Tax on Natural Gas - Who Pays the Taxes?

Who pays the taxes on natural gas production in PA? Mostly, the answer seems to be: the landowners and not the gas companies. Unless something is done.

As reported in a recent CSCC email, several state legislators (mostly from the GOP) have touted the idea of taxing the gross value of gas at the wellhead "to pay for the economic impact of the shale drilling." Their proposal is an alternative suggestion to a severance tax that would be paid by the gas companies (as it is in 38 other states). Their idea has even been advertised in headlines such as "GOP legislators back bill to tax gas drilling." However, it is important for people to realize that this kind of tax would be on the landowners, not the gas companies. State Sen. Chuck McIlhenny (R-10) has said, "It comes out of the royalties."

Our own state senator (Gene Yaw) has discussed a similar tax. His argument is that gas companies would just pass on the cost of a severance tax by paying smaller royalties anyway, but the math just doesn't add up, does it? Let's just imagine that right now, companies were paying landowners a royalty equal to 20% of their (after-tax) profits. For every $1000 of profit, the gas companies would pay the landowner $200. Now what would happen if we instituted a 10% severance tax? (The current State House proposal is actually more like 7.3%.) Gas companies would pay $100 to the state and... $180 to the landowners. So yes, the landowner has gotten 18% of (pre-tax) profits instead of 20%, and lost $20. But the state now has $100, and the gas company has paid $280 instead of $200. They can't possibly "pass on the [full] cost of a severance tax to the landowner" so that argument just doesn't make sense. Does it make sense to anyone else?

What about corporate income taxes? The PA Budget and Policy Center (PBPC) has published an excellent summary titled, "Fact Check on Marcellus Shale and Severance Taxes." It points out that over 70% of wells are owned by companies that incorporate as partnerships or limited liability companies (LLCs), so they pay the 3.07% personal income tax rate on profits, rather than the 9.99% corporate net income tax rate. Most other states impose both corporate taxes and severance taxes.

What about property taxes? The same article by the PBPC says that "companies don’t pay property taxes on gas reserves." I asked Michael Wood, Research Director of the PBPC for more information about this. He writes:

Property taxes for surface properties are paid by the owner. So if a farmer leases land to a driller, the surface area is taxed, and paid for by the farmer. If a drilling company owns a building, they pay the property taxes on the building and the land it sits on.

When you get to the gas reserves, it is a different story. These haven't been taxable since 2002, but when they were, the tax was paid by the drilling companies. The property taxes on reserves are based on the production that has come out of the reserve over the past 5 or so years...depends on how the "assessment" is done. So, if there were a property tax on reserves in PA (which only requires a law from the Legislature authorizing such taxation), the drillers would pay it.

If the lease with the landowner allows the driller to deduct certain costs (transportation of the gas to market, processing to get the gas in sellable condition, and taxes), a portion of the tax would be "passed on" to the landowners in the form of lower royalty payments. That entirely depends on how the leases are drawn up. Drillers like to include those clauses in their leases, as it cuts their royalty payments. We don't have a good figure on what percentage of leases in effect have such provisions, but it is likely most of them.