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Inside The State Supreme Court Hearing On Lawsuit Over Oil And Gas Tax Rate

Jul 29, 2014

A lawsuit over recently signed legislation that changes state oil and gas tax rates will be heard by the Oklahoma Supreme Court today, a constitutional challenge that could have broad impact on industry and legislative procedure.

I broke down the lawsuit on an Oklahoma News Report segment with OETA’s Dick Pryor, which you can watch above. But there are five things you need to know about today’s hearing, which could hinge on legal subtleties and word interpretations.

1. Background On The Bill

The state levies a 7 percent tax on crude oil and natural gas production in Oklahoma. House Bill 2562, authored by House Speaker Jeff Hickman, R-Fairview, lowers the tax rate to 2 percent for vertically and horizontally drilled wells during the first three years of production.

The new tax rate goes into effect next year, and it replaces an incentive that expires next year. The expiring incentive included a lower tax rate — 1 percent for the first four years of production — but only applied to horizontally drilled wells.

Big-name oil and gas executives, industry groups and Republican lawmakers lobbied hard for HB 2562, which would keep the effective tax rate levied on booming production from horizontal drilling from returning to 7 percent, give a tax break and parity to vertical producers, and help Oklahoma compete with other states for new drilling activity.

Many oil and gas companies also say the tax incentives help Oklahoma’s comparatively less-productive wells compete with other states that have wells that yield a lot more oil and gas, such as those in North Dakota.

Other high-profile energy executives and the left-leaning Oklahoma Policy Instituteargue the incentives did little to encourage drilling and instead amounted to a subsidy or handout for an influential industry.

The bill was approved by the state Legislature and signed by Gov. Mary Fallin in May.

2. Who Filed The Lawsuit, And Why

Oklahoma City attorney Jerry Fent on June 26 filed a lawsuit challenging the constitutionality of HB 2562. Fent is a legislative legal watchdog, and he’s has successfully challenged bills in the past. His lawsuit over HB 2562, like his other suits, challenges legislative procedure.

In 1992, Oklahoma voters — fueled by oil busts, budget crises and a last-minute approval of a controversial school-reform package — approved State Question 640, which amended the Oklahoma Constitution to include extra legislative burdens for revenue bills.

Here’s Article 5, Section 33 — emphasis mine:

A.  All bills for raising revenue shall originate in the House of Representatives. The Senate may propose amendments to revenue bills.

B.  No revenue bill shall be passed during the five last days of the session.

C.  Any revenue bill originating in the House of Representatives shall not become effective until it has been referred to the people of the state at the next general election held throughout the state and shall become effective and be in force when it has been approved by a majority of the votes cast on the measure at such election and not otherwise, except as otherwise provided in subsection D of this section.

D.  Any revenue bill originating in the House of Representatives may become law without being submitted to a vote of the people of the state if such bill receives the approval ofthree-fourths (3/4) of the membership of the House of Representatives and three-fourths (3/4) of the membership of the Senate and is submitted to the Governor for appropriate action. Any such revenue bill shall not be subject to the emergency measure provision authorized in Section 58 of this Article and shall not become effective and be in force until ninety days after it has been approved by the Legislature, and acted on by the Governor.

Fent argues that because HB 2562 changes oil and gas tax rates, it’s a revenue bill that didn’t meet the bolded requirements above, and was unconstitutionally passed by the Legislature on its way to the Governor’s desk.

Steven Dow, executive director of the nonprofit CAP Tulsa, former member of the Oklahoma Commission for Human Services and one of five members of the Oklahoma Department of Human Services Family and Children Advisory Committee, supports Fent’s lawsuit. In a brief in support of invalidating HB 2562, excerpted by the Tulsa World‘sBarbara Hoberock, Dow argues that because the bill increases a tax rate it “imposes a tax,” and is therefore a revenue bill:

“The primary purpose for collection of gross production revenues is to fund government services,” Dow’s brief states.

3. Who Is Defending The Bill, And Why

Oklahoma Attorney General Scott Pruitt is defending Gov. Fallin and the State of Oklahoma, which are named in Fent’s lawsuit.

Pruitt’s argument — a position shared by Speaker Hickman and the Governor’s Office — is that HB 2562 isn’t a “revenue bill.” They argue the bill is a temporary “tax incentive,” that doesn’t actually change the state’s gross production tax rate.

Further, Pruitt argues tax increases were voters’ primary motivation when they approved the 1992 constitutional amendment.

“The contemplation of State Question 640, as it was passed by the voters, was to place limitations on the Legislature’s ability to raise your taxes,” Pruitt told StateImpact in May 2014.

Alex Weintz, a spokesman for Gov. Fallin, likened the bill to a “discount” rather than a revenue bill. Here’s how we explained his argument in June:

Weintz says lawmakers can change that tax “discount” without changing the tax “rate.” Replacing a 1 percent effective tax rate with a 2 percent effective tax rate isn’t a tax increase — it’s just decreasing the discount. And when oil and gas royalty owners see that 2 percent effective tax rate return to 7 percent after three years, it’s not a tax increase — It just means the tax discount is over.

4. Impact On Industry

The Oklahoma Oil and Gas Association and the Oklahoma Independent Producers Association have filed briefs siding with the state, arguing that HB 2562 is valid. Here’s section of the Oil and Gas Association’s brief excised by the Tulsa World‘s Barbara Hoberock:

“When the producer in question conducts operations in multiple states, the varying impact of each state’s production tax rates will truly impact the estimated profitability of the potential new wells for each state, giving the state with the lower tax rates an advantage over states with higher rates, if the other considerations are roughly equal,” the association’s brief said.

The oil industry doesn’t want the gross production tax rate to return to 7 percent, but it also worries that if the court invalidates HB 2562, it could mean business uncertainty for energy companies that have to think long-term about when and where they drill.

5. Impact On Government

The lawsuit is being heard by a referee for the Oklahoma Supreme Court, but if the justices invalidate HB 2562, it could have a big impact on the 2015 legislative session and a wide range of future legislation.

Fent’s lawsuit and the defense of the challenged bill center on the definition of “revenue bill.” If the court decides that “revenue bill” means “tax increases” as the State of Oklahoma argues, the effect could be narrow. Still, under this interpretation, the justices could decide that increasing an incentivized tax rate counts as a “tax increase,” invalidating HB 2562, but limiting impact to this bill alone.

But if the justices rule broadly, perhaps invalidating HB 2562 because they interpret the measure as “revenue bill” passed by the Legislature without proper procedure, the impact could affect all measures that deal with revenue-raising, such as taxes and fees, as well as tax credits and economic incentives, which have been a contentious topic at the Capitol in recent years and are likely to remain so in upcoming legislative sessions.

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