Ohio has an interesting case study in principles and politics in the current clash over the potential of new natural gas and oil reserves in the eastern and southeastern parts of the state.

North Dakota, Pennsylvania, Texas and Louisiana are all savoring employment gains and tax revenue increases from the relatively new horizontal drilling that has allowed parts of the nation to add centuries of oil and gas to the national reserves.  That’s pretty important, considering that the American economy runs on essentially two rails – cheap energy and cheap credit.  We have gone through a major credit crunch in the last several years, and the federal government seems intent on driving us completely into the ditch with its multi-faceted war on energy production.

The Ohio governor, known for his common-sense approach to managing the state, has proposed an increase of the severance tax, a tax on natural resources that companies who separate minerals from Ohio soil pay back to all Ohioans.  With the proceeds of this enhanced tax levied against what promises to be a huge emerging business in Ohio, the governor would fund an income tax reduction for Ohio taxpayers.

There are a couple of principles regarding sound taxation that should be applied to this proposal, however.  The first is pretty straightforward.  It is not a good idea to disproportionately tax one industry to extract a benefit for the public at-large.  Some years ago, King County in Washington State raised a cigarette tax to pay for enhanced wastewater treatment.  These schemes present numerous opportunities for political mischief and favoritism. And miscalculation, considering the widely-held truth that good politics is bad economics and vice versa.

More importantly, this causes skewed allocation of resources, which brings me to the second principle.  It may not be productive — that is, helpful to the mission of running a state — to tax an emerging industry that can emerge somewhere else on more favorable terms.  Arkansas is living this lesson right now.  They were one of the first states to present favorable enhanced drilling opportunities for these resources and, as a result, were one of four or five states without serious budget deficits just a few years ago. They got excited and raised the severance tax in 2008, resulting in a 50% decrease in drilling operations since.  Michigan and West Virginia both have a high severance tax and shale oil plays.  Drilling has gone down in both states in the last five years, but is up 600% in Pennsylvania, which levies no severance tax.

The third caution of the proposed Ohio approach to taxing the golden goose before it starts laying any eggs is that government estimates of oil and gas production are higher, and estimates of the expenses of producing the energy lower, than the industry projects.  To my mind, it is not a good bet to go with the government on how much will be produced or how much it will cost to produce, especially when the fruits of this calculation are promised to all the rest of us in advance.

It makes far more sense to wait until the wells are flowing before any adjustments are made in the government’s share. The companies engaging the Utica shale energy treasures already pay the corporate activity, ad valorem, sales, fuel and property taxes. If the Ohio economy booms (there are reportedly openings for 8,000 truck drivers in North Dakota today) there will be resources available for an income tax cut without increasing taxes on the industry that made much of it possible.  Even the increase in steel production we have seen lately in Ohio is partly due to manufacturing for new pipelines.

The Ohio House of Representatives has decided to look more carefully at this proposal, the history, and what is going on in our neighboring states  before they act.  They will probably not get the credit they deserve for this, but they are clearly doing the right thing.

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