Gaffney (2006): A Severance Tax on California Oil?

Overview

"A Severance Tax on California Oil?" is a July 2006 policy essay by Mason Gaffney, written, he states, for the "California State Assembly Committee on Revenue and Taxation," in the run-up to that November's Proposition 87 ballot measure.[1] Prop. 87 would have imposed a severance tax on oil production (a graduated 1.5%–6% of gross wellhead value depending on the oil price, topping out at 6% above $60/barrel) to fund alternative-energy programs; Gaffney's essay, describing it in simplified form as a flat 6% levy, was written before the final measure text and campaign were fully settled.[1][2] Prop. 87 was defeated at the ballot, 54.7% to 45.3%, after a then-record $154 million in campaign spending, most of the opposition funded by Chevron and Aera Energy.[2] The essay is a work of applied public-finance advocacy — Gaffney frames it explicitly as an attempt to referee an internal Georgist dispute: "Georgists are of mixed minds on severance taxation. Some oppose it as being a tax on production... Others say that extracting a natural deposit is not the same as production... There are elements of truth in both views."[1]

California's Property-Tax Alternative and Proposition 13

Gaffney's starting point is that California already had a working instrument for capturing oil and gas rent before 1978: an in-situ property tax on mineral reserves, administered by the State Board of Equalization, which he says produced substantial county revenue (Los Angeles County above all) and was, per BOE specialist Robert Paschall's testimony to the Alaska legislature, no harder to assess accurately than ordinary real estate.[1] Proposition 13 (1978) — aimed, per Gaffney, entirely at residential property taxes, with "no voter intent to untax oil and gas" — cut the property tax rate to roughly a third of its prior level and froze/rolled back assessed values, which by Gaffney's own arithmetic ("1/3 the original rate times 1/2 the original base equals 1/6 the original tax revenue") eliminated most of that resource-rent revenue as an unintended side effect.[1] California, he notes, "is the only state, major or minor, with no severance tax" — a state that once captured mineral rent through property assessment lost that capacity through a tax reform aimed at an entirely different target, then had no substitute mechanism in place.[1]

The Constitutional and Legal Foundation

Gaffney treats the severance tax's constitutionality as settled: Commonwealth Edison Co. v. Montana, 453 U.S. 609 (1981), upheld Montana's 30% coal severance tax against a Commerce Clause challenge from an out-of-state utility buyer, reasoning that in-state buyers were taxed identically and that much of the tax burden fell on Montana coal-land owners rather than being exported to consumers.[1]

The Case That There Is a Large Taxable Rent

Gaffney assembles six converging indicators that California oil and gas carries substantial economic rent (defined as "fat in the private sector" — private income in excess of what is needed to induce production): most fields were developed and remain profitable at prices far below current levels; major-oil-company acquisitions of California fields at high valuations are themselves evidence of high rent; the state already taxes no severance at all, unlike every other oil-producing state; publicly owned California "tidelands" and federal Outer Continental Shelf leases fetch high competitive-auction prices, implying comparable private-land rents; oil and gas extraction earns roughly 40% of Fortune 500 profits with only about 10% of Fortune 500 employment — a high profit-per-employee ratio Gaffney reads as a rent signature; and the state gasoline tax fails to capture rent because it is a flat per-gallon (not ad valorem) charge that erodes with inflation, taxes low-cost and high-cost wells identically, and does not even cover the state's highway-building and maintenance costs.[1]

Incidence: Why the Tax Would Not Simply Pass Through to Consumers

The essay's most theoretically developed section addresses the standard objection that a severance tax would be "shifted forward to California consumers, and therefore be regressive, like a retail sales tax."[1] Gaffney sets out four conditions under which a production tax passes to consumers — inelastic demand, elastic supply, a high world market share for the taxed jurisdiction, and a tax structured to hit marginal production — and argues California meets, at most, one of them partially:

• World demand for oil is price-sensitive, evidenced by the demand collapse and price crash that followed the 1970s Arab oil embargoes despite OPEC's market power.[1]
• California's supply is comparatively inelastic: most fields were developed and remain productive at prices well below current levels, so — unlike, in his example, the high-price-dependent Overthrust Belt — most of the state's production is not on the margin the tax would discourage; heavy, low-quality oil (often cited against severance taxes) is taxed on wellhead value before refining costs are incurred, so the tax does not touch the added refining burden.[1]
• California is a small share of world oil supply, so even a fully inelastic domestic demand curve would face a highly elastic supply of substitutes (Alberta's oil sands, Rockies shale, Middle Eastern and Latin American imports).[1]
• On the fourth condition, Gaffney argues the tax's bite on marginal production would be largely offset by lower royalties: because royalty payments and a severance tax are both variable, unit-of-production charges, lessees negotiating new leases would rationally offer landowners lower royalty rates once a severance tax is anticipated, shifting the tax's incidence toward existing rent recipients rather than new production decisions. Gaffney frames royalty owners' incentive relevance as minimal in the standard lease structure, since lessees (not royalty owners) control extraction rates.[1]

He separately notes that oil and gas already carry standard royalty rates far above the proposed severance rate (minimum 12.5%, and above 50% in Saudi Arabia) "with no noticeable disincentive effects," offered as evidence that a single-digit severance rate is unlikely to be the disincentive critics warn of.[1]

Design: Toward a "Net Proceeds" Tax Base

Gaffney's policy recommendation is that a severance tax be redefined, where administratively feasible, from a gross wellhead value base toward a net proceeds (post-cost) base — closer to the "well-foot" value before extraction costs are incurred — citing this design as already used in Nevada, Idaho, Utah, and South Dakota, and developed theoretically by Australian economists Ross Garnaut and Anthony Clunies-Ross for Papua New Guinea's mining tax regime.[1] He argues this design change would let the state raise the rate (recovering revenue lost to the narrower base) while more precisely targeting pure rent, sparing genuinely marginal or high-cost fields (steam-injection recovery, for instance) from bearing a tax that would abort production rather than merely capture surplus. He closes: "Oil and gas are indeed a source of rent. The severance tax would abort only a minor share of it, and this flaw may be remedied by modifying the tax to allow reasonable cost deductions."[1]

Standing and Limits

Claim class. This is advocacy testimony/essay writing by a credentialed economist for a live legislative and ballot-measure debate, not a peer-reviewed paper — Gaffney says so implicitly by describing the piece as written "for" a legislative committee and pegged to a specific initiative. The incidence theory (who bears a severance tax) is standard public-finance reasoning and can be read as a C-claim (theoretical, citing accepted tax-incidence conditions); the empirical claims about California's supply elasticity and the profit-per-employee rent signature are asserted rather than formally estimated in the essay — Gaffney himself flags uncertainty in a footnote on the Fortune 500 profit-share figures ("these figures are only roughly correct; check specific source before publishing"), a caution this page inherits.[1] The essay predates, but is broadly consistent with, the design principles this wiki documents from the IMF (Baunsgaard & Vernon) and Canadian public finance (Mintz & Chen) on the resource-rent-capture-works page — that rent-targeting, cost-deductible tax bases outperform blunt gross-value levies — though those sources were not available to, or cited by, Gaffney in 2006.

Bears On

• Benefit: Capturing resource rent works — where institutions are strong — adds a US state-level historical case distinct from Norway and Botswana: California once captured oil-and-gas rent effectively through an in-situ property tax, then lost that capacity as an unintended side effect of Proposition 13 — illustrating that capture can be lost through an unrelated political shock, not only through weak institutions or a resource curse, and that Gaffney's proposed remedy (a net-proceeds severance tax) is a design response to that specific loss.
• Concept: Resource Rents — supplies a detailed incidence argument (the four pass-through conditions, and the royalty-offset mechanism) and a concrete design alternative (net-proceeds taxation) that the concept page's one-line mention of "severance and royalty taxes" did not previously carry.

See Also

• Capturing resource rent works — where institutions are strong
• Resource Rents
• Gaffney (2006): New Life in Old Cities — Gaffney's companion note on California's pre-Prop-13 land-value tax reliance (San Francisco, 72% statewide land share of the 1917 assessment roll)
• San Francisco — cites this page for the parallel case of Prop 13 curtailing California land/resource-rent capture
• Gaffney (1977): Oil and Gas Leasing Policy for Alaska — the closest structural parallel: a public-landlord rent-capture design for another resource, referencing this essay as the later ad valorem/in-situ property-tax case
• Gaffney (1977): Counter-colonial Land Policy for Montana — the earlier, less formally developed statement of this essay's severance-tax design critique
• Mason Gaffney
• Cash-Flow Tax — the modern neutral-design instrument (Norway) that the net-proceeds approach anticipates
• Economic Rent

Sources

1. Mason Gaffney, "A Severance Tax on California Oil?," July 2006, masongaffney.org — used for the entire page: the Prop. 13/property-tax history, the Commonwealth Edison v. Montana citation, the six rent indicators, the four-condition incidence analysis, the royalty-offset argument, and the net-proceeds design recommendation. PDF · archived (verified against the PDF directly for all direct quotations on this page).
2. Ballotpedia, "California Proposition 87, Severance Tax on Oil Producers to Fund Alternative Energy Programs Initiative (2006)" — used for the actual graduated 1.5%–6% rate structure, the election result (54.7%–45.3% against), and the $154 million campaign-spending figure, none of which are in Gaffney's essay (written before the election). Ballotpedia