Editorial: New thinking needed; Pa. must back natural gas tax that helps local governments

The good news is it appears likely there will be a severance tax on natural gas extracted from the Marcellus Shale play under Pennsylvania, including Bradford County, arguably the center of the gas industry's prospecting in the play.

Gov. Ed Rendell and the Democratic and Republican leaderships in the Legislature have agreed, in conjunction with the state budget resolution signed in July, to work out the details of such a tax by Oct. 1 and have it go into effect beginning next January. Rendell favors such a tax helping to balance the state budget; Republicans generally are opposed to such a tax.

Depending on the version enacted, it could raise several hundred million dollars per year in a state where governments are hard-pressed to balance budgets, and the gas boom promises to become the most profound, life-changing economic phenomenon in a century or more.

The bad news is that with the legislature in summer recess until mid-September, no one of influence agrees yet on what the formula for the tax will be, raising the possibility it will become a campaign issue in the upcoming November general election, and subject to all the good and bad such campaigning brings to rational analysis. Gov. Rendell will not seek re-election. Republican candidate Tom Corbett is opposed to the tax and Democrat Dan Onorato, his opponent, favors one.

The ideological contention is unfortunate, to say the least.

The gas companies, even though they stand to reap considerable profit from prospecting the Marcellus Shale, ought not to be treated as cash cows, to be milked whenever government has a need for more tax revenue. Prospecting is an enormously expensive undertaking at considerable financial risk for companies and their investors. On average, it costs $4 million to drill a single well in the Marcellus Shale. In the past two years, 963 wells have been drilled by several companies, and through Aug. 21 this year, 1,067 permits for new wells were issued by the state Department of Environmental Protection.

Gas companies deserve to make a profit commensurate with their risks and investment. In this case, we're talking really big bucks. What's more, such success stimulates growth, brings new business jobs and, as a result, additional tax revenue. In a word, the natural gas boom here is expected to generate "prosperity."

And, in discussing treatment of the gas companies, let's not forget that some of them, at least, including Chesapeake and Talisman and others active in Bradford County, already have contributed upwards of several hundred thousand dollars for good works by local groups and organizations.

But, making a profit in what Penn State researchers have documented is the huge, gas-rich Marcellus Shale is about as close to a sure thing as prospecting gets. Penn State estimates the Marcellus Shale is worth $500 billion in recoverable gas.

How state and local leaders and others react now, and how effectively they lead the transformation to a new era now, will make a difference in the decades to come in the quality of life in the state and, in particular, the area above the Marcellus Shale, including Bradford County.

The governor has a severance tax proposal, which is just one aspect of an overall state natural gas policy - but an important one - and so do a goodly number of members of the General Assembly. Some two dozen bills to that end had been introduced in the state House or Senate by July, proposing a variety of formulas and schemes to levy such a tax, which has been enacted, in one form or another, in most of the 32 natural-gas producing states. However, many Republicans in the GOP-dominated Pennsylvania Senate have sided with the gas industry and oppose the tax as premature. What's more, none of the Pennsylvania legislative proposals, so far, duplicate the governor's plan, which is modeled on the one enacted in neighboring West Virginia.

The Rendell proposal is what's known as a hybrid tax: It would tax the volume of gas extracted at the well head, and tax the value of the gas at market. In other words, a 5 percent tax at the wellhead, plus 4.7 cents per thousand cubic feet (MCF) extracted, with exemptions for low producing wells, at the front-end and back-end of a well's life, projected at 20 or more years. While estimates vary, it is expected to generate some $177 million in the first year and grow to $528 million within four years, according to the non-partisan, left-leaning Pennsylvania Budget and Policy Center, which favors the tax.

Here's the most worrisome point: There is no assurance that any proposal enacted in Pennsylvania will provide enough money to local governments to cover their costs of dealing with the effects, direct and indirect, of the natural gas boom. Gov. Rendell's proposal would divert 90 percent of the tax to the state's general fund to help the plug the state's $280 million budget gap created when the federal government came up short with its subsidy.

However, the governor's proposal is deficient in key aspects, one of which is the amount of money that would be returned to the local governments.

While the state's budget shortfall is serious, especially since so much money for bridge and highway repair is needed, among other obligations, The Review cannot support diverting so much (an estimated $159 million the first year) of any gas tax to the general fund.

It is patently unfair, even absurd. To do so would be to deprive local governments of equally needed revenue. Local governments above the Marcellus Shale are entitled to replenish their treasuries with revenue from natural gas extraction that takes place within its jurisdiction, just as surely as the state is entitled to replenish its general fund from the same drilling revenues.

Local governments, including counties, townships and boroughs, face significant expenses for infrastructure repair (roads) and environmental protection (water), among other costs, such as for social services like public health, law enforcement and fire protection made necessary by the additional people here working in the gas industry.

Local governments already are collecting substantial revenue - as well as already incurring expenses - from, for example, such sources as fees to record gas-prospecting documents at the courthouse, and the sale of water needed in the drilling process. But it is not enough money to deal with both current expenses and a variety of costs for dealing with industry impacts expected in the future. That's because while drilling will continue for years, wells gradually will dry up and tax revenue will taper off, yet demand for government services to deal with the continuing impacts of the industry will remain high.

Furthermore, counties cannot collect property tax from the drillers. The Pennsylvania Supreme Court ruled in 2002 that oil and gas interests, unlike in Texas, for example, were not subject to property taxes, depriving county government and schools of another source of revenue at a time when school finance is a critical issue.

So, what's fair?

Bradford County officials are not unanimous. The split generally is along political and ideological lines. At the county level here, for example, Commissioner Doug McLinko, a Republican, does not favor a severance tax. Growth will stimulate the economy, he maintains. But, should such a tax be enacted, he has said - no doubt with an eye on the political reality - a significant portion ought to be returned to local governments.

Commissioner John Sullivan, himself a Democrat, has told people a more reasonable amount of any severance tax revenue to be diverted locally would be 25 percent, which obviously still leaves the lion's share going to the general fund.

That's generally high, compared with what other states pay and other proposals in the state legislature.

Nevertheless, we agree with Mr. Sullivan that the rate must be higher than the governor proposes, but exactly how much ought to be based on an accounting of actual local expenses, as well as a sound projection of what local expenses are likely to be in the years ahead, especially toward the end of the life of a well when production is low as will be tax revenue. The Marcellus Shale Coalition, a pro gas industry group, advocates something similar.

Bills pending in the legislature vary as to the amount of the severance tax as well as how much money goes where. The splits generally are along party and ideological lines, but Democrats also are divided amongst themselves.

Democrats are split on how much of the severance tax should go to local governments and how much to state funds.

"This is an anti-growth tax, it's an anti-jobs tax, it's an anti-manufacturing tax," House Republican Minority Whip Mike Turzai said at one point. "And it is an anti-energy-independence tax."

The gas industry maintains that gas should not be heavily taxed until gas companies can recover reasonable start-up costs, generally at least through the first three years. In general, we do not disagree. But, what is reasonable? The gas industry, citing Pennsylvania corporate income tax of 9.99 percent, wants tax breaks on gas extracted at the beginning of a well's life, when the volume is high, as well as at the end, when it is low.

What the gas industry does not mention, however, is that most drillers do not pay the corporate tax, which, admittedly, is the highest in the nation. Most gas companies are organized as Limited Liability Companies (LLC) which are taxed at the rate of 3.7 percent, the same as an individual's flat income tax. That would exempt nearly 71 percent of Marcellus Shale drillers from the Pennsylvania corporate income tax, according to a number of studies.

Many legislators in the Democratic-controlled Pennsylvania House favor a severance tax. Those include Rep. Camille "Bud" George, or Rep. David Levdansky, for example, co-sponsors, at one point, of leading gas tax bills, who do not agree with the industry and pro-gas industry organizations such as the conservative Commonwealth Foundation that an exemption in the early years of well-production is needed to recoup costs and make Pennsylvania competitive with other states.

Adding to the debate that the drillers do not pay property taxes, such economics put local governments, the ones that depend largely on property tax to operate, at a potentially devastating financial disadvantage.

Therefore, at this point, what is clear in this tangle is that Bradford County residents and elected officials must urge the county's elected state representatives: Reps. Tina Pickett and Matt Baker, and Sen. Gene Yaw, all Republicans, to rise above ideological constraints and vigorously support a natural gas industry tax structure that recognizes the need for a significant portion of natural gas industry tax revenue to be returned to local governments.

At the same time, they and other opinion leaders must assume a leadership position in the debate to focus us on what Penn State Cooperative Extension said in an insightful report, including:

"The vast economic and social impacts related to exploration of the Marcellus shale deposit call for new thinking. Sound, innovative, continuous comprehensive planning is needed for Pennsylvania municipalities to maximize the long-term benefits from Marcellus shale development while minimizing potential negative impacts.

"Gas drilling brings many new factors to communities that have not been experienced previously in many areas of Pennsylvania. Exploration of the Marcellus shale will generate large amounts of money from the leasing of land, construction, trucking, commerce, and housing development.

"Some residents will have more money to spend, but will they spend it in the community and region? Will they take that capital somewhere else if there are no places for them to spend their money locally? New opportunities for business development should increase with gas drilling, which will require infrastructure investments in roads, water, and sewer facilities.

"Housing needs for gas and related workers will increase. Will their needs be met with a temporary variety of housing or is the plan to build long-term residential areas that will be attractive to gas industry workers and their families? There will also be new services, public safety, and other expenses imposed on local governments that may not be consistent with tax revenues derived from natural gas drilling or leasing activities.

"To address these complex issues, the comprehensive planning undertaken by municipalities and counties should have four components:

"1. Taxation and municipal finance: a component to examine tax revenues and expenditures related to gas exploration and project future financial resources needed for municipal and county operations, and school districts in the region.

"2. Public investment: for examining and developing a plan on how municipalities, counties, and school districts can use their assets and facilities to generate revenues from drilling, transmission, water, and wastewater activities related to gas exploration.

"3. Comprehensive land use: a plan to incorporate natural gas development as a new and distinctive land use and provide for economic development, new commercial and residential activity, and improvements to the local transportation system.

"4. Municipal management: a component of planning to provide personnel that will keep track of mining activities, carry out inspections, anticipate production changes, and encourage workforce development to supply skilled workers. Since gas exploration is regional in scope, the management process needs to be carried out jointly by affected municipalities, counties, and school districts, as well as the private sector."

Change is in the works. It's time to take charge of our destiny. Who will emerge as the leaders of this new era?