Association for Public Policy Analysis & Management

Hydraulic fracturing and horizontal drilling, having recently reignited many states’ oil and gas industries, raise considerable economic sustainability concerns in public finance.  To mitigate both the volatility of industry activities and the eventual exhaustion of the resource, many states established trust funds supported by natural resource revenues. Generally, these funds can take on three distinct forms: endowment to plan for when the resource diminishes statewide; current impact to alleviate the immediate financial burden of supporting the industry; and remedial to lessen the adverse local impacts of extractive exploration when activity declines. However, these energy-rich states may be experiencing revenue shocks from declining economic activity due to falling oil and gas prices in recent years, leading many government officials and industry leaders to question the vitality of natural resource economies, given the industry’s boom-bust nature.

Commodity prices for oil and natural gas largely drive these oil and gas trust funds, as both severance taxes and federal royalties paid to the state are contingent on market rates. For the purposes of this paper, severance taxes include a broad range of fees and taxes, such as impact fees, production taxes, severance taxes, or privilege fees. Similarly, federal royalties from drilling account for a large diversity of investments in funds. While severance taxes and royalties function as considerable economic factors these states’ fiscal health, states differ in when and how much of the funds can be spent.

Furthermore, how states allocate and manage these monies, especially after recent oil and gas price declines, poses another interesting research question. Some states earmark these revenues for special, dedicated natural resource-specific trust funds, while others deposit them into their general funds, leading to very different revenue usage with potentially divergent outcomes.

This paper examines recent economic and statutory changes to severance taxes and associated impact on collections and the earmarked allocations of these revenues. Sampling states with high extraction activity and revenues, this paper employs difference-in-difference OLS regression to estimate the relationship between fund types and state fiscal health. In looking at fiscal health, this study is particularly concerned with revenue volatility and reserve balances in states’ pre- and post- boom periods.

Preliminary results indicate that states whose natural resource trust funds earmark revenues for specific purposes tend to maintain better fiscal outlooks than those with whose revenues are deposited into state general funds.