Colorado mulls a special fund from oil and gas taxes

In 2010, voters in North Dakota approved the creation of a state-administered fund that would collect hundreds of millions of dollars a year in severance taxes generated by the oil and gas boom that was beginning to explode across the Peace Garden State.

As production in the Bakken Formation raced upward from 112 million barrels in 2010 to nearly half a billion barrels last year, the severance taxes feeding the North Dakota Legacy Fund have swelled its balance to $6.2 billion. The fund last year generated $225 million in earnings and interest that the state can use to address numerous needs, like fixing roads or funding schools.

The trust fund’s balance is expected to more than double over the next decade — to nearly $15 billion — assuming the Bakken continues to produce at robust levels and oil prices stay steady.

Three years before voters in North Dakota went to the polls, a committee of 11 Colorado state lawmakers convened to take a look at how severance taxes were allocated in the Centennial State. After a half dozen meetings and a couple of field trips to mineral-rich Rio Blanco and Garfield counties, the group came to the conclusion that it would behoove Colorado to create a permanent trust fund “as a resource in the future when the mineral extraction industry declines.”

“Interest from a trust fund could also be used to provide additional resources for higher education to educate the state’s workforce,” the committee wrote in its 2007 report.

Fast forward to 2019 … and Colorado still has no permanent trust fund.

The taxes collected from the state’s oil and gas fields are directed annually to water projects, natural resource management efforts and local communities impacted by oil and gas activity. Nothing is saved in the way North Dakota, Wyoming, New Mexico and other energy-producing states are salting away money for the future.

Dick Lamm, who was governor in 1977 when the legislature first authorized Colorado’s severance tax, still fumes about the failure of the state to establish a permanent fund to capture in perpetuity the value of what is being extracted from the ground today.

“I think it’s outrageous that Colorado, this late in its history, is still literally giving away its natural resources,” Lamm said. “Those other states have come to the conclusion that you don’t want just one generation or one decade of citizens and legislators to benefit from this. It’s a one-time natural resource and it should be to the continuing benefit of the people.”

But Jim Cole, a long-time oil and gas lobbyist with Colorado Legislative Services LLC, said the state simply took a different approach to the issue of capturing wealth at the wellhead.

Instead of creating a rainy-day fund overseen by the state, lawmakers gave local communities in Colorado the power to impose a substantive property tax — or ad valorem levy — on what flows out of the well. In fiscal year 2016-2017, the ad valorem tax put $470 million in Colorado’s coffers — significantly more than what other energy-producing states, with the exception of Texas, collected in property tax in the oil patch, according to the Colorado Legislative Council.

“The thinking was that we were going to start out with a lower severance tax and we were going to let the locals apply their mill levy to the production in order to pay for the impacts,” Cole said. “So, rather than pushing it up to the state and doing a program like Wyoming and New Mexico do by building it into their budget, Colorado decided to go another way, which is the impacts are local so let’s have the mill levies pay for those local impacts.”

The Colorado Oil and Gas Association said the state’s extraction tax system results in $600 million going toward school districts annually. Tax proceeds from energy production also went toward the $110 million upgrade of Weld County Road 49 in 2017, for example.

“That’s why in Colorado, unlike other states, the oil and natural gas industry pays most of its taxes at the local level, where those funds support a variety of social services, education, road and infrastructure projects,” COGA president and CEO Dan Haley said.

When other taxes are included — severance, property, income, sales and use — the industry’s tax burden in Colorado places it roughly in the middle of nine Western oil- and gas-producing states, according to data from the Colorado Legislative Council, the legislature’s nonpartisan research arm.When just severance taxes and accompanying deductions are considered, Colorado’s effective severance tax rate was only 0.6 percent in fiscal 2016-2017, the lowest in the pack. Montana was at the top, with an effective rate of 10.5 percent.

Colorado’s severance tax revenue levels rise and fall from year to year in part because of swings in commodity prices and because of a lag between when severance taxes are paid and a property tax credit is applied. After tax deductions, the state collected $132.8 million in severance tax revenue in fiscal  2017-2018.

Lamm thinks it’s time for Colorado to look at reducing tax credits so the state can get more for the depletion of a finite resource by setting up a permanent trust fund.

“When you look at other conservative states that have done this for years, it’s not a radical idea,” he said.

“Holding the sack”

Neighboring Wyoming is one of those states. In the mid-1970s, former U.S. Sen. Al Simpson, then a Wyoming legislator, and other Republican lawmakers gathered at The Hitching Post in Cheyenne, a hotel, restaurant and home away from home for elected officials. They sat down to map out what would become an economic cornerstone of the Cowboy State — a multibillion-dollar trust fund built from mineral severance taxes.

Simpson, a self-described cowboy from Cody, said the goal was a trust fund fed by severance taxes whose principal couldn’t be touched. The Permanent Wyoming Mineral Trust Fund, approved by the voters in 1974, now stands at nearly $8 billion and the interest income generates hundreds of millions of dollars for the state budget, a rainy day fund and water and construction projects across Wyoming.

The fund’s creation came at a time when the state’s reserves had dwindled to a mere $80, prompting the legislature to impose a 1 percent severance tax on energy production in the state. Prodded by Gov. Stan Hathaway, Simpson, along with industry players and fellow GOP lawmakers Tom Stroock and Warren Morton, looked at whether Wyoming could capture some of that new revenue stream and build on it.

“They were very deep into the oil and gas industry financially. They were heavy hitters, both Yale graduates,” Simpson said of Stroock and Morton. “They came to some of us and said, ‘You know, we have a truth to tell you. When the oil and gas are gone and the coal is gone, we will be gone and you will be left holding the sack.’”

It was a message that resonated with voters, Simpson recalled.

“It was not hard when you explained very clearly to the people of the state — look, this is just called fairness,” he said.

At the end of June, Wyoming’s trust fund had $7.9 billion and interest income from the fund made up about 20 percent of the latest state budget. Since the fund’s inception, Wyoming has earned ust under $5 billion in interest income.

In North Dakota, the state’s legacy fund collected just under $60 million a month on average in 2018, adding to a principal that cannot be touched unless two-thirds of both chambers in the legislature vote to crack into the “corpus” of the fund.

North Dakota tax commissioner Ryan Rauschenberger said that allows the $6.2 billion fund to steadily grow, much like a university endowment.

“As long as that continues to grow, the earnings will continue to grow,” he said. “Eventually, this fund could be our number one funding source.”

Although many in Colorado say they like the concept of a rainy day fund flush with energy industry tax proceeds, they say it would be disruptive and painstaking to create one at this point. Rauschenberger understands the hesitation but said it’s about securing the future.

“It is difficult for a state that is currently relying on a revenue source to put it in a trust fund that can’t be touched,” he said. “But you have to think about the future and not just the current budget cycle.”

Is a trust fund possible?

One of those questioning the practicality of launching a permanent trust fund now is Kevin Bommer, executive director of the Colorado Municipal League.

“I think that ship has sailed,” he said.

First of all, he said, it would have to come in the form of a constitutional amendment voted on by the people, to protect the money from being raided by future legislatures. But in 2016, voters passed Amendment 71, which makes it harder to get a Constitution-altering measure on the ballot and get it passed.

Furthermore, Bommer said, local governments have come to depend on the severance tax revenue they receive from Colorado’s oil and gas fields. If a portion of that is diverted to a trust fund, he asked, what would be the impacts to municipal and county budgets?

“What is this money going to be replaced with?” Bommer said. “I don’t think anyone has the answer to that question.”

State Sen. Mike Foote, D-Lafayette, said a “big pot of money” in the form of a permanent trust fund would be a huge plus for Colorado, but he recognizes the challenges of tackling that after decades of not having one.

“I imagine resistance would be pretty strong from where you’re taking the money from,” he said.

Foote said the better approach is to increase the effective severance tax rate in Colorado by reducing the credits the industry can take, which currently includes applying 87.5 percent of the ad valorem tax as an offset to severance tax owed. The senator calls that allowance the “sweetest of sweetheart deals in Colorado.”

“We have the lowest effective severance tax rate in the country when you take into account all the loopholes the industry enjoys here,” Foote said. “The state should be getting a long-term benefit from those minerals extracted and we’re not getting that.”

Republican Sen. Bob Rankin, of Carbondale, also has questions about the tax deductions the industry enjoys.

“We do not really have good insight into ad valorem deductions and where they’re coming from and whether or not there should be some change and some restriction, some limit on deductions that are used,” he said. “I’m quite concerned about that and I think that means the state is not collecting as much as it could if there were fewer deductions.”

Rankin teamed up with Foote two years ago to sponsor an amendment directing the Department of Revenue to answer some of those questions. They’re still waiting for answers because the department’s system isn’t set up to grab that kind of information, he said.

While they await a response from the Department of Revenue, Gov. Jared Polis is working on ways to lower taxes for “hardworking families and companies” by eliminating tax “giveaways” to the oil and gas industry.

“Colorado’s tax code gives too much power to special interests who can afford expensive lawyers and lobbyists to reduce their own tax burden,” Polis’ office told The Denver Post last week in an email. “The energy industry and many other well-connected industries benefit from generous tax giveaways in Colorado that aren’t available in any other state, and the rest of us unfairly pay more in taxes as a result.”

But it won’t be easy to change the tax system. An effort 11 years ago to wipe out the property tax reduction on oil and gas failed at the ballot box. The proposal, spearheaded by former Gov. Bill Ritter, would have raised an estimated $321 million to be split among state and local governments, education, conservation and water and transportation projects.

“The thought behind Amendment 58 was that Colorado is not getting fair value for its resources. There’s no reason we should not get as much value as they are in Montana or other states,” said Kelly Nordini, who was Ritter’s deputy chief of staff and oversaw the Amendment 58 campaign.

Nordini, now executive director of Conservation Colorado, said it’s still important to scrutinize severance tax policies and whether a permanent trust fund is something to pursue.

“It’s never too late to get our full value out of this resource,” she said.

Gift that keeps giving

Mark Haggerty, of Headwaters Economics, a Bozeman, Mont.-based independent research firm focused on community development and land management, said the debate over Colorado having or not having a permanent trust fund isn’t black and white.

“You don’t have a permanent fund per se,” he said. “Money goes into a revolving fund for water projects, which is a type of permanent fund. But it isn’t the same type of big permanent fund that Wyoming or New Mexico or Alaska has.”

That said, simply having a permanent trust fund isn’t a fiscal panacea, Haggerty said. While Wyoming set up a trust fund to provide for future generations, he noted that the state uses the interest income annually to make up part of its general budget. That has allowed it to keep taxes low on other sectors, keeping it more dependent on the energy industry, Haggerty said.

Generally speaking, he added, states with smaller budgets and less diversified economies have tended to set up long-term trust severance tax funds.

“Because Colorado has a much larger and more diverse economy than many of the other states that have a lot of oil and gas and coal, there’s not as much attention paid” to having a permanent fund, Haggerty said. “Having a savings fund is less consequential for the state budget.”

Colorado’s distribution to local governments of severance taxes and revenue from fees on drilling on federal lands is actually high compared to other states, he said.

But a savings fund is still a good idea, Haggerty said. Colorado could reduce or eliminate property tax deductions and use the resulting revenue to create a permanent fund.

“A more broad purpose of severance taxes is that you should be able replace the wealth that you’re depleting from the ground with assets that will continue to generate wealth over time,” he said.

Charles Wollmann, a spokesman for New Mexico’s State Investment Council, said his state’s Severance Tax Permanent Fund, started in the early 1970s, now carries a balance of $5.5 billion. More than $200 million in earnings on the fund went into New Mexico’s general fund last year.

Some of that was used to invest in small businesses in the state, while a portion was directed to New Mexico’s booming film production industry.

“We like to look at this as a wealth-creating engine for the state,” Wollmann said. “We’re trying to plan not only for today but for when these resources are gone.”