profits to be made from extraction from Ohio’s Utica shale (not to mention that there is a good argument to be made for disincentivizing fracking, although again, a tax is unlikely to do that given the potential profits).

But the interesting argument, from a tax policy perspective is that, as the article discusses, this tax as proposed could potentially put Ohio in a bind down the road a few years. As with any extractive industry, particularly one with such global price volatility, revenues are not predictable and will inevitably decline. If Ohio uses the frack tax to offset cuts in the (much more stable) income tax, the state could face a revenue crisis if and when oil and gas revenues decrease — and it is unlikely that state elected officials will find the political will to raise the income tax back up when the need arises.

Indiana will be facing the same situation with its gambling tax revenue.  Created to offset a number of other taxes, gambling revenue has been remarkably stable in Indiana in the past; however, new casino development in neighboring states — Ohio, in particular — will undoubtedly cause the revenue to decline substantially.

It is often politically more palatable to replace a broader-based tax (like income or property) with a more narrowly-based excise tax. But jurisdictions that do this frequently find themselves in a budget crisis down the road when the excise tax revenue becomes unstable or declines.

The frack tax is ultimately a positive development. However, it should not be used to allow corresponding cuts in income taxes. Instead it should be used for one-time investments (infrastructure repairs, for example) and to add to reserves, particularly since there may be long-term environmental costs of fracking that aren’t yet known.