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Severance Taxes at a Glance

Severance Taxes at a Glance

Severance Taxes at a Glance: An Overview of the Taxation on Non-Renewable Resources

Natural resources that cannot be replenished and are limited in supply, such as coal, oil, and gas, are considered non-renewable resources. They play a significant role in the economy, but their exploitation can also cause environmental harm and other social costs. Governments have devised various policies to manage their extraction and use, and one such policy instrument is through taxation in the form of severance taxes. This article will provide an overview of severance taxes, their rationale, design, and current trends in the United States.

What are Severance Taxes?

Severance taxes are taxes imposed on the extraction of non-renewable resources from the earth, such as oil, coal, natural gas, and minerals. Unlike income taxes, which are based on profits from selling resources, severance taxes are levied on each unit of resource extracted, either by volume or value. The tax rate is determined by the government, usually at a fixed percentage of the resource’s price or value, and varies by state or country. Severance taxes are also called depletion taxes, excise taxes, or resource taxes in some jurisdictions.

Why are Severance Taxes Important?

Severance taxes serve several purposes, both fiscal and non-fiscal. First, they generate revenue for governments that rely on resource extraction as a significant part of their economy. This revenue is used to fund public services, such as education, healthcare, infrastructure, and environmental conservation. Second, severance taxes can serve as a form of compensation for the depletion of non-renewable resources, which are finite and belong to the public. They can also mitigate the social and environmental costs associated with resource extraction, such as land disturbance, water contamination, and air pollution. Finally, severance taxes can also discourage over-extraction and promote sustainable resource management, by making the cost of extraction higher and encouraging companies to invest in alternative forms of energy.

How are Severance Taxes Designed?

The design of severance taxes varies depending on the type of resource, its market price, and production costs. Some states or countries use ad valorem taxes, which are based on the resource’s market value, while others use volume-based taxes, which are based on the amount of resource extracted. The tax rate can be a fixed percentage of the resource’s price or vary based on production levels, quality, or location. Some jurisdictions also use a combination of various tax forms, exemptions, and deductions, to incentivize certain types of production, stimulate economic growth, or reduce environmental impact.

For example, Alaska’s oil severance tax is based on the volume of oil extracted, with a rate that increases as production declines. The tax rate can also vary based on the price of oil, to adjust for market fluctuations. However, Alaska also offers several exemptions and deductions, such as a credit for hiring in-state workers, a tax holiday for new oil production, and a tax credit for investing in certain projects. In contrast, Wyoming imposes a flat severance tax on coal mining, with a rate of 7% of the sale price, regardless of the volume or location of production.

What are the Current Trends in Severance Taxes in the US?

The use of severance taxes in the US has been declining over the past decades, as many states have reduced their rates or phased them out. One reason for this trend is the changing economics of resource extraction, which have made it more expensive and less profitable to extract certain types of resources. For example, the decline in the price of natural gas has made it less lucrative for companies to drill for gas, leading some states to reduce their tax rates or offer incentives to encourage production. Similarly, the rise of renewable energy sources has reduced the demand for coal and oil, leading some states to shift their focus to other sectors or reduce their reliance on severance taxes.

In recent years, some states have also debated increasing their severance tax rates, to generate more revenue or address environmental concerns. For example, Colorado voters approved a ballot measure in 2020 to increase the state’s oil and gas severance tax from 2% to 5%, with the additional revenue earmarked for education and environmental projects. Similarly, New Mexico passed a new law in 2019 that raised the severance tax rate on oil and gas production from 3.75% to 5%, with the revenue going towards early childhood education and other state programs. However, such proposals often face opposition from industry groups, who argue that higher taxes would make it harder for companies to compete and invest in new projects.

Conclusion

Severance taxes are an important policy tool for managing the extraction of non-renewable resources, generating revenue, and mitigating social and environmental costs. The design and implementation of such taxes vary widely depending on the type of resource and the context of production. While many states have reduced their severance tax rates in recent years, some are also exploring ways to increase them to address various challenges. As the global energy landscape continues to evolve, it will be interesting to see how severance taxes and other resource management policies adapt to meet the changing needs of the economy and the environment.


Severance taxes are imposed on natural resources, such as trees, gasoline, coal and similar items. The tax is only imposed when those natural resources are used in a state, other than the state from which they came.

If lumber were harvested from New Jersey, and then used in New Jersey, the severance tax would not apply. If however, that lumber were used for construction in New York, severance taxes would apply. In most states however, severance taxes only apply to non-renewable resources. In those states, there would not be a severance tax on lumber, though that is likely to change in the immediate future.

The severance tax is not the burden of the entity making the purchase. There may be an additional sales taxes imposed on the natural resource and that tax would be the responsibility of the consumer.  However, the severance tax is imposed on the company that harvests the natural resource.

The severance tax is imposed at a flat rate, based on productivity in regards to a particular natural resource. For example, oil may have a severance tax imposed on a per barrel basis.  If that company only sells the natural resource in the state where it is harvested, they do not have to pay a severance tax. Severance taxes are utilized as a means of keeping non-renewable resources in state boundaries, while keeping the cost to consumers in that state lower.

The severance tax is different from the income tax and other corporate taxes. Companies that make no profit from the sale of the harvested natural resources, still may be subjected to the severance tax. In fact, any person that has a financial interest in a company that harvests natural resources, would be subject to severance taxes.

Generally, the tax is imposed on the volume of natural resources. For example, an oil well may be have severance taxes based on the amount of oil sold from that pump. In fact, recent reports suggest that British Petroleum will be responsible for a tax, much like severance taxes, on the amount of oil pumping into the ocean each day. The oil spill and impending disasters, is a good example of why the severance tax can sometimes be used to discourage abuse of natural resources.

Severance taxes are utilized to protect non-renewable natural resources. The tax revenue is sometimes used to fund programs to protect the environment. However, the government can use the revenue from severance taxes in any way they see fit.