State budgets squeezed by dropping oil prices

The New York Times says that the oil industry is in its “deepest downturn since the 1990s, if not earlier”. The price of a barrel of oil has plummeted, falling more 70 percent since mid-2014, and gas prices at the pump have followed – falling from $2.21 one year ago to $1.70 today (AAA). Unfortunately, a drop in energy prices means a headache for several states that rely heavily on severance taxes for revenue.

A recently released report by Standard & Poor’s analyst Gabriel Patek – Collapsing Oil Prices Seep Into State Credit Profiles – explains that states that are heavily dependent on oil-related revenue may be facing some tough fiscal times.

“In short, the more aggressive a state was with regard to its assumptions and use of oil-related revenues during the oil boom, the more acute its fiscal pressures now, in the oil price bust,” said Patek. “For states with greater budgetary reliance on oil-related revenue, the unrelenting decline in prices places a larger budget on state lawmakers to identify and enact corrective fiscal measures.”

The S&P report points out that three states — Alaska, Louisiana and New Mexico — are at risk of having their credit ratings lowered as a result of falling revenues. For example, in Alaska, Patek says that the state has relied on taxes and royalties from oil production but the drop in prices means the state has had to use its budgetary reserves to cover the expense gaps. Those reserves, although substantial, can’t cover the full gap. “Despite comparatively large reserves, we do not view the arrangement as sustainable considering that the state’s unrestricted general fund faces a budget deficit equal to roughly two-thirds of baseline expenditures,” said Petek. Year-over-year, total tax revenues in Alaska declined in the first quarter of fiscal year 2015 by 72.7 percent.  

A majority of states (35) impose at least one form of severance tax, which is a tax on natural resource extraction. According to the National Association of State Budget Officers, severance taxes are determined by the value and/or volume of the resource being extracted. Resources that are subject to severance taxes include oil, minerals, metals, natural gas, timber, fish and other natural resources. You can find state-by-state severance tax descriptions and rates in CSG’s 2015 Book of the States.

While overall severance taxes don’t make up a large percentage of total state taxes collected – 2.1 percent in 2014 – they have very different impacts across the states. For example, in 2014 severance taxes collected ranged from 72 percent of total tax revenue in Alaska and 54 percent of revenue in North Dakota to less than 1 percent in 18 states. In seven states, severance taxes make up 10 percent or more of total tax collections.