Montana’s Nickel-A-Widget Business Plan

By Bob Decker
April 1, 2009

Suppose you own a business that sells widgets. In a given period of time, would you rather sell 100 widgets at a nickel apiece, or 95 widgets at a dime apiece?

In determining a tax policy for oil and gas production in the state, the Montana Legislature has adopted, in defiance of common business sense and in servility to industry, a nickel-a-widget approach. The mismanagement has cost the state hundreds of millions of dollars.

Over the past 20 years, the Legislature has steadily lowered taxes for the oil and gas industry. The state’s generosity peaked in 1999, when the Legislature both expanded the applicability of tax “holidays” and significantly reduced basic severance tax rates.

Oil was selling for $20 per barrel in 1999, but soon began a multi-year climb: $28 in 2003, $50 in 2005, $67 in 2007. All the while, Montana’s discounted tax rates remained in place, even as oil reached $145 per barrel in mid-2008. According to data from the Montana Department of Revenue, the Legislature’s 1999 actions produced a decrease in revenue to state government and oil- and gas-producing counties of $500 million during the period 2003-2007. Add another $100 million for 2008.

Oil and gas companies contend that differences in state tax rates figure centrally in their decisions about where to drill wells, but they don’t substantiate the argument. In fact, evidence demonstrates that drilling decisions are based predominantly on the location of reserves and secondarily on global product prices and accessibility to markets. Tax rates are down the list.

Montana could learn from Wyoming, which also lowered its oil and gas tax rates in 1999, yet took the additional step of mandating research on the question of how tax rates affect development. The resulting study published by the University of Wyoming concluded that the reduced tax rates would generate 2.3 percent more production over 40 years, but would decrease state revenue by 37 percent.

Following the study, Wyoming repealed its tax reduction and hasn’t looked back. Mineral development has boomed there in the past decade, yet the state now has the highest effective tax rate for oil and gas production in the intermountain West. It has built a $3 billion mineral trust fund, fueled mostly by oil and gas taxes.

Wyoming is an aggressively pro-growth state, but its Legislature recognized the truth about drilling decisions and the value to the state of setting higher tax rates. By choosing to sell a fraction fewer widgets at a higher price, it increased its revenue stream and built a sizable savings account that provides permanent income to the state.

When Montana’s Legislature swerved errantly in 1999, both Republicans and Democrats were culpable. In the current session, however, the lines are clearly drawn. Several bills have been introduced by Democrats to terminate or amend Montana’s oil and gas tax holiday; all of them have been opposed – and defeated – by Republicans.

Republicans portray themselves as the “party of business,” but the brand is misleading. Most Republican legislators simply serve established wealth and have little interest in pursuing good business principles or negotiating firmly on behalf of the state. Some Republicans are so hostile to the existence of government that they reflexively resist a fundamentally conservative idea – a Montana oil and gas trust fund – that would increase earnings, protect the corpus, and provide tax relief for most Montanans.

If your answer to the opening query was to sell 95 widgets at a dime apiece, your business instincts are sound. Now you should examine Montana’s oil and gas tax policy and ask your own question: Who’s running the store?