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A severance tax is a tax charged on the removal of natural resources, not based on profits but on the total amount removed. It can be levied on a graduated scale and is important for regions where natural resource exploitation is a large part of the economy. Critics argue it raises costs, but studies suggest it does not reduce production or business. Regions without such taxes may lose potential revenue, and in some cases, the initial consumer may pay the tax.
A severance tax is a tax charged on the basis of the removal of natural resources. The tax is not based on the profits made by the producers and partners, but rather on the total amount of resources removed. In some regions, taxes are levied on a graduated scale, so small-scale producers are not taxed at the same rate as producers extracting large volumes of natural resources. Compensation taxes vary from region to region, with some areas charging no tax at all, while others may charge a range of taxes related to the extraction of natural resources, including oil and gas taxes, taxes on coal, fishing taxes, and timber taxes.
For regions where the exploitation of natural resources accounts for a large part of the economy, compensation taxes are an important way to support government operations, including paying regulatory agencies that oversee the disposal of natural resources. This tax can be collected in addition to other taxes related to the use of natural resources. A company that extracts oil, for example, may pay an indemnity tax on all oil extracted, in addition to paying income taxes on profits from oil production.
Critics of severance taxes argue that they have a negative effect on business in one region by making the costs of doing business higher than in other areas. Studies seem to suggest that this is not the case, as the existence of a compensation tax is not related to lower levels of production or reluctance to do business. Businesses that take advantage of natural resources cannot simply relocate their operations, as they need to work in an area where those resources are available. In a region with a vast supply of resources, severance taxes do not create a disincentive for business, as they are generally set very low and do not reduce profits.
Regions without indemnity taxes may experience significant loss in potential revenue. Studies commissioned in regions where such taxes do not exist or are restricted to a few resources show that the implementation of an indemnity tax could generate large government revenues and these revenues could help pay for costs associated with resource extraction industries, as well as general government expenditures.
In some regions, instead of being paid by the producers, the initial consumer of the resource may pay compensation taxes. The indemnity tax is structured on the price of raw resources. This can result in passing the price on to end consumers, raising overall costs slightly, and can be a concern in areas with high prices for commodities such as oil and gas.
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