In his 2015 State of the State Address, Governor Kasich argued that Ohio needed to increase the tax on oil and gas extraction—the severance tax—because removing oil and gas from the ground makes Ohio poorer. Is this true? Is Ohio poorer because of oil and gas extraction? This debate isn’t new. In fact, there was once a school of thought, the mercantilists, who made similar arguments in the 16th and 17th centuries. Fortunately, the work of great economists such as Adam Smith soundly proved the error of this thinking. What was true in the days of Adam Smith is true today. Ohio benefits from the economic growth induced by the shale boom. Increasing the severance tax will discourage shale-drilling activity, which will be the true culprit in making Ohio poorer.
Mercantilists did not see free trade as mutually beneficial because they thought one party could gain only at the other’s expense. They were strong nationalists who wanted to maximize the national wealth by tightly controlling the economy. These ideas and motives led them to implement misguided policies that restricted trade in order to hoard gold and silver.
But this was a flawed doctrine that only hindered its adherents in their stated goal of maximizing national wealth. Adam Smith correctly explained that when producers and consumers freely trade, both parties win. This leads to economic growth and true prosperity, regardless of how much gold is in the king’s vault.
Governor Kasich argued that, “Ohio’s being made poorer as a result of the depletion of our resources… Much of the wealth the shale boom is generating is being shipped out of our state, being shipped out of Ohio.”
His proposed remedy is to dramatically increase the state severance tax on horizontal drillers so that, like the mercantilist philosophers in days of old, the state can build up its savings with the tax revenue. He views the shale oil and gas deposits sitting in the ground as part of Ohio’s wealth. Because of this view, Kasich hopes to maintain this wealth by taxing shale production and saving the revenues.
But as Adam Smith ably proved, this economic view is erroneous. Oil and gas deposits do not create wealth for Ohio by merely sitting in the ground beneath thousands of feet of rock. It’s the extraction of the deposits, thanks to new horizontal drilling technology, that makes them profitable. Horizontal drillers add value to those oil and gas deposits by using advanced machinery, skilled labor, and technical know-how to bring them to the surface and make them usable. In the process, these drillers generate business for Ohio-based companies and create high-paying jobs for Ohio citizens. In turn, the state government, local governments, and local schools receive higher tax revenues as well.
Increasing the severance tax discourages shale-drilling activity, which consequently discourages growth. Moreover, any surplus to the state from this tax increase will be more than offset by the loss of jobs, investment, and spending that would have been created by keeping those resources in the private economy. Those who benefit directly from the shale boom re-invest some of their proceeds, resulting in even more wealth and job creation. Their income also becomes their spending, which becomes income for people who then benefit indirectly from shale production. In this way, all Ohioans share in the benefits of the shale boom without the need for state intervention.
The Kasich administration has repeatedly overestimated the level of oil and gas production in Ohio, and consequently, has repeatedly overestimated the amount of severance tax revenue the state would receive. Significantly increasing the tax will surely maintain this pattern. The Governor further argued for his proposal by emphasizing that, “If you don’t drill, you don’t pay.” But the last thing that Ohio should want is for companies not to drill, and to instead take their valuable economic contribution elsewhere.