Local Revenue Volatility and Oil and Gas Development in Texas

Volatility is nothing new to oil and gas markets. But for communities in the United States where the shale revolution has led to rapid growth in the industry, the ups and downs of commodity prices can present new and unexpected challenges. As we have discussed in related research, state and local fiscal policies can exacerbate or smooth out revenue volatility for local governments, with major implications for the quality of public services like schools, roads, and public safety, as well as important tax implications for residents and businesses. In recent years, the boom and bust of oil and gas development has highlighted policies in Texas that amplify volatility for local government revenues.

In Texas, the ability of local governments to raise revenue through property taxes is constrained by state policies that pressure tax rates downward when property values rise. Specifically, local governments must hold elections to approve tax rates that result in revenue growth of 8 percent or more in a given year. When property values fall, as they do when oil and gas prices drop, local elected officials are often left in the unenviable position of either raising tax rates, a difficult political proposition, or decreasing expenditures, potentially reducing the quality of public services. The end result is a policy that dampens the upside of volatility for localities while fully exposing them to the downside.

Figure 1 provides an example of how dramatic these changes can be. Gonzales County, a major producer in the Eagle Ford shale region of south Texas, experienced growth in property valuations of more than 500 percent from 2011 to 2014, driven entirely by oil and gas development. In response, local officials reduced tax rates by almost 60 percent to limit overall revenue growth. When property values fell in 2015 as the result of a downturn in oil prices, property tax rates increased, but not by enough to hold revenues steady. Many other counties in the Eagle Ford region, along with those in west Texas’s Permian Basin, have experienced the same dynamic.

Figure 1. Property Values and Tax Rates in Karnes and Gonzales Counties, Texas

Data source: Texas Comptroller of Public Accounts (2017). Data provided via email.

This raises the obvious question: What’s the downside to lower tax rates? There are two responses. First, local governments are often strained by rapid growth in oil and gas activity and may struggle with issues such as road maintenance or increased demand for law enforcement. By restricting growth in property tax revenue, Texas makes it difficult for local governments to keep up with rapid growth in demand for these services during “boom” times.

Second, see-sawing property tax rates create planning challenges not just for local governments, but also for companies and residents. Consider an oil company looking to develop a field in Texas. During a period of high prices, the company drills wells profitably, and benefits further because property tax rates are driven down by the growth of county-wide property values. During a period of low prices, when the company may struggle to drill new wells profitably, county governments will tend to raise property tax rates, further discouraging investment.

Now consider a homeowner with a home worth $100,000 in the same region. When oil prices are high, low tax rates will give them a welcome break on their annual property tax bill. But when oil prices are low, tax rates will tend to go up, increasing their bill. This might not be a problem, except for the fact that many oil- and gas-producing regions are heavily reliant on the industry—meaning that the homeowner may see a downturn in wages or a loss of employment at the same time that their property tax bill rises.

An analysis of property tax data from Texas shows that counties relying more heavily on oil and gas revenues have greater volatility in both tax revenues and tax rates than those that depend less on oil and gas property in their tax base.

Analyzing data from 2000 through 2015, counties where oil and gas property accounts for 50 percent or more of the tax base experienced on average a 20 to 22 percent change in countywide taxable value each year, while counties where oil and gas accounted for less than 25 percent of property values saw annual changes of 7 percent. These swings in valuation in turn lead to volatility in property tax revenues. For counties where oil and gas property accounts for 50 percent of more of the tax base, annual revenues varied by an average of 13 to 15 percent, compared with 8 percent for counties in the lowest quartile.

This revenue volatility occurs despite the fact that oil- and gas-dependent counties are more likely to make larger changes in property tax rates to account for changes in valuation. Counties in the top two quartiles have experienced average annual tax rate changes of 12 to 13 percent, while counties in the lowest quartile have experienced changes of just 4 percent.

Table 1. Property Valuation and Tax Volatility in Texas Counties, 2000–2015

Data source: Texas Comptroller of Public Accounts (2017). Data provided via email.

Currently, the Texas state legislature is considering a proposal that would exacerbate revenue volatility even further. The bill under consideration, Senate Bill 2, would require governments to hold elections to approve of revenue growth of more than 5 percent, more restrictive than the current 8 percent. But as mentioned above, these policies make it difficult for local governments to set tax rates that best suit their needs. What’s more, they also incentivize oil and gas investment when favorable conditions already exist—then discourage investment during periods of low oil prices, when the economy could use a boost.

Along with allowing more flexibility in the setting of tax rates, one way to mitigate the challenges of oil and gas volatility for local governments would be the use of “rainy day” funds. During periods of high prices and production, state or local governments could save a portion of oil and gas tax revenues to be spent when prices inevitably fall.

There’s a common bumper sticker found in west Texas and other longtime oil- and gas-producing regions that reads along the lines of, “Dear Lord, please just give me just one more oil boom. I promise not to screw it up this time.” Policymakers may want to keep this sentiment in mind when considering the design of revenue policies.