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What is a severance tax?

The Ohio legislature has been considering changing the state's severance tax recently. In the last session, the legislature created tax policy study commission, whose job is to examine the state's severance tax and put together proposals to reform the tax to "maximizes competitiveness and enhances the general welfare of the state." Laudable goals indeed, but many in Ohio may wonder what a severance tax is and why it could be increased.

Severance taxes are typically used on commodities that cannot be replaced. When oil or gas is "severed" from Ohio and shipped to a neighboring state, it is gone forever. While the producer receives revenue from the sale, without a severance tax, some portion of the original value of the land within the state is diminished, as the mineral is extracted and a hole is left in the ground. Most states use some form of a severance tax to recoup some of that permanent loss. 

These taxes are also popular for legislatures to use as a means of obtaining additional tax revenue while leaving most businesses and individuals unaffected. Some states fund much of their budgets in this manner, the most extreme being Alaska, which funds 78 percent of its state's budget from severance taxes.

In Ohio, some of the increased revenue raised by the oil and gas severance tax would be used to fund units of local governments and would provide financial assistance to these entities. Many rural townships have had to cope with the increased infrastructure wear and tear caused by oil exploration. They also have had to deal with the development of emergency management plans to respond in the event of explosions or spills on drilling sites.

Unless you are Alaska, severance taxes cannot solve all of a state's financial problems, but wise use of the revenue can help those areas of the state that are responsible for that revenue in the first place.

Source: crainscleveland.com, "Consensus developing around plan for a severance tax hike in Ohio," Jim Samuel, August 7, 2015

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