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Severance Taxes Too Volatile

By Macy Scheck

Between November 5, 2019 and January 21, 2020, natural gas prices dropped 33.6%.  This dramatic price decline occurred even before March, when the coronavirus began to have a large impact on U.S. economic activity.  This price volatility causes fluctuations in the revenue the state receives from its taxes on natural gas sales, making it difficult for Arkansas to plan long-term road construction projects.      

Arkansas generates revenue from its severance taxes.  A severance tax is a tax on the extraction of non-renewable resources, such as oil and natural gas. Since January 2009, the state of Arkansas has taxed natural gas according to its market value.  The severance tax collected $80 million in 2015, but as the price of natural gas dropped, so did the state’s revenues. By 2019, the tax only generated $40 million. 

Arkansas has specific guidelines regarding the allocation of the revenues created from the natural gas severance tax. 95% of the revenues are allocated to the Arkansas Highway Commission, while the remaining 5% is allocated to the general fund.  As a result of this arrangement, when the price of natural gas is high, the Arkansas Highway Commission receives more tax revenue.  In contrast, when prices are low, which they have been for the last few years, the Arkansas Highway Commission obtains less revenue.  For example, in 2014, when natural gas prices were near $4 per million BTU, the Arkansas Highway Commission received nearly $73 million in revenues. In 2017, when prices were just $3 per million BTU, the Commission received only $36 million in revenues.  Over just a three-year span, this volatility in natural gas prices caused a 50% drop in the Highway Commission’s severance tax revenue. 

  Between 2014 and 2016, the Arkansas Highway Commission’s total expenditures remained consistently around $1.2 billion per year but increased to $1.5 billion in 2017. The three main sources of revenue for the commission include registration and fuel fees, diesel taxes, and natural gas severance taxes. During 2014 to 2017, the severance tax revenues contributed, on average, 4.15% to the commission’s budget, although this percentage varied between 2.3% and 6%.  Over the same time span, revenue from registration and fuel fees as well as the diesel tax remained fairly constant comprising 37% of the budget in 2017.

The Arkansas Highway Commission has full authority over the planning, construction and maintenance of Arkansas roads, and it funds many long-term projects.  In 2012, the Arkansas Highway Commission undertook one of the largest highway connection programs in its history. The Connecting Arkansas Program is a ten-year program comprised of 35 different projects. Additionally, the Arkansas Highway Commission is also actively working on the Interstate Rehabilitation Program, which entails more than $1 billion in improvements to Arkansas’s Interstate highways over the multi-year life of the program. 

If a state can contribute 20% of the funding for interstate highway construction, the federal government will pay the remaining 80% of the cost of the project.  However, the federal funds are “use it or lose it,” meaning that if Arkansas does not produce the funding for 20% of the project, it will not receive any of these federal funds.  According to Scott Bennett, the former Director of Highways and Transportation in Arkansas, decreases in the revenue from natural gas sales have made it difficult for the state to consistently provide its 20% contribution.  

Recent legislation (Act 416) raised taxes on gasoline, diesel fuel, and car registration to help finance the highway commission.  Importantly, the act also diverted a minimum of $35 million a year in casino tax revenue to the State Highway and Transportation Department Fund.  While the tax hikes were unpopular with many Arkansans, the diversion of casino money provided a stable revenue source to the Department of Transportation.  Even though the money generated by Act 416 must be used to repair existing roads and bridges, the additional revenue directed to the Department of Transportation gave the agency flexibility, making the department more willing to transfer money obtained from other sources away from repairs.  This flexibility makes it easier for the state to finance new construction highway projects in the years when the revenues from the natural gas severance taxes are low.

Macy Scheck is an ACRE Undergraduate Research Fellow at the University of Central Arkansas. His views do not represent those of UCA.