As advisors to Gov. Palin on oil and gas issues, we and Deputy Commissioner Marty Rutherford of the Department of Natural Resources are proud to stand behind the governor's oil tax plan. We look forward to working with the Legislature to provide the details of our team's analysis and to cooperatively develop the best production tax system for Alaska.
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Alaska's departments of Revenue and Natural Resources each have significant responsibilities regarding the state's oil and gas policy. As the leaders of these two departments, and the governor's key staff on oil and gas issues, we have worked together closely to advise the governor on oil and gas policy, including advancing a gas line, promoting new oil and gas investment, and most recently, proposing a new oil and gas production tax.
In May, the governor directed the Department of Revenue to review the performance of the current Petroleum Profits Tax, and when it became clear that a change was needed, she further directed the Department of Revenue to develop a proposal to address the deficiencies with the tax. the Department of Revenue requested input from the Department of Natural Resources, and together, with a collection of oil and gas consultants, the team analyzed a variety of potential tax structures. The team included the Department of Revenue's economists and accountants, the DNR's Division of Oil and Gas commercial analysts, geologists, engineers and attorneys from the private sector and the Department of Law.
The governor provided a set of principles by which to judge the options: 1) The tax system should be as transparent as possible to maximize public confidence and minimize risk to the state of taxpayer manipulation, 2) It should provide a fair share of revenue to the state, and 3) It should create an attractive investment climate for new oil and gas explorers to discover new fields, and for existing producers to re-invest in existing fields, including development of our heavier oils and natural gas.
When the analysis began, the three of us, like the governor, strongly favored a system based on the gross value of the oil and gas sold. However, the analysis eventually showed that with such a system there was a tremendous trade-off between revenue and investment climate.
The team analyzed a wide range of gross tax structures with credits for a variety of capital investments covering drilling costs, general capital costs, and specific heavy oil development costs. Each of the gross tax structures failed to provide a reasonable balance between revenue and investment climate. In trying to add adjustments or "fixes" to provide more flexibility to the gross tax, the options became exceedingly complex and the simplicity inherent in a gross tax was lost.
The team then pursued innovative approaches to try to include net tax features into a gross tax. These all ran into either practical or economic barriers to success. In the end, we were unable to come up with an entirely gross-based tax system that we could recommend to the governor as satisfying her three principles. None of the team wanted to propose a tax system that was not in the state's long-term interests. We began looking at a hybrid combination of a gross tax to protect the state in low prices, and a net-based approach to best meet the state's other interests.
We recognized that the net-based approach of the Petroleum Profits Tax created risks to the state from possible taxpayer manipulation, and we turned our attention to minimizing those risks. To do so, the Department of Revenue needs to increase its ability to manage the industry information provided through a net system. In particular, the Department of Revenue must require more complete and timely information from taxpayers and needs to increase its auditing capabilities. These necessary tools will allow the state to better forecast revenues and prepare for and conduct audits.
Our ultimate recommendation became the Alaska's Clear and Equitable Share Plan. Under the ACES Plan, the state will have a gross tax-based safety net for revenues when prices dip, or costs rise, while maintaining the full benefit of a net-based system that will provide a greater share of value from our oil and gas resources while still spurring new investment. ACES also includes a number of needed tools for protecting the state's interests in light of the net-based approach.
Pat Galvin is commissioner of the Department of Revenue. Tom Irwin is commissioner of the Department of Natural Resources. The Department of Natural Resources Deputy Commissioner Marty Rutherford also contributed to this letter.
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