Lawmakers Question Tax Exemption for Natural Gas

In a Texas House Appropriations Committee hearing this morning, natural gas producers fought back against suggestions that a major tax exemption they receive be rolled back.

The committee is casting around for ways to plug the state's estimated $15 billion to $27 billion budget deficit. State Rep. Mike Villarreal, D-San Antonio, is urging that a tax exemption begun in 1989 and made permanent in 2003 be made more "efficient," i.e. reduced. State Rep. Lon Burnam, D-Fort Worth, has separately introduced a bill (not discussed at this hearing) to end the exemption, which slashes the amount of severance tax that gas producers pay on the gas they extract from the ground.

The tax exemption covers "high-cost natural gas drilling," which accounted for only 5 percent of the state's gas operations two decades ago but now accounts for more than half (including, for example, all of the Barnett Shale, which is drilled via a controversial method known as hydraulic fracturing). According to a recent Legislative Budget Board study not made public until this week, the exemption generally brings the effective rate down from 7.5 percent of the gas' market value to less than 2 percent.

The exemption results in the "potential for lost state revenue of $7.9 billion through 2019," according to the LBB report.

Gas producers testified that removing the exemption would hurt Texas, because it would cause drilling operations to move to other states. John Rex Jones, chairman of EnerVest, an oil and gas investment company, testified that Texas would drop from the second-best place in the country to drill to the sixth. (First place presumably belongs to Pennsylvania, which has no severance tax; lawmakers there have considered one but run into staunch resistance from the governor.)

"Being number six is like being in last place," Jones said. He and other industry representatives argued that the tax exemption is a net gain to the state because, by keeping rigs here, it creates jobs and economic activity that more than compensates for the loss in tax revenue. Gas companies also note that they pay other types of taxes in Texas, such as sales and property taxes. Three-quarters of the severance tax (above a certain amount) goes into the state's Rainy Day Fund.

State Rep. Warren Chisum, R-Pampa, agreed with the drillers that reducing the tax exemption would harm drilling operations. Villarreal argued that it wouldn't: "The shale is permanent. It's here. Folks aren't going to pick up and leave the state and take the shale with them," he said.

State Rep. Sylvester Turner, D-Houston, expressed concern that the exemption — originally intended to be temporary — had become permanent, apparently quietly, in 2003. Committee members said the provision was slipped into a bill that went through the Local and Consent calendar, a path intended for bills that attract no controversy and minimal discussion.

Villarreal said that the LBB study pointed to another troubling issue — namely that dozens of recent investigations by the Comptroller's office into individual companies' exemption applications resulted in 52 percent of the gas companies' refund requests being denied. Such investigations or audits are rarely conducted because the Comtrollers office has limited resources. 

"High-cost drilling" does not necessarily imply high costs. The definition is based on a 1978 federal law, the relevant section of which has since been repealed. It refers to the manner of drilling, rather than the actual cost — so in fiscal 2009, gas wells as cheap as $24,000 to drill received the exemption, as did wells costing as much as $14.7 million.

With stacks of other committee business, Rep. Jim Pitts, R-Waxahachie, the committee chairman, cut off testimony after more than an hour.