A Longstanding Loophole on Federal Royalty Exemptions Has Been Allowed to Continue for Too Long
Today we filed comments on a proposal by the U.S. Office of Natural Resource Revenues to eliminate a long-standing exemption on royalties for coal taken from federal lands.
As the coal-royalty rule stands today, mining companies aren’t paying taxpayers their fair share on what, after all, is a taxpayer-owned natural resource. Through some clever accounting, the coal companies get around most of the standard federal 12.5 percent royalty on coal sales. Our research has shown that this accounting amounts to an industry subsidy worth billions of dollars annually.
Here’s how it works: A coal-mining company sells the coal it takes from federal leases to a subsidiary company for, say, $10 a ton. That subsidiary, in an up market, turns around and sells the coal into higher-priced foreign markets for $90 a ton. The company pays royals only on the “domestic” sale, that is, the sale that gets $10 per ton.
Both state and federal taxpayers lose out on this deal because coal-lease royalties are split evenly between the states and the federal government. The states that are most damaged by this arrangement are Montana and Wyoming, home to the Powder River Basin, which is where the vast majority of U.S. coal reserves are.
And while the royalty exemption not only provides a de facto subsidy to the coal industry, it benefits several foreign countries that are in economic and political competition with the U.S. by providing those companies with U.S. taxpayer-subsidized coal. It’s bad public policy that’s not in our best national interest.
In the formal comments we filed today we note that the reforms proposed by the Office of Natural Resource Revenues (ONRR) get it right in three ways:
- First, by requiring that royalty revenues are based on the first “arm’s-length” transaction, the $90-dollar-per-ton sale (minus deductions) in the example above rather than the $10 sale.
- Second, by limiting transportation-cost deductions to a reasonableness standard.
- Third, by allowing the agency to substitute its own royalty-accounting methodology if it is not satisfied with a coal company’s methodology.
HOWEVER, THE ONRR REFORMS DON’T GO AS FAR AS THEY SHOULD AND COULD ACTUALLY CREATE UNINTENDED CONSEQUENCES, further subsidizing coal-mining companies at taxpayer expense. Here are three holes in the proposed rules, all of which can be easily repaired:
- As written, the proposed regulations appear to reduce royalty payments to zero whenever coal prices are low (as they are now). If this glitch is not corrected, federal and state governments will actually lose revenue, and under no circumstance should these regulations result in per-ton revenue collections for the federal and state governments that are less than currently received.
- As written, the proposed rules do not give sufficient guidance to ONRR on expense deductions. Such deductions should not be allowed on speculative export transaction transportation costs. And no deductions should be allowed for liquidated damages, for instance, or for take-or-pay contract penalties.
- As written, the rules don’t include a mechanism for independent and public overview of the program. Such a mechanism is crucial to making sure that the proposed changes work as intended. The Government Accountability Office and the Department of Interior Inspector General have both commented on the lack of regular oversight of the program. These new regulations are the result of oversight activity that started in 2012. Until then, no audit activity had occurred for 30 years!
We’ll elaborate further on our comments over the next few days with three follow-up commentaries published in this space that will focus on the following:
- More about those unintended consequences of the proposed new rules, and how the rules can (and should) be tightened before they’re implemented.
- Detail on how the coal industry has changed radically in recent years, and a debunking of the anti-reform assertions put forth by the National Mining Association.
- Notes on why it’s important to include in the new rules an audit-and-oversight mechanism to keep the federal coal-leasing program honest.
We don’t want to lose the forest for the trees, of course, and our overriding message is this: The federal government should close this coal-industry subsidy now—and close it all the way.
Tom Sanzillo is IEEFA’s director of finance.