Legal Challenge to New Drilling Incentive Could Raise Big Constitutional Questions

  • Joe Wertz
A legal challenge to a recently signed bill authored by Republican House Speaker Jeff Hickman could have wide-ranging effects.

Joe Wertz / StateImpact Oklahoma

A legal challenge to a recently signed bill authored by Republican House Speaker Jeff Hickman could have wide-ranging effects.

A controversial bill setting the effective tax rate on new oil and gas wells was one of the capstones of the 2014 legislative session.

Gov. Mary Fallin signed the measure on May 28, ending months of intense debate and oil industry lobbying. But the bill is already headed for a legal challenge, and some of the constitutional questions could have a far-reaching effect because they could define the very words and terms lawmakers use to fund government in Oklahoma.

The State of Oklahoma runs on tax revenue, and House Bill 2562 looks like a tax bill. It modifies the tax code. It changes a tax rate that provides revenue for state agencies. But the bill’s supporters say it’s not a “revenue bill.”

The bill deals with taxes on new oil and gas production on new oil and gas wells, which replaces a tax incentive that expires next year that provided a tax break for horizontally drilled wells.

Many lawmakers and oil company executives lobbied hard for the bill, which they said made Oklahoma more competitive for new drilling activity. But the bill had other critics, including energy company executives who said Oklahoma’s oil and gas taxes were low enough and argued that tax rates don’t have any bearing on where oil companies drill.

Tax Rates, Effective Tax Rates

Depending on who you ask and how you ask, it either raises — or lowers the effective tax rate oil and gas royalty owners will pay. Defending the bill on the capitol floor, Republican House Speaker Jeff Hickman explained the differences as he sees them.

“Once again, the tax rate is not changing,” Republican House Speaker Jeff Hickman of Fairview told lawmakers. “The tax rate — the gross production tax rate in Oklahoma — has been 7 percent and is 7 percent today and it will be if this passes. The incentive program that is about to expire is being changed. That will result in an effective tax rate of 2 percent going forward for 36 months.”

Representative Hickman says the tax rate isn’t changing. But the “effective tax rate” is. He says HB 2562 isn’t a “revenue bill,” it’s an “incentive bill.” But Oklahoma City attorney and legislative watchdog Jerry Fent, who has successfully challenged laws in the past, says that explanation is nonsense, and he’s preparing a lawsuit.

The roots of Fent’s challenge were planted in the 1980s. Oil busts fueled a funding crisis, and lawmakers raised taxes to fill budget gaps. And a controversial $230 million school reform package that passed on an emergency clause spurred outcry from opponents who wanted a statewide vote.

“Revenue bills would appear in the last week that never did go to a committee or anything like that, which would give a lot of hanky panky ability of the Legislature to do things,” Fent says.

Oklahomans were fed up. In 1992, voters approved State Question 640, an amendment to the state constitution putting extra burdens on passing revenue bills.

“No revenue bill shall be passed during the last 5 days of the session,” Fent says, reading from the Oklahoma Constitution. “Also, revenue bills must be approved by three-fourths vote in both the House and Senate.”

Raising Taxes or Ending Discount?

House Bill 2562 fails both of those tests. “It’s null and void,” Fent says.  But supporters say it doesn’t matter since it’s not a revenue bill. They say revenue bills are bills that raise taxes. A spokesman for Governor Mary Fallin, Alex Weintz, says that’s not what this measure does.

“Basically, it works just like any other tax incentive or tax credit bill does,” he says. “Oil and gas companies will essentially get a discount.”

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.

For its purposes, the Office of Management and Enterprise Services, which oversees the state budget office, interprets “revenue bill” to mean any bill that could affect revenues for the following budget year. Since HB 2562 wasn’t expected to negatively effect revenues, it wasn’t flagged as a “revenue bill,” says agency spokesman John Estus.

In a letter to Gov. Fallin, Fent said he’d sue if she signed the bill into law. Now that she’s signed the measure, Fent says he’ll file a lawsuit in the coming weeks. It’s Attorney General Scott Pruitt’s job to defend the bill in court. While the wording of the constitutional amendment places the legislative burdens on any new “revenue bill,” Pruitt says the intent of voters was to fight tax increases.

“Clearly that was the contemplation of the voters, to say, ‘Look, you’re not going to raise my taxes unless you do these things,” Pruitt says. “There’s more to it than just simply whether it was a revenue measure or not.”