$1 billion in natural gas subsidies missing from Texas' official tax expenditure report

Overview

Texas’ Tax Exemptions & Tax Incidence report is missing the largest individual tax break to oil and gas in the state. This provision reduced taxes on the industry by $1 billion in 2022 according to analysis by the Texas Comptroller of Public Accounts that was provided in response to a public records request by Earth Track. The revenue losses from this provision are far larger than all other tax subsidies to fossil fuel production that the state does report on. It's omission results from the way the authorizing legislation requiring tax expenditure reporting is worded. Specifically, large exemptions from smaller tax bases can be excluded, even if they result in large losses to Texas taxpayers. Whether this reporting loophole was created intentionally or by accident, it should be fixed. As shown here, the effect has been to exclude disclosure from the sections of the tax code that are most important to natural gas producers. 

Texas’ Tax Exemptions & Tax Incidence report is missing the largest tax break to oil and gas in the state.

Good governance requires complete and unbiased data

Tax preference items available to any group should be routinely disclosed in the Tax Exemptions & Incidence report. Where this is not happening -- particularly for provisions generating large revenue losses -- the data gap should be of great concern to both Texas taxpayers and legislators. This posting focuses on subsidies to oil and gas. However, the example inevitably raises the question of whether other significant tax breaks to any sector are also being excluded. Such omissions would make it much more challenging to ensure strong fiscal controls and accurately-measured policy tradeoffs in state policies. 

A central tenant of tax expenditures, and the primary reason they are now reported in nearly every state in the country, is that regardless of who is getting special treatment the government still needs to raise sufficient revenues from taxes and fees to run the government. This means that tax reductions granted to one group need to be offset by higher taxes on others. If some groups are able to exclude the scale of tax benefits flowing their direction from standard reporting, governmental decisions are likely to be worse. Indeed, it is reasonable to expect that groups with more political power will be more successful in shaping authorizing legislation to keep the scale of their tax breaks private. This outcome is not good for market competition in the state, particularly where new industries with far less political heft are taking on established incumbents with better, cheaper, or cleaner products. 

A related question goes beyond Texas. Whether, and to what degree, do other states, provinces, or even entire countries have enabling legislation on tax expenditure reporting that also masks material beneficiaries? Exploring the extent and scale of these omissions is something that perhaps the team producing the Global Tax Expenditures Database could take on in the future.

Baseline tax expenditure reporting in Texas

Texas releases its Tax Exemptions & Tax Incidence report roughly every two years, with the most recent version published in December 2020. At 80 pages long, and running through exemptions to all different types of taxes, the report seems a comprehensive tally of state revenue losses from targeted tax reductions to specific groups of people, industries, or activities. The review even includes exemptions from oil production taxes under section 202 of the Texas tax code. These have been worth roughly $30 million/year in recent years (Table 9 in the report linked to above). 

Unfortunately, the authorizing statute mandating this report is not comprehensive, enabling large tax preferences to be legally excluded. This includes tax breaks that parallel those to oil but that instead apply to natural gas and reside in a different section (Section 201) of the Texas tax code. Section 201 appears to include five tax exemptions (see table below), of which data from the Texas Comptroller of Public Accounts indicates two have resulted in significant revenue losses over the past decade:

• Reduced taxes on "high cost" natural gas wells (section 201.057(c)) with annual revenue losses of hundreds of millions of dollars per year, and more than $1 billion in FY2022; and 

• Low producing gas wells (section 201.059) that had minimal revenue losses in 2022, but exceeded $80 million as recently as FY2018. 

Value of Gas Production Tax Exemptions in Texas, Fiscal 2009 to 2022 ($millions)    

Table notes and sources
(a) Asterisk (*) denotes an estimated revenue loss that is either zero or negligible.
(b) Columns may not sum because of rounding.
(c) Data provided by the Texas Comptroller of Public Accounts, October 2022, in response to a public records request submitted by Earth Track. 

The basis for this reporting gap arises through Section 403.014 of the TX government code that calls for a "Report on Effect of Certain Tax Provisions." The specific scope is worded as follows:

(a) Before each regular session of the legislature, the comptroller shall report to the legislature and the governor on the effect, if it is possible to assess, of exemptions, discounts, exclusions, special valuations, special accounting treatments, special rates, and special methods of reporting relating to:

(1) sales, excise, and use tax under Chapter 151 (Limited Sales, Excise, and Use Tax), Tax Code;
(2) franchise tax under Chapter 171 (Franchise Tax), Tax Code;
(3) school district property taxes under Title 1, Tax Code;
(4) motor vehicle tax under Section 152.090; and
(5) any other tax generating more than five percent of state tax revenue in the prior fiscal year.

Despite the scale of oil and gas production in Texas, and the outsize role Texas plays in the industry nationally, exemptions to oil and gas production taxes are not reported by default, but rather fall under the terms of the "catch all" provision in Section 403.014(a)(5). Unless the production taxes meet a 5% of tax revenues threshold, associated exemptions from these taxes will not be reported.  Based on tax revenue data provided on the Comptroller portal, and a review back to FY2018, oil production taxes exceeded this 5% hurdle every year. Natural gas production taxes were below 5% during this period until FY2022. While it is possible that the next tax expenditure report (likely at the end of 2022) will include natural gas, it does not seem guaranteed. This is because the hurdle is measured in the year prior to the report and natural gas did not exceed 5% in FY21. Under this latter interpretation, exemptions from natural gas production taxes may not show up in the tax expenditure report until the end of 2024 despite surging prices, production, and likely revenue losses as well. 

Fixing the problem

A few observations may be helpful in fixing this gaping hole in tax expenditure reporting in Texas:

• Tax groupings should be reviewed and revised. Oil and gas are often co-produced at the same wells, and the separation of oil and gas production taxes into separate statutory categories for evaluation seems arbitrary. Indeed, it would be interesting to hear from those involved with the Texas legislative process whether there were any political drivers behind this separation at its inception. Clearly, if one looked at the revenue share of oil and gas production taxes jointly, they would have exceeded the 5% revenue threshold every year and been transparently reported. This is what should be done going forward.

• Non-reported tax subsidies may still be both large and distortionary. Despite falling below the 5% reporting threshold, the revenue losses from section 201 tax exemptions were equal to 40% of what the natural gas production taxes actually raised in 2018. This share exceeded 20 percent of natural gas production tax collections in every year between 2019 and 2022. This illustrates that the 5% test is not a useful one for establishing good fiscal controls.

• High-cost gas subsidy is not linked to price, but should be. Further, the structure of the high-cost natural gas tax break allows benefits to continue to flow to producers even during times of historically high prices for natural gas because the "high cost" element is linked to the relative cost of one field versus others in state, not to profitability. As a result, the provision results in large losses to Texas taxpayers even though all of these fields would be profitable without the subsidy in robust markets such as what prevails today. At the very least, the provision should phase out during periods of high prices.

• Large tax expenditures should be included in the formal tax exemption report report even if underlying tax base is less than 5% of revenues. Because tax exemptions can be large and unfairly benefit particular subgroups in ways that are environmentally damaging or inequitable, and because these distortions can arise even for taxes comprising less than 5% of what is a very large state budget, the criteria for inclusion within the Tax Exemptions & Tax Incidence report should be modified. A more logical approach would be to replace a 5% of revenues test in §403.014(a)(5) of the statutes with one based on the scale of the tax expenditure in terms of revenue losses -- perhaps with a $50m/annual impact for inclusion.

• Third parties have provided transparency on natural gas tax breaks despite lack of formal reporting, but formal reporting should now be implemented. Despite section 201 tax breaks to natural gas not having been included in the biennial tax expenditure reporting, it is reassuring that third parties have periodically gotten data on these provisions released. In 2014, this resulted from statutory language included in the budget by the legislature. In 2018 there was a public records request in support of research being conducted by UT Austin's Energy Institute; and the information was included in the Comptroller's 2009 report (no longer on the web, but accessible here), perhaps because the natural gas provisions hit the 5% minimum in 2008. Further, the Comptroller quickly and comprehensively responded to our public records request as well. All of these examples highlight a commitment to transparency within the state, and that the Comptroller continues to track the provisions even if they are not all published. Despite these examples, however, an ad hoc approach to transparency for provisions costing taxpayers tens or hundreds of millions of dollars is insufficient. Instead, the standard tax expenditure reports need to include all material tax breaks, even if modifications to the authorizing language in section 403.014 are needed to make it happen. 

Note: this posting was updated to add 2009-2022 revenue loss totals to the data table.