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IMFG Papers on Municipal Finance and Governance No. 38 • 2018

�e Public Finance Challenges of Fracking for Local Governments in the United States

Austin Zwick

The Public Finance Challenges of Fracking for Local Governments in the

United States

ByAustin Zwick

IMFG Papers on Mun ic ipa l F inance and Governance

Institute on Municipal Finance & GovernanceMunk School of Global AffairsUniversity of Toronto1 Devonshire PlaceToronto, Ontario, Canada M5S 3K7e-mail contact: [email protected]://munkschool.utoronto.ca/imfg/

Series editors: Philippa Campsie and Selena Zhang

© Copyright held by author

ISBN 978-0-7727-0997-4ISSN 1927-1921

About IMFG

The Institute on Municipal Finance and Governance (IMFG) is an academic research hub and non-partisan think tank based in the Munk School of Global Affairs at the University of Toronto.

IMFG focuses on the fiscal health and governance challenges facing large cities and city-regions. Its objective is to spark and inform public debate and to engage the academic and policy communities around important issues of municipal finance and governance. The Institute conducts original research on issues facing cities in Canada and around the world; promotes high-level discussion among Canada’s government, academic, corporate, and community leaders through conferences and roundtables; and supports graduate and post-graduate students to build Canada’s cadre of municipal finance and governance experts. It is the only institute in Canada that focuses solely on municipal finance issues in large cities and city-regions.

IMFG is funded by the Province of Ontario, the City of Toronto, Avana Capital Corporation, Maytree, and TD Bank Group.

Author

Austin Zwick is a Planner in the Ontario Ministry of Transportation. He recently received his PhD in Planning from the University of Toronto, during which time he held the 2016–17 IMFG Graduate Fellowship in Municipal Finance and Governance. He previously received his MPA in Public Finance and Fiscal Policy and a BSc in Industrial and Labor Relations from Cornell University. His research interests focus on the local public finance and governance challenges caused by emerging industries.

Acknowledgements

The author would like to thank the wonderful people at the Institute on Municipal Finance and Governance – Enid Slack, Selena Zhang, and Almos Tassonyi – for the multiple rounds of comments and feedback that vastly improved the clarity and content of this work.

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AbstractFracking has revolutionized international oil and gas markets practically overnight, but its impact on local public finance and governance have largely been overlooked. While operating under federal and state constraints, the key ongoing policy question is whether and to what extent local governments can – and should – have the power to manage the industry’s effects on their communities. This IMFG Paper explores the fiscal health risks associated with the industry, its local revenue generation implications, and what local governments can do to address the spatial and temporal mismatches between the two. As the industry expands internationally, including to Canada, lessons from the United States can inform future regulatory response in other places.

Keywords: fracking, resource extraction, boom-bust economies, municipal finance

JEL codes: H71, H72, H79, Q33, Q38

The Public Finance Challenges of Fracking for Local Governments in the

United States Austin Zwick

Austin Zwick

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1. IntroductionThe technological innovation of Horizontal Hydraulic Fracturing, more commonly known as “fracking,” ignited a nationwide boom of oil and gas drilling practically overnight. Fracking, which started becoming widespread in 2007, combines horizontal drilling techniques with advances in chemical extraction processes. Conventional technologies drilled vertically, aiming for large underground reservoirs of oil and gas. Shale resources, tightly packed in tiny pockets in a thin and geographically spread-out layer of rock, were previously deemed physically inaccessible. Technological breakthroughs expanded the natural fissures in shale, releasing its contents.

At first, this technology was used to re-drill older vertical wells to squeeze out the remaining oil, but starting in 2009, new well designs were created. Fracking wells, even with their higher upfront production costs, turned out to be more profitable than their conventional counterparts because of significantly greater output.

The fracking industry spread rapidly throughout the United States, wherever oil and gas could be found in shale rock; more than 45,000 wells were drilled during the next five years (Cho 2014). The technology has since spread to other countries.1 Canada appears to be the next frontier of fracking (Williams 2018), particularly the Duvernay and Montney shale basins in Alberta. There is also significant future potential in Southern Ontario (Hamilton 2010) and Quebec (Van Praet 2014). Lessons learned from the United States may be applicable to the Canadian context.

Wherever fracking was carried out, regulatory regimes were unprepared to handle the speed, size, and scale of this new industry (Carter and Eaton 2016). Communities were split by the competing demands of economic development and environmental protection. On the one hand, fracking provides much-needed jobs in otherwise declining rural regions; on the other hand, the industry reduces the livability of those regions.

Local governments are on the front line in attempting to manage the effects of this new industry, which include water safety and air quality concerns, noise pollution, wastewater disposal, truck traffic, and even minor manmade earthquakes (Goho 2012). Moreover, beyond the immediate environmental risks, resource extraction communities operate on a boom-bust cycle (Christopherson 2011;

The Public Finance Challenges of Fracking for Local Governments in the United States

1 The U.S. Energy Information Administration (2013) investigated 137 shale basins in 41 different countries. The top five countries for shale oil are Russia, the United States, China, Argentina, and Libya. The top five countries for shale natural gas are China, Argentina, Algeria, the United States, and Canada. Fracking is expected to grow significantly worldwide, overtaking conventional drilling within a decade.


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Jacobsen and Parker 2016; Jacquet 2006), and these communities often struggle with inadequate social and health services to deal with crises of depression, family stress, addiction issues, and violence towards women (Shandro et al. 2011). Yet little research has been done on municipal responses to fracking.2 “Questions about what mechanisms local governments can use to regulate fracking, the scope of local authority over fracking, and which aspects of the fracking boom local government regulations can and should target remain largely unanswered” (Minor 2014: 65).

As local governments grapple with these challenges by adding administrative capacity, increasing staffing levels, buying equipment, and hiring outside expertise (Christopherson and Rightor 2015), the boom-bust cycle is reflected on their municipal balance sheets, creating fiscal health risks. Choosing the right fiscal course is a tightrope; underinvestment in the present may result in shortages compared to service-level needs, while overinvestment may leave communities overleveraged when drilling comes to an end.

Local governments typically bear a disproportionate share of the expenses in relation to the revenue that they receive; making the fracking industry a “bad deal” for local governments. As these local governments are constrained by state governments in terms of the responses they are allowed to take, state regulation becomes the only regulation in most circumstances.

State and local governments need to use this opportunity to re-examine their relationships, roles, and responsibilities, because state governments have a perverse fiscal incentive to promote fracking at the expense of local fiscal and environmental health. There are four fundamental mismatches that make this industry difficult for local governments to manage3:

• the disparity between public concerns and municipal powers;

• discrepancies between governmental responsibilities and revenue streams;

• the timing gap between costs and revenues;

• spatial differences between drilling locations and the sites of externalities.

At the heart of these mismatches is the debate on “home-rule” powers for municipalities. Home rule allows local governments to pass any laws and ordinances that they see fit to operate their own governance functions within their jurisdictions unless there is a state law that pre-empts a specific act.

2 Regulatory responses to the fracking industry at the federal (Brady 2012; Tiemann and Vann 2015; US Environmental Protection Agency 2017) and state (Richardson et al. 2013; Schenk et al. 2014; Zirogiannis et al. 2016) levels are well documented, particularly in relation to health and environmental issues.

3 This paper groups municipal, county, school district, and special-purpose entities together under the catch-all term of “local government.” The exact distribution of revenues, costs, and responsibilities between these entities and their state governments varies by state.

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The initial reaction by most local governments has been to ban fracking, perhaps because smaller municipalities lack the administrative capacity to regulate new environmental issues (Hanna 2005; Miller et al. 2009; Wilson 2006), making a ban a simple administrative solution. But local fracking bans have been struck down by state courts and pre-empted by state legislatures. Nevertheless, local bans do serve as a powerful symbolic signal to the state government from the local community. New York State, followed by Vermont and Maryland, have banned fracking statewide following numerous local bans. However, all other states have passed statewide legislation to allow fracking to proceed, provided that drilling companies comply with local regulations; while often limiting what and how municipalities can regulate.

Other solutions are possible. One would be to give municipalities more home-rule powers to manage their own affairs. This change would be inadequate to solve all four of the mismatches, but would be an improvement over the status quo. A more encompassing yet politically fraught option, is to grant greater taxation, spending, and regulatory powers to interstate regional planning organizations (RPOs) that could (1) use greater collective bargaining power in favour of local interests and (2) align revenue sources with expenditure needs across space and time. In essence, RPOs could act as an insurance fund by allocating fiscal benefits to cover fiscal risk.

2. What are the costs of fracking for local communities?

2.1 Costs related to short-term employment boomsBoomtowns are defined by “too many unfilled jobs and not enough empty beds” (Sulzberger 2011). The average time of completion from construction to production of a well is between three and six months, yet the peak of the employment boom is quickly reached during the drilling phase, at which time 900 workers are needed for the average well (Jacquet 2006). But many of these jobs take hours or days to complete instead of weeks or months, which makes the hours of this work equal to the equivalent of only 13 full-time employees for a year. Although production may last decades, once the well enters the production phase, tasks are relatively simple and therefore a small number of workers can service many wells.

The boom-bust nature of natural gas extraction is therefore better understood in the context of short-term employment levels than through longer-term production levels (Jacobsen and Parker 2016). If dozens (or up to hundreds) of wells are drilled in geographic proximity, the local area may experience a short-lived population boom to accommodate the workers and the service needs they bring, while it remains unknown how many people will stay behind after drilling activity ceases.

2.2 Environmental risks and costsWhen fracking begins, the first question on the public’s mind tends to be “Will our drinking water be safe?” Despite numerous studies documenting the environmental


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risks of the industry (Howarth, Ingraffa, and Engelder 2011; Jackson et al. 2014; Osborn et al. 2011), answers have not always been forthcoming.

The anti-fracking movement has focused primarily on this one issue, coupled with general mistrust of the fossil fuel industry (Smith and Richards 2015). Thousands of protests have been held throughout the United States. In 2010, the documentary Gasland was released, which included stories of those whose health was compromised by fracking and vivid scenes of water taps catching fire. Widespread fears of contaminated groundwater took root in the public consciousness. Some of the claims of the movie have since been called into question, but it was the point at which the industry’s hazards entered mainstream awareness.

Local governments have very little control over environmental issues. The passage of the Clean Air Act of 1970 and the Clean Water Act of 1977 shifted environmental protection from a municipal to a federal responsibility; the federal Environmental Protection Agency (EPA) devolved enforcement and additional regulation to state-level agencies. Federal and state agencies have passed supplementary rules for fracking, but federal and state regulators are often overburdened and stretched thin.

Local communities have become the de facto regulator of local health and environment risks associated with fracking (Christopherson, Frickey, and Rightor 2013), but are constrained as to what they can do by state law. Local governments do have the power to direct the location of fracking infrastructure (e.g., compression stations, wastewater facilities) through zoning powers and to regulate industrial externalities that have local impacts on residents (noise, light, dust) through setbacks, but these powers have been proven to be far from adequate (Brown et al. 2014; Fry 2010).

This new industry presents an open question of where local powers ought to end and state powers begin. For example, the industry produces millions of gallons of wastewater per well and its disposal has health and environmental risks (U.S. Environmental Protection Agency 2016). Does wastewater management fall under municipal water responsibilities, since it interferes with the local government’s ability to provide clean tap water? Or is it a state environmental concern, as it affects groundwater tables? Do local governments have the power to ban certain disposal techniques (e.g., waste wells) that have been found to cause health issues in their communities? Ohio deems this issue to fall under local government jurisdiction, while Pennsylvania considers it a state responsibility. The answers to this question and many others4 are currently being determined state by state through courts and in legislatures.

2.3 Infrastructure costs and other expendituresLocal governments are hard pressed to provide the services and infrastructure needed to support a rapidly increasing population and industry. As tax revenues

4 Similar questions arise in relation to noise pollution, light pollution, air pollution, traffic, and other externalities.

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from fracking may lag months to years behind expenditures, the effect is a timing gap between costs and revenues. Local governments must decide whether to raise taxes immediately, take out debt to finance new or expanded services, or leave needs unfulfilled.

Social and public safety services – particularly to address the needs of “outsiders” – are the highest priority of residents in local communities (Morrone, Chadwick and Kruse 2015). As Figure 1 shows, the Pennsylvania Public Utility Commission (2016)5 found that approximately 13 percent of total revenues given to local governments to mitigate negative externalities of fracking were spent on public safety, 5.1 percent went to social and judicial services, 2.5 percent went into environmental programs, and 6.5 percent into all other programs, including administration, planning, and housing.

From a public finance perspective, the cumulative damage heavy trucks cause to roads is the greatest expenditure risk. The Pennsylvania Public Utility Commission (2016) found that approximately two-thirds of the funds for mitigating fracking impacts were immediately spent, or put in reserve, for capital projects. Most county and local roads were not built for this kind of heavy industry.

5 Percentages in this paragraph come out of the total $95.2 million ($35.8 million to municipalities, $60.4 million to counties) distributed in 2015.

Counties

Public Safety / Emergency Preparedness Current Infrastructure

Capital Reserve Social & Judicial Services

Environment Other

Municipalities

Figure 1: 2015 Pennsylvania Act 13 Disbursements by Spending Category

Source: Pennsylvania Public Utility Commission 2016


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The U.S. Department of Transportation (USDOT) uses the “Generalized Fourth Power Law” to predict the amount of damage vehicles do to roads: estimating axle weight to the fourth power. According to this formula, a nine-ton truck causes 410 times the amount of damage to a road relative to the average car. Considering that each well requires between 1,800 and 2,600 truck trips to move and remove pipes, water, and fracking equipment, the amount of damage that such roads will sustain is equivalent to millions of car trips. Without considering increased personal vehicle traffic, additional truck traffic alone can cause 30 years’ worth of wear and tear in a single year (Reynolds and Northrup 2012). Abramzon et al. (2014) estimated that each hydraulically- fractured well in Pennsylvania caused between $13,000 and $23,000 of damage to local roads. It is up to the local and state government to figure out how to pay for these added infrastructure costs.

Most state governments either recommend or require that fracking companies negotiate Road Use and Maintenance Agreements (RUMAs) with local governments. These agreements typically require companies to post bonds earmarked for road repair. Some states cap the value of the bonds, limiting the liability of the company, from as low as $25,000 per mile in West Virginia (Mattox 2012) to $250,000 per mile in Ohio (Locher 2012). Critics argue that these bonds (1) may be insufficient to cover the damage to roads in worst-case scenarios, (2) regularly do not cover damages operators do to third-party property, and (3) often have loopholes and exemptions that further limit operators’ liability (Ditzik et al. 2013).

Even after accounting for RUMA revenue, Abramzon et al. (2014) concluded that a conservative estimate of road damage was $5,000 to $10,000 per well. Multiply that by hundreds or thousands of wells in fracking-intensive counties, and the costs become considerable, particularly to rural local governments that do not have the fiscal capacity to take on these additional capital costs.

The New York State Department of Transportation made a preliminary statement on the profound cost of fracking on state roads and infrastructure:

The impacts of Marcellus Shale gas development on State transportation financing needs is likely to be profound… The incremental costs to mitigate Marcellus impacts for the State range from $90 million to $156 million per year. The estimate for costs for local roads and bridges range from $121 million to $222 million per year, some of which may well flow from the State Transportation Budget (New York State Department of Transportation 2011).

Similarly, referring to the local road damage caused by fracking, Deputy Executive Director of the Texas Department of Transportation John Barton stated, “We need $2 billion, and the shortfall is $2 billion…. And that doesn’t include the costs of maintaining interstate and state highways” (Schlachter 2012). Unless local governments can come to an agreement with the industry to repair or rebuild the local roads, local governments must either raise the capital themselves through taxation, or permanently close unsafe roads due to a lack of revenue for repair.

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Depending on the policy area, government responsibilities may fall to the federal, state, or local levels, or some combination of these levels. Intergovernmental transfers and cooperation are common in many policy areas.

Environmental protection is foremost a federal responsibility, but the federal government has devolved most rulemaking and enforcement powers to state agencies, leaving the federal government with the responsibility only to ensure state agencies follow federal law and correct procedures. Local governments can only marginally affect environmental policy through their zoning, land use, and police powers.

Oil and gas administration – the licensing, taxation, and oversight of wells and their related infrastructure – is divided among levels of government by location and ownership of the location. Offshore well sites (such as those in the Gulf of Mexico) or wells on federally owned land are regulated by the U.S. Department of the Interior. Well sites on privately owned or state-owned land are regulated by a state-level agency. Local government has no role in this policy area.

Economic development is not explicitly assigned to any level of government, but all three levels of government may make policies to help their jurisdictions grow economically. Though strategies and actions taken may differ, the goal is the same: the creation of jobs.

Roads and infrastructure are shared between all government levels, depending on the intended use of the road. Interstate highways are a federal responsibility, which are typically contracted out to the state level. State highways and state roads

Box 1: Overview of federal, state, and local government responsibilities related to fracking

Policy area Federal State Local

Environmental protection

Federal EPA rulemaking and oversight

State EPA rulemaking and enforcement

Local powers

Oil and gas administration

Federal land and offshore resources

Private and state land

None

Economic development

Potential role Potential role Potential role

Roads and infrastructure

Federal interstate highways

State roads and highways

Local roads and highways

Socioeconomic impacts

Federal entitlement programs and mandates

State entitlement programs and mandates

Potential role


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are a state responsibility, which is sometimes contracted out to local counties. County and local roads are a local government responsibility, which may receive funds from higher-level governments.

Socioeconomic impacts have been devolved to local government, which must fulfil federal and state mandates. Some programs are partially funded (e.g., Medicaid); others are entirely unfunded (e.g., Americans with Disabilities Act). Through home rule, local governments do have discretion on the degree to which they address additional health, environmental, housing, safety, and other service needs. Local governments may also apply for grants and matching funds from federal and state governments to achieve social goals that are not explicitly mandated (e.g., social housing).

2.4 Costs related to the bust that follows the boomThe bust can cause more problems than the boom. The costs of the bust are the result of “over-entry and over-capitalization in boom-specific capital by local business proprietors who inaccurately anticipated that conditions experienced at the peak of the boom would persist for a longer time period” (Jacobsen and Parker 2016: 1113). Local governments may make the same mistake: debt-financed expansion during the boom may result in fiscal distress when such investments are no longer necessary or the revenues to pay for them have dried up.

In addition, municipal governments may face even higher social service costs during the bust as the local community struggles with property foreclosures, higher unemployment, falling wages, and out-migration. The boom-bust cycle also tends to be associated with social problems such as increased crime, increased drug and alcohol abuse, and homelessness (Shandro et al. 2011). Shrinking economies may get stuck in hysteresis, a self-reinforcing cycle of decline that makes it even more difficult to rebound (Martin 2012). Jacobsen and Parker (2016) studied resource boom-bust communities in the 1970s and 1980s and found that more than two decades later their local economies still had not recovered.

Former extraction sites are often abandoned, leaving behind a legacy of environmental degradation (e.g., chemical contaminants in the soil) and lingering issues that were not addressed during the boom (e.g., wastewater in temporary holding facilities). Wastewater wells – if maintenance is neglected – may cause further contamination. Attempts by municipal governments to address these issues may cause further fiscal distress, so that ecological issues continue to go unresolved and close potential future pathways for economic growth.

2.5 Costs borne by local governments for non-local fracking sites The municipality that collects revenue from the industry may not be the same as the ones that bear the costs. Shale basins are big. The largest by land area, the Marcellus Shale basin, stretches over 170,000 square miles (about 440,000 sq. km) in five

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states. The most productive shale basin, the Permian Basin in west Texas, stretches over 75,000 square miles (almost 200,000 sq. km). Others vary in size, but these geological formations almost always lie underneath hundreds, if not thousands, of independent municipalities; each attempting to manage the externalities of the shale boom on its own, subject to differing state laws and municipal bylaws.

Moreover, the geography of drilling is not evenly distributed within these shale basins; rather, there are concentrations – called “sweet spots” – of drilling in some areas and few or none in others. This is due to differences in topography, underlying geology, and the legal frameworks of the places in which they operate. “Sweet spots” can change location over time as the workers move between drilling sites in response to labour needs. These changes cause localized booms and busts (even while the industry in the larger shale basin continues to grow overall), resulting in a spatial differentiation between drilling locations and the sites of externalities.

Where workers choose to reside – meaning which municipality is responsible for providing social services – may be different from where the well sites are located. Sometimes workers live in temporary housing units (such as trailers) close to their current job site, while at other times they may choose to live in a central location (e.g., work camps) within driving distance of several work sites. It is common for families of economic migrant workers to move to metropolitan areas with better access to services, better infrastructure, and more job opportunities instead of permanently relocating to isolated communities (Haslam-McKenzie 2011; Storey 2010).

Lastly, some local governments may see an increase in business caused by upstream and downstream supply linkages, even if they are not close to fracking sites. Other municipalities may sustain damage to their roads as heavy trucks drive through them to reach drilling locations. Some local governments end up as fiscal “winners” while other, neighbouring municipalities are fiscal “losers,” bearing the burdens without compensation in the form of greater tax revenue or jobs for their communities. With such disparities in costs and benefits, local governments may be reluctant to work with their neighbours to solve the spatial fiscal issues caused by this industry.

3. What are the local revenue implications of fracking?

3.1 Property taxes Although local governments do have other revenue streams, such as sales taxes, most are heavily dependent upon property taxes (see Box 2). As property taxes do not automatically grow with the growth of the local economy, raising the total revenue from this source requires a decision by local councils, which tends to be unpopular in most rural communities.


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Fracking may change the distribution of taxation based on the changes in assessed values. Local Governments may add new property tax classifications or revisit rates for resource extraction or heavy industry to target the fracking industry. But since the property tax is a blunt instrument, such policies may also raise rates on pre-existing businesses within these sectors (e.g., coal mining, food manufacturing), and may be strongly opposed by representatives of these industries. In some cases, farmers, after a fracking well was built on their land, have received large property tax bills as their parcels had been reclassified from agricultural land, which has a very low tax rate, to industrial land, which has much higher tax rate (Bamberger and Oswald 2015). Some states (including Pennsylvania, North Dakota, and West Virginia) explicitly disallow local assessment and property taxation of mineral property wealth or land owned by extractive industries.

Income tax: The federal government collects progressive income taxes from all citizens, though many are exempted through deductions. Forty-three out of 50 states have progressive income taxation, with the top marginal rate ranging from as low as 3.07 percent in Pennsylvania to as high as 13.3 percent in California. Only select cities (such as New York City) have permission to collect income taxes on their residents, as granted by their state constitutions.

Royalties: Mineral rights in the United States are held by private landholders – a system known as “freehold rights.” In the case of government-owned land, governments collect the royalties. The federal government, through the U.S. Department of the Interior, collects mineral royalties on offshore sites and federal lands; state governments collect royalties on their state lands; and city and county governments collect mineral royalties on their lands.

Box 2: Overview of federal, state, and local revenue streams related to fracking

Revenue stream Federal State Local

Income tax All citizens Select states Select cities

RoyaltiesOffshore and federal lands

State public lands Local public lands

Severance tax Select states

Carbon taxation (or equivalent)

Select states Select cities

Impact fees Select cities

Sales tax Select states Select cities

Property tax All cities

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Severance tax: Thirty-three state governments have some form of severance taxes, a tax on the output of mineral resources owned by private entities. The typical range of this taxation is 2 to 7 percent but varies considerably by state. The average effective tax rate is 4.4 percent (Weber, Wang, and Chomas 2016).

Carbon taxation: The United States is the only industrialized country that does not tax greenhouse gases, directly or indirectly, but that may change in the future. Byrne and Zyla (2016) suggest that climate exactions – charges to carbon polluters to offset damage by climate change – may be a growing source of future revenue for all levels of government. For the time being, some U.S. states and cities participate in cap-and-trade schemes (such as the Regional Greenhouse Gas Initiative in California) from which they may derive revenue. Some cities (including San Francisco and Boulder) have passed carbon taxes on utilities, while other municipalities (such as New York) have sued oil and gas companies for carbon exactions.

Impact fees: Some states allow municipalities to charge impact fees to offset negative externalities from industry.

Sales tax: Forty-five states collect sales tax. Thirty-eight states collect local sales tax on behalf of local municipalities. Average combined rates vary from 1.76 percent in Alaska to 9.45 percent in Tennessee. A couple of states (Alaska and Montana) allow local governments to collect local sales tax even without a statewide sales tax. As economic activity grows, so do sales tax revenues.

Property tax: All local governments collect revenue from property taxes. Some states (such as West Virginia) explicitly disallow property assessment and taxation of natural resource wealth, leaving property taxation to collect only on supporting infrastructure and secondary effects on adjacent properties.

In most states, parcel reassessment is the responsibility of county government. A county may take many years to reassess property values to take drilling activity into account – particularly if its administrative capacity is limited or it is constrained by state government guidelines regarding when and how reassessment must be carried out. Automatic reassessments based on formulas cannot account for individual parcels that (1) have mineral resources, (2) are the sites of fracking, or (3) have property values affected by the fracking industry. Such effects must be manually calculated.

There is a lag between drilling activity (and well production) and reassessment. Drilling may already be greatly diminished by the time the property is properly reassessed. The process is further complicated when property assessments are challenged by property owners who want their properties assessed at current market value instead of what they were worth at the height of the boom. Because of these complications, local residents and industries may be disproportionately burdened with an undue share of taxation as tax rates rise to pay for services and capital investments.

This is not the case everywhere. Some states and local governments are active in keeping their assessment rolls up to date. Furthermore, local governments may feel compelled to invest in greater assessment capacity to prevent this situation.


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Box 3: Does fracking increase or decrease adjacent property values?

The extent to which oil and gas drilling affects the property values of nearby land parcels is still unknown despite being an intensely studied research question for decades. On one hand, gas drilling is taking place in homeowners’ backyards, or nearby, and therefore detracts from livability through air, noise, and light pollution. Farmers worry that contamination, or even the fear of it, will drive down their ability to lease their land, to grow their crops, and ultimately diminish their long-term property values for a highly unequitable short-term gain (McGraw 2011). On the other hand, increased property valuations of large tracts may be expected due to potential income from drilling, and an influx of transient workers will probably increase the demand for and value of rental properties.

Earlier studies did not find any relationship between gas drilling and residential property values (Deloitte Haskin and Sells 1998; J. Lore and Associates 1999; Serecon Valuation and Agricultural Consulting 1997), but their objectivity is dubious as they were funded by the oil and gas industry. Weber, Burnett, and Xiarchos (2014) found property values in Texas are higher in zip codes with shale. Another study by Boxall, Chan, and McMillan (2005) demonstrated that the risk of groundwater contamination from natural gas extraction leads to “a large and significant reduction in house prices.”

A more recent study by Muehlenbachs, Spiller, and Timmins (2015), looking at house price changes within two kilometres of a well, found small positive impacts for homes on municipal water supplies, but a precipitous drop for those dependent on well water. Similarly, Boslett, Guilfoos, and Lang (2015) found that groundwater-dependent homes in New York State are associated with increases in value due to the possibility of shale gas development. Results may be specific to each market depending on a multitude of factors (e.g., state laws, geology, etc.), but the main consideration seems to be the source of water for the property. More research is needed in this area.

3.2 Impact fees To offset some of the externalities of the industry, a few local governments have turned to assessing impact fees, which are charges to mitigate the externalities caused by the industry, including road repair and environmental remediation. Rio Blanco County, Colorado, was the first to enact an impact fee in response to the fracking industry at $18,000 per well in 2009. It raised nearly $4 million within a year of being imposed (Williams 2009). Boulder County, Colorado, conducted

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a planning study to accurately measure the cost of externalities generated by the drilling industry, calculating and then recommending a flat impact fee of $36,800 per well in 2013 (Boulder County 2013).

Despite the promise of this fiscal tool to better align revenues and expenditures, examples of impact fees outside Colorado are difficult to find. In some states, this may be due to limits by state governments on the ability of local governments to charge such fees.

3.3 Severance taxes State governments have the power to charge severance taxes, a percentage sales tax based on the wellhead value of the mineral wealth extracted. Currently more than 35 states have some sort of severance tax (Tax Policy Center 2017). On average, but with considerable variation, severance taxes make up over a third of total taxation derived from fracking (Weber, Burnett, and Xiarchos 2014).

Since revenues from severance taxes are not explicitly tied to where the drilling took place nor are they linked with any state costs or state responsibilities, states can do as they wish with this additional revenue, including: (1) balance state budgets by putting the money into the general fund; (2) cut other forms of taxation, particularly income taxes; and (3) store the revenue in a statewide reserve fund such as a legacy fund (Weber, Burnett, and Xiarchos 2014). Alaska’s Permanent Fund pays out dividends to each citizen of the state – $2,052 as of 2015 (Carroll 2015). A few states (e.g., North Dakota, Montana) share a portion of severance tax revenue with local governments that bear fiscal costs related to fracking, but most do not.

Pennsylvania, which calls this tax an “impact fee,” automatically redistributes more than $200 million per year in severance tax proceeds to all 67 counties in the state, according to a formula that accounts for – but is not completely dependent upon – the amount of drilling activity in each county (Pennsylvania Public Utility Commission 2016). As most wells are concentrated in 7 of the 67 counties, while the benefits go throughout Pennsylvania, this dispersal of tax revenue may be good politics, but it defies the principle of “Pareto efficiency” – the principle that winners of a policy change should compensate the losers in proportion to their costs – by redistributing the natural resource wealth of a handful of local economies to the rest of the state.

As Figure 1 shows, Pennsylvania counties and municipal governments (nearly 70 percent) overwhelmingly spent their state government disbursements, intended to offset the externalities of fracking, on either current infrastructure or capital reserves for future infrastructure. A good portion of the remainder was spent on either public safety initiatives or social and judicial services. Very little was spent on environmental protection or clean water initiatives, which suggests that social and environmental issues continue to go unaddressed.


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4. What can local governments do about the mismatches between revenues and expenditures?

4.1 Municipal bans As licensing wells is a state responsibility and states collect a disproportionate share of the revenue compared with their responsibilities and costs, local governments end up bearing the fiscal and environmental burden of this new industry. Municipalities have little choice over whether fracking comes to their communities or not, and limited discretion over how to regulate the effects of fracking in their backyard. Unfortunately, “the most common [municipal] policy is no policy” as communities typically lack either the ability or a political consensus to act (Loh and Osland 2016).

When municipalities do take action, it is overwhelmingly in the form of municipal bans; more than 250 municipalities have passed some form of anti-fracking legislation to date (Americans Against Fracking 2017). Although these bans are almost always overturned or pre-empted by state governments when challenged, fracking companies may decide to forgo legal action and seek lucrative opportunities with more accommodating governments elsewhere.

Additionally, bans serve as a powerful political indicator of where communities stand on an issue, which may become a precursor to statewide bans. In New York State, following many local municipal bans, the state issued a moratorium until a full environmental assessment of the industry could be completed. The findings concluded, “While the Department of Environmental Protection is mindful of the potential economic opportunity that this represents for the state, hydraulic fracturing poses an unacceptable threat to the unfiltered water supply of nine million New Yorkers and cannot safely be permitted with the New York City watershed” (NYC.gov 2017). The State moved to ban the industry completely in 2014. A similar pattern of events occurred in Maryland in 2017.

4.2 Home rule When Pennsylvania’s Act 13 first passed in February 2012, the intent was to create a statewide system for allocating fracking permits and revenues. The industry would be able to streamline its requests for drilling permits by removing local legal barriers, in exchange for paying severance taxes.

Since December 2013, a series of rulings by the Pennsylvania State Supreme Court has returned some powers to local governments; the court ruled that sections of Act 13 were unconstitutional because they interfered with municipal zoning powers. Pennsylvania is now effectively the only state in which a local government can choose to ban fracking within its borders.6 The state has also created pathways

6 New York State has likewise empowered its municipalities to do so, but a statewide ban enacted in 2014 pre-empts that action.

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for municipalities (such as Murrysville and Plum) to find “middle ground” solutions that allow the industry to operate while mitigating its externalities. Requirements include (1) increasing setback ordinances, (2) mandating design to blend in with the city, (3) notifying residents of pending activity, (4) limiting the location of ancillary facilities through zoning, (5) mandating fire inspections, and (6) imposing light and noise controls.

At the same time, Pennsylvanian local governments are not allowed to tax oil and gas ancillary facilities (e.g., pipelines, machinery and equipment, compression stations, etc.), which could be a source of revenue. Classifying and taxing such property at higher rates has proved to be a key source of revenue for municipalities in Alberta, which can create their own tax classifications (Conger and Dahlby 2015).

At the bare minimum, states should devolve powers to municipal governments to tax the industry as they see fit (for example, through impact fees), because doing so would produce more local legitimacy for an industry that has been defined by social conflict. “As these [fracking] disputes play out, government leaders should remember the public is more likely to accept unconventional gas development if the public revenue stays local,” said Dr. Naveed Paydar, who found that public support for fracking rises substantially if residents know their local government is benefiting. “The public prefers to give more responsibility to local units of government because they are confident they’re the people who can best handle any problems resulting from development. And the public also has greater trust that the revenues will be spent by their municipal government in ways that benefit the local economy” (Indiana University–Bloomington Newsroom 2016).

The benefit of this approach is its simplicity. In many cases, implementation would require state governments only to roll back specific pre-emption provisions, allowing home rule to emerge. Moreover, devolving power to smaller units of government tends to be politically popular.

However, this approach does not address the mismatches of revenue generation relative to externalities over space and time, and local governments may still not be able to produce revenue when needed to address the spillover effects of externalities in neighbouring jurisdictions. State governments still have a role to play here to address these mismatches. Even then, an uneven regulatory landscape will still emerge as some local governments act and others do not.

4.3 Regional planning organizations Another way to deal with the mismatches is to shift powers from the local and state government to interstate regional planning organizations (RPOs), empowering them with the necessary fiscal and legal tools to engage in regionwide planning over an entire shale basin. These RPOs can partner with local governments to collectively bargain and enforce regulations on their behalf, adding significant administrative capacity while creating a relatively smooth regulatory landscape for drilling companies to work with. Beyond all those listed in the Pennsylvania example above,


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powers shifted from state government may include: (1) environmental regulation and enforcement, (2) negotiation of RUMAs and traffic controls, (3) severance tax revenues, and (4) infrastructure responsibilities.

The advantages to this approach address the mismatches mentioned in the introduction. First, local governments have increased administrative capacity, as RPO administrative staff have experience with the same companies in the same industry in other parts of the shale basin, reducing local governments’ information disadvantage in relation to fracking companies.

Second, RPOs with revenue streams directly address – or indirectly, by allocating money to municipalities – the negative externalities of the industry, thereby closing the gap between the level of government responsible for policy areas and the level of government that receives tax revenues. This also eliminates the peculiar incentive system that states currently have to approve wells at the expense of local environmental and fiscal health.

Finally, by pooling revenues from different parts of the shale basin at different times, the RPO can reallocate money to municipalities based on their current service and capital needs, acting as an insurance fund by spreading risk across time and space. This would prevent some municipalities from becoming fiscal “losers” while others benefit.

In many places, RPOs already exist. One example is the Appalachian Regional Commission (ARC), which spans 420 counties over 13 states, with the northern half geographically overlapping the Marcellus shale basin. ARC, founded as a “War on Poverty” program in 1965, has been responsible for allocating federal investment dollars to infrastructure and training programs in the region for more than 50 years. The organization has established political networks and buy-in from the general public. By extending its mission, responsibilities, and revenue streams, ARC could be an ideal entity to help local governments manage the fracking boom. The biggest downside to this approach is that implementation would be more difficult, politically and legally, as it takes extensive negotiation between a multitude of stakeholders who have entrenched interests.

ConclusionThe fracking industry has brought new challenges to local governments, who receive little compensation compared with the negative externalities caused by the industry. As policy currently stands, fracking is a bad fiscal deal for local governments in the United States. It is time to reflect on how revenues and responsibilities are split between state and local governments, and to remake this relationship with forthcoming governance challenges in mind. Failure to do so will result in (1) additional fiscal pressure on municipal governments, (2) new and unfulfilled service-level needs, (3) unaddressed capital damages, and (4) unaddressed environmental degradation. These impacts will have long-term detrimental effects on the social, economic, and environmental livability of the municipalities where fracking is taking place.

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Although literature on federal and state responses to the fracking industry is common, the dearth of research on how local governments are managing the fracking industry is troubling. This paper sets the stage for further work on the costs imposed by resource extraction on local public finance. Future research is needed to:

• document the differing responses of local governments to resource extraction (such as timber haulers) across the United States;

• measure longitudinal changes to local governments’ fiscal health caused by resource industries;

• assess the value of unaddressed environmental damage in local contexts;

• conduct comparative international research on municipal impacts as fracking spreads around the globe (including to places such as Canada and Argentina).

As natural resource extraction industries continue to evolve, so does the need for research into their local governance and public finance implications.

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IMFG Papers on Municipal Finance and Governance No. 38 • 2018

�e Public Finance Challenges of Fracking for Local Governments in the United States

Austin Zwick

ISBN 978-0-7727-0997-4 ISSN 1927-1921

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