The Federal Royalty and Tax Treatment of the Hardrock Mineral Industry: An Economic Analysis

The Federal Royalty and Tax Treatment of the
Hardrock Mineral Industry: An Economic Analysis
Updated June 13, 2008
Salvatore Lazzari
Specialist in Energy and Environmental Economics
Resources, Science, and Industry Division

The Federal Royalty and Tax Treatment of the
Hardrock Mineral Industry: An Economic Analysis
Under current law, the hardrock mineral industry pays no royalty to the federal
government for the privilege of extracting resources from federal lands. This differs
from the federal policy toward the coal and oil/gas industries, the policy of State
governments, and the leasing arrangements in the private sector, which often require
bonus bids and an ad-valorem royalty on the value of the resulting output. Hardrock
mining on acquired federal lands pays a 5% royalty.
The current federal policy toward hardrock minerals is inconsistent with the
fundamental market principle that a royalty is a factor payment, part of the rent paid,
or the return, to land as both a marketable capital asset and input to production. In
general, the free development of federal mining land will result in more public land
developed and more minerals produced than is economically efficient. Another
implication is that any economic rents, i.e., excess profits to a resource owner above
the level required to produce or supply the resource in the long run, would accrue to
private rather than public beneficiaries. The free development regime for hardrock
minerals on federal lands was created to stimulate economic development of the west
and has more recently been sustained to protect the viability of the United States
hardrock mineral industry and to prevent negative economic impacts on western
communities built around that industry. Introducing a royalty payment system might
have an adverse economic effect on hardrock mineral producers but it would also
tend to increase output in the rest of the economy and promote a more efficient use
of national resources. The hardrock mining industry generally has, over the last four
years, been booming, and any adverse industry effects would tend to be mitigated.
The appropriate royalty system, according to economic principles, is the ad-
valorem royalty based on the market value of the mineral upon extraction, adjusted
for any externality-related taxes. Using “gross income for depletion purposes” is
conceptually the same as market value, although it has practical advantages since that
is the basis for a producer’s computation of its percentage depletion allowance for tax
purposes. Using net smelter return — the basis for most private royalty contracts —
is conceptually the same as gross income, although there may be differences due to
deductions for costs, and would require a new administrative apparatus. Using the
producer’s net profits as the basis would render the royalty an income tax, which
would be inconsistent with mainstream economic principles that a royalty is part of
a factor payment, and would likely reduce, and at times totally eliminate, royalty
payments. The U.S. hardrock minerals industry pays income taxes, including the
alternative minimum tax, and, in addition, is assessed a variety of claims and patent
fees. In addition, hardrock mining firms qualify for some special tax benefits or
subsidies: expensing (i.e., a current deduction) of exploration and development costs;
the percentage depletion allowance, at rates ranging from 14% to 22% of gross
income; and a deduction for mine closing and reclamation costs. The special mining
tax breaks are sufficient to lower the effective marginal tax rate slightly below that
for other industries. These tax rates, however, are currently much higher than the
historical rates, which were either close to zero or negative.

History of the General Mining Law of 1872.............................4
Conveyance and Patenting of Federal Hardrock Mineral Lands..........5
Royalties on Leasable Minerals...................................5
The Economics of Federal Royalties on Public Domain Lands...............7
What is a Royalty?.............................................7
Economic Implications of Royalty-Free Use of Federal Land............9
What Would Be the Structure of an Economically Efficient (and Fair)
Royalty? .................................................9
Alternative Bases for Royalty Payments...........................10
Percentage Depletion’s “Gross Income” Measure of Mineral Value
Under the Tax Laws...................................11
Definition of Gross Income from Mining..................12
Net Smelter Return (NSR) Royalty...........................15
Net Profit Royalty........................................17
The Fixed Royalty........................................18
Comparison With Oil, Gas, Coal, and Geothermal Royalties.......18
What Would Be the Appropriate Royalty Rate?.....................19
External Benefits.........................................20
External Costs...........................................21
Absence of Competition...................................22
Should Royalties Rates Differ by Mineral Type?....................23
Effects on the Mining Industry..................................23
Other Economic Implications of Imposing a Royalty.................25
Revenue Effects..............................................25
Federal Tax Treatment of the Hardrock Mining Industry..................26
Three Special Tax Preferences or Subsidies........................27
Expensing of Mine Exploration and Development Costs..........28
The Percentage Depletion Allowance.........................28
The Interaction Between the Percentage Depletion
Allowance and the Royalty.........................30
Deduction for Mine Closing and Reclamation Costs.............31
Revenue Losses from Special Tax Preferences......................32
Alternative Minimum Tax......................................32
Effective Tax Rates...........................................33
Fees Paid by the Hardrock Mining Industry........................33
Appendix: Description of H.R. 2262..................................34
List of Tables
Table 1. Royalty Rates Paid by Mining Companies on Minerals from
Federal Lands.................................................7
Table 2. Illustration of Ad-Valorem Royalty Calculations Based on Recent
Minerals Prices...............................................24

H.R. 2262...................................................26
Table 4. Percentage Depletion Rates for Minerals.......................30

The Federal Royalty and Tax Treatment of
the Hardrock Mineral Industry: An Economic
Since 1872, hardrock mining on federal lands has been governed by the General
Mining Law, which allows virtually free access to open public domain lands for
mineral prospecting, staking claims, exploration and development, and extraction1
without payment of a royalty. And until annual moratoria were imposed by Congress
starting in 1994, claimants on hardrock mineral lands could take title to both the
mineral rights and the land, after paying to the U.S. Department of Interior (DOI) the
required fee or either $2.50 or $5.00 per acre, and after demonstrating diligent
development of the mining claim.
Proposals to reform the Mining Law have been made almost from the time it
was signed by President Grant, and throughout its 135 year history. Many Presidents
— Presidents Roosevelt, Nixon, Carter, and Clinton — have endeavored to reform
the law, as have many in Congress. One of the contentious issues has been that the
law makes no provision for the payment of a royalty on the production of the
hardrock minerals from federal lands. The royalty-free treatment of the hardrock
mineral industry is unlike mining arrangements (leases) on private and state lands,
mining of the leasable energy minerals (coal, oil, and gas) on federal lands, and even
unlike hardrock minerals on acquired (as contrasted with public) federal lands, all
of which provide for a royalty payment to the landowner.2
In recent years, the Congress has repeatedly considered, but not passed, reform
of the Mining Law, including, in part, to require the payment of royalties. In 1990,
committees held several hearings on proposed Mining Law reform, e.g., on S. 1126,st
(101 Congress) which among other things would have imposed an 8% ad-valorem
royalty. In 1993, President Clinton’s comprehensive economic proposal, part of the3
State of the Union Address, included claims fees and a 12.5% ad-valorem royalty.
Several bills were introduced in the 103rd Congress to impose a royalty (H.R. 322,4
H.R. 1708, S. 257, S. 375, and S. 775) and hearings were held in 1993. S. 775

1 19 Stat. 91, 30 U.S.C. §§ 21-54.
2 The term “public domain lands” refers to the original endowment of territory (also called
the general territory) comprising the United States. Acquired lands are those lands that have
been purchased by, or given to, the federal government, including lands obtained through
condemnation. The sum of public domain lands and acquired lands comprises federal lands.
3 Executive Office of the President. A Vision for Change for America. House Document 103-

49, 103rd Cong, 1st Sess. February 17, 1993. p. 78.

4 In 1993, the Senate was considering S. 775, which proposed a 2% net profits royalty, and

passed the Senate in May 1993 and was incorporated into H.R. 322 which was
approved by the House in November 1993. H.R. 322 went to conference in 1994 but
was not approved reportedly because of opposition from Western lawmakers, mainly
over the royalty issue.5 In 1995, there was an unsuccessful attempt to incorporate a
royalty as part of the FY1996 budget. In its FY1998 budget proposal, and again in
FY2001, the Clinton Administration proposed a 5% “net smelter” royalty but, like
previous efforts, this failed.6
At this writing, the major reform bill in the House — there is currently no
Senate bill — is H.R. 2262, which, among other things, would impose an 8% ad-
valorem royalty based on the value of the minerals as defined under the gross income
definition of the income tax code (essentially the mining firm’s sales revenue) and
use the proceeds for the cleanup of abandoned sites. The 8% royalty would apply to
new production. Production from existing mining operations would pay a 4% royalty.
On October 2, 2007, the Subcommittee on Energy and Minerals of the House Natural
Resources Committee held a hearing on this bill. A substitute bill was marked up and
approved by the full committee (the House Natural Resources Committee) on
October 23.7 The House approved this committee bill, with minor amendments, on
November 1 by a vote of 244 to 166. A summary of the provisions of the House-
approved version of H.R. 2262 is described in the Appendix to this report. The
comparable bill in the Senate is S. 2750, which also proposes an 8% royalty on new
production and a 4% royalty on production from existing leases.8
This report analyzes the economic issues underlying proposals to impose a
royalty on hardrock (locatable) minerals on public domain lands.9 It also discusses
the federal tax treatment of the hardrock mineral industry. In particular, the report
addresses the following questions:

4 (...continued)
the House was considering H.R. 322 (Representative Rahall), which proposed an 8% net
smelter return royalty.
5 The two major bills were S. 775 and H.R. 322. See CRS Report 93-632, Reforming the
General Mining Law of 1872: A Comparison of S. 775, and H.R. 322, by Marc Humphries.
6 A royalty based on “net smelter return” (either mineral price or profits) attempts to
determine or assess the royalty payments — the amounts paid to the landowner — on the
value of the mineral after it is separated or smelted from its ores. The term is somewhat
misleading and will be discussed in detail in the text.
7 The original bill provided for only an 8% royalty; the bill approved by the full committee
provides for the two-tiered royalty: 8% on future mining operations and 4% to existing
mining operations.
8 See CRS Report RL33792, Federal Lands Managed by the Bureau of Land Management
(BLM) and the Forest Service (FS): Issues for the 110th Congress. May 9, 2008, by Ross W.
Gorte, Carol Hardy Vincent, and Marc Humphries and Kristina Alexander.
9 “Locatable minerals” refers to the hardrock minerals subject to the Mining Law of 1872
i.e., “those for which the rights are initiated by the location, recordation, and maintenance
of a mining claim.” “Leasable minerals” refers to coal, oil/gas, and other energy, chemical,
or soft minerals.

!What exactly is a royalty, and how does a royalty differ from other
rental payments or, for that matter, taxes?
!Were a royalty imposed, what would be the best way to structure
such a royalty? Should the royalty be an ad-valorem type (i.e., one
based on the value or price of the mineral), a fixed unit based royalty
(i.e., one based only on mineral output), or a net profits royalty (i.e.,
one based on the net income or profit of the mining company)?
!If there is to be an ad-valorem royalty based on price or value, at
what stage in the mineral producing process should value (or price)
be measured? Should it be based on gross income (value of the
mineral at the mine) or net smelter return (the value at the smelter
less certain deductions)? When does a mining company produce a
saleable or marketable product whose value can be measured? What
deductions, if any, should be allowed from that price?
!What should the royalty rate be? And how does Congress decide
what a fair royalty rate is?
!How does one balance the various considerations, such as efficiency
and administrative considerations in deciding whether to impose a
!What would be the economic effects of introducing a system of
royalty payments and other rental payments where one did not exist?
Would a royalty harm the domestic and international
competitiveness of the U.S. hardrock mining industry?
!Finally, what taxes and fees does the hardrock mineral industry pay,
and do they have any bearing on the question of whether to impose,
or the magnitude of, a royalty?
The first section of this report provides a brief history of the 1872 Mining Law,
including the mineral leasing system and royalty payment requirements for the energy
minerals. The second section discusses the economic rationale for the payment of
royalties on hardrock minerals. It (1) addresses the question of the appropriate
economic basis for payment of royalties to the federal government as landowner, (2)
compares royalties based on market value with alternative criteria such as royalties
based on gross income from depletion and net smelter return, (3) examines the
question of an appropriate royalty rate, and (4) discusses some of the likely economic
effects of royalty-free provision of public lands, as well as the effects of introducing
a royalty. The fifth and final section examines the federal tax provisions, including
the three tax subsidies that affect the hardrock minerals industry, as well as claims
and patent fees that the industry pays.
Note that the question of payment of royalties from hardrock mineral production
on public lands is part of a much broader debate relating to reform of the Mining Law

of 1872, which encompasses many other issues — such as whether public domain
lands should be patented — which are not addressed in this report.10
History of the General Mining Law of 1872
The General Mining Law of 1872 (17 Stat. 91) can be traced to 16th Century
English and Spanish property and mineral rights laws and customs, which, as
practiced in Colonial America, formed the basis for the granting of the rights to lands11
including those containing minerals, including a share of the minerals (a royalty).
One of the earliest statutes was the “Royal Code of 1783.” This Spanish law became
the basis for acquiring mineral rights in Spanish colonies in the Americas, and was
used to settle claims disputes. Also, the land charters issued by England to the
original thirteen colonies provided generally that 1/5th of the minerals on chartered
lands were reserved for the crown.12 Independence for the American colonies meant
that issues of land and mineral ownership between the national government, the
states, localities, and even private individuals had to be decided. Several ordinances
were enacted — the Ordinance of 1785, the Land Act of 1796, and the Preemption
Act of 1841 — but these did not address the question of mineral royalties
The “California gold rush” of 1849 and the silver strike in Nevada of 1860
caused a significant westward population migration for the purposes of prospecting
and claiming public domain lands. During this pre-Mining Law period, the issue of
land ownership and easy and free access to federal lands was very controversial and
fiercely debated. The Congress had approved several temporary leasing or land sales
acts for gold, silver, lead, and iron — which were administered by the War
Department — but prospectors disregarded them, trespassed onto federal lands, laid
their claims anyway, and paid no royalty to the federal government. Also after the
Civil War, congressional policy became more openly geared to encouraging
westward migration, and the economic development of the West.13

10 For example, under the patenting system, fee title to mineral lands was conveyed to the
mineral companies or claimants at a price of either $2.50/acre or $5.00/acre, depending on
the type of claim. In response to concerns about this patenting system, since 1994 the
Congress has imposed annual moratoria on patenting via the annual Department of Interior
appropriation bills.
11 A mineral is a chemical element or compound that occurs naturally in the Earth’s crust.
Deposits of minerals that are mined are called ores.
12 Ely, Northcutt. “Mineral Titles and Concessions.” The American Institute of Mining,
Metallurgical, and Petroleum Engineers, Inc. Economics of the Mineral Industries. Edward
R. Robie, Editor. (The Maple Press, 1964.) pp . 81-130.
13 There were also various homestead acts and land grants (such as for railroads) and other
acts which further encouraged westward migration and economic development of the west.

These practices and policies became embodied in two statutes that became the
precursors to the General Mining Law of 1872: the Lode Law of 1866,14 which
provided free and open access to federal lands with lode deposits for prospecting,
claiming, and patenting, and the Placer Act of 1870,15 which applied the same
provisions to placer deposits.16
Conveyance and Patenting of Federal Hardrock Mineral
The General Mining Law of 1872, approved by President Ulysses S. Grant on
May 10, 1872, was the consolidation of amended versions of both the 1866 Lode
Law and the 1870 Placer Act. Under this law, as amended, public lands with
hardrock minerals (metals such as gold, silver, copper, lead, etc., and non-metals
such as uranium, barite, and fluorspar) are conveyed, rather than leased for a rent and
royalty to the federal government as landowner. More specifically, the law permits
citizens and businesses to prospect for hardrock minerals on those public lands not
withdrawn from mining, and to file a claim, which gives them the right to explore,
develop, mine, and sell hardrock minerals from the claim (such as gold, silver,
platinum, copper, lead, tin, etc.) without paying a royalty.17 Further, up until 1994,
a claim holder could obtain title — called a patent — to the land and mineral rights
upon demonstrating the discovery of economically recoverable minerals. Patenting
basically means that the title to the land and mineral rights are conveyed to the
claimant — the mineral lands become private property.18 The claim holder may also
claim and patent nonmineral, noncontiguous lands to mill and process the ores. As
noted, the General Mining Law was enacted to promote westward migration and the
economic development of the West, and the land and mining rushes that followed
further accelerated the great Westward settlement and expansion.19
Royalties on Leasable Minerals
Originally, the Mining Law applied to all minerals. But over time all but the
hardrock or “locatable” minerals were removed from the law’s purview.20 Beginning

14 14 Stat. 86, Revised Statute § 2318, 30 U.S.C. § 21.
15 16 Stat. 217, Revised Statue § 2329, 30 U.S.C. 35.
16 A lode deposit is a vein of valuable mineral that resides in hardrock (or quartz); a placer
deposit is an alluvial deposit of a valuable mineral.
17 Also, for some minerals the federal government earlier sold the lands outright instead of
leasing them, and the question of royalties did not arise.
18 In 1994, in response to concern about the “giveaway” of federal lands, the Congress began
to impose annual moratoria, via the Department of Interior Appropriation bills, on the
patenting of public mineral lands.
19 Leshy, John D. Testimony at the Hearing on HR. 2262, the Hardrock Mining and
Reclamation Act of 2007. Subcommittee on Energy and Mineral Resources, House
Committee on Natural Resources. July 26, 2007.
20 For example, under the Coal Lands Act of 1873, a separate claim/patent system was

in 1920, for example, the Mineral Leasing Act of 1920 introduced a leasing system
for coal, oil, and gas, and certain other minerals.21 Each lease was negotiated on a
case-by-case basis, and provided for both an annual rental per acre and a fixed royalty
of so many cents per ton.22 Where there is competition, the minerals are alienated
through a bonus bidding process. Beginning in 1955, the Mineral Materials Act of
1947 instituted a leasing system for the non-hardrock and non-energy minerals — the
common and less valuable minerals such as sand and gravel.
For coal, this system of leasing continued until the early 1970s, when the Arab
oil embargo and shortages of petroleum reserves focused attention on the vast coal
deposits in the western states. Thus, in 1976 the Federal Coal Leasing Amendments
Act (P.L. 94-377) was enacted, which among other changes, replaced the fixed
royalty with an ad-valorem royalty of 12.5% for surface mines and 8% for
underground mines.23 This kind of royalty payment system is now also used by the
federal government in leasing oil and gas properties, which typically are assessed ad-
valorem royalties ranging from between 12.5% and 16.67%.24 As will be discussed
below, under an ad-valorem royalty — the most prevalent type of royalty system —
the royalty payments are based on the value of the mineral. State governments also
typically charge ad-valorem royalties for the extraction of locatable minerals,
although some tend to use the fixed royalties. Finally, hardrock mining on acquired
federal lands (as opposed to public domain lands) is required to pay a royalty of 5%.
The royalty rates currently in effect on various types of minerals, both leasable and
locatable, from federal lands are shown in Table 1.
Thus, despite the evolution of the system for paying royalties on coal, oil, and
gas, and certain other minerals, the location system for the hardrock minerals industry
— involving no royalty payments or any other type of rental payment — has
remained essentially unchanged since 1872.25

20 (...continued)
created for federal coal lands. The law allowed the purchase of public coal land for ten to
twenty dollars per acre, depending upon its distance from a railroad, and established
guidelines for staking claims for coal mines on federal lands. See U.S. Department of the
Interior. Federal Market Value Policy for Federal Coal Leasing. Report of the Linowes
Commission. February 1984.
21 Coal royalties were not an issue prior to 1920 because with the exception of coal-bearing
lands in Alaska, federal coal-bearing lands were sold rather than leased. The Alaska Coal
Leasing Act provided for a minimum royalty of 2¢/ton beginning in 1914.
22 For a discussion of the history and economics of coal leasing policy see CRS Report 83-

169, A History and Economic Analysis of Federal Coal Leasing Policy, by Duane A.

Thompson and Dennis Zimmerman.
23 According to a 1974 coal leasing study by the Council on Economic Priorities, the DOI
had begun to apply ad-valorem royalties somewhat before 1976. See Council on Economic
Priorities Leased and Lost: A Study of Public and Indian Coal Leasing in the West. (New
York, New York, 1974. p. 27.
24 The 12.5% royalty has been standard practice in the oil and gas business.
25 There are exceptions to this general rule, for lands that are not subject to the Mining Act

The Economics of Federal Royalties on Public
Domain Lands
What is a Royalty?
Part of the problem in deciding whether to assess a royalty on hardrock minerals
from federal lands, and how to structure such a royalty, is confusion over just what
a royalty is and what it is not. Economics is very clear on this: A royalty is a factor
payment, part of the rent paid, or the return, to land as both a marketable capital asset
and input to production. It is a payment made by the renter of the land to the
landowner (whether private or public) in a voluntary exchange for the flow of
services provided by that land over time. As a factor payment, the royalty is
analogous to the wage rate, which is a payment for the services of labor, or the
interest rate, which is a payment for the services of capital.
Table 1. Royalty Rates Paid by Mining Companies on Minerals
from Federal Lands
Mineral Type or LocationRoyalty Rate
Hardrock Minerals on Acquired Federal5.00%
Coal from Underground Mines8.00%
Coal from Surface Mines12.00%
Onshore/Offshore Oil and Gasa12.50%
Deepwater Offshore Oil and Gas16.67%
Geothermal Leasesb10-15%
Electricity from Geothermal Leasesc1-2.5%
Source: U.S. Department of Interior. Minerals Management Service. Mineral Revenue Management.
September 2006; and U.S. Department of the Interior. Minerals Management Service. Mineral
Revenues 2000: Report on Receipts from Federal and American Indian Leases. p. 134.
a. Most federal oil and gas is leased at a 12.5% royalty rate both onshore and offshore; in addition to
the above royalties, oil, gas, and coal leases pay rents and a variety of fees.
b. Byproducts from geothermal reservoirs, such as sulfur or zinc, are assessed a royalty of 5%.
c. This is the royalty rate applicable from 2006-2015. The rate applicable after that is between 2% and
5%. The Secretary of the Interior has the discretion to set the actual rate between this range,
depending on several criteria, such as revenues.
Mineral producers, as business organizations, require land, as well as labor,
capital, energy, and other materials, in order to establish their enterprises and produce
goods and services — minerals that provide utility to consumers. And just as mineral
producers must pay a wage in exchange for the services of labor, or interest for the

25 (...continued)
of 1872, such as acquired lands. In these cases, which are not frequent, miners pay ad-
valorem rates typically ranging from 4% to 6%.

service of capital, they generally must pay landowners for the services of land that
contains a mineral deposit. The exception to this rule, of course, has been the case of
locatable minerals on public (or federal) lands in the United States, on which
royalties are not paid.
In the case of mineral lands, rents could be paid in various forms such as a
bonus bid, annual rentals, or a royalty, or in various combinations of these depending
on the type of mineral, and whether there is a lease or not, and the contractual
agreement between a developer of the resources and the landowner. For example,
under the Outer Continental Shelf Lands Act of 1953, as amended, the federal
government leases lands for oil and gas development in return for a bonus bid, annual
rents, and royalties.26 Lease sales are conducted through a competitive bidding
process, and leases are awarded to the highest bidder, who makes an up-front cash
payment called a bonus bid in order to secure the lease. Annual rents range from $5
to $9.50 per acre, with lease sizes ranging form 2,500 to nearly 6,000 acres, and
royalty rates are, as noted above, either 12.5% or 16.67%.
These mineral rents are an attempt to capture the returns to the land above and
beyond the returns paid to labor (wages), capital (interest), entrepreneurship (profits),
and other factors, and above any taxes that have to be paid to government. With
perfect knowledge and no risks, for example, the rents resulting from mineral lands
could be captured by the landowner as up-front payments — as the price of the
mineral rights, for example. However, mineral production, like all business, is risky;
it is difficult to know in advance of production precisely the quantity and quality of
the mineral. There are long lead times between exploration, discovery, and actual
production, and it is difficult to project what mineral prices will be upon production
and sale. These and other uncertainties make it risky for both the hardrock mineral
producer and landowner to predict up front what rents would be earned by mineral
lands, and therefore what the mineral producer should pay the landowner. In general,
the precise division between royalties or bonus bids and annual rentals depends
primarily upon how production risk is shared between landowner and mineral
producer. The royalty becomes a way of allowing for mineral land rents to be paid,
for the landowner to earn a return on the land, in a way that simultaneously
minimizes the risk of either overpayment or underpayment. As a land rental, then, an
ad-valorem royalty protects the mineral producer against excessive royalty payments
(overestimation of rents) and the government against underestimation of economic
Being a factor payment, then, a royalty is not a tax, which is a compulsory levy
on individuals and businesses to finance the cost of government for the common
welfare and not a return to a factor of production in exchange for specific services
provided. This is an important point, one that might be used, for example, to argue
against proposals to impose a royalty based on net profits, which would make the
royalty more of an income tax rather than a factor payment.27 The distinction between

26 CRS Report RS22567, Royalty Relief for U.S. Deepwater Oil and Gas Leases, by Marc
27 There are examples of profit sharing, instead of revenue sharing, such as in the movie

a tax and the rental payment also distinguishes between the federal government as a
sovereign entity with the power to tax, and as a landowner or proprietor with the right
to earn a return on that land for the public.
Economic Implications of Royalty-Free Use of Federal Land
Forgoing royalty and other payments through the location system in effect
means that the services of a factor of production are provided free of charge. In this
case the services of federal land are provided free to the producer by virtue of the fact
that no royalty is ever collected from its use. In economic terms, this is comparable
to the free provision of labor or capital equipment. Economic theory suggests that a
consequence of providing factor services for free that would otherwise have
economic value would be to distort the allocation of resources. This theory holds that
if a factor is provided to a firm without charge, too much of that factor would be
hired and the output of the firm would exceed the socially desirable amount.
Consequently, not enough of a more valuable good is provided.
From another perspective, the federal government is the steward of the public
lands which it holds as trustee of American public. The development of public
resources should only occur at a fair market value return to the nation, it is argued.
An implication of the location system on federal lands is that all economic surplus
that may be earned by the industry in the long run is retained by the industry rather
than allocated to society at large. These profits are excess or surplus returns to a
resource owner above the level required to produce or supply the resource, i.e., above
the normal rate of return. In theory, they accrue naturally to the owner of any natural
resource but are not necessary to secure the continued supply of the resource; only
a normal long-run return is necessary to ensure such a supply. This is an important
rationale for the payment of bonus bids and other rental payments. The theory
suggests that any pure economic surplus return from a natural resource should accrue
to society.
What Would Be the Structure of an Economically Efficient
(and Fair) Royalty?
In general, the economic concept of a royalty as a factor payment implies that
the payment should be based on the market value of the producer’s output, whether28
it be hardrock minerals, coal, or oil and gas. For hardrock minerals, however, as a

27 (...continued)
business. But these reflect the reality that the return to labor (wages) could be paid in
different forms.
28 In theory, the demand schedule for factors of production by a producer of an exhaustible
resource, such as hardrock minerals, is based on an amount somewhat less than the value
of the marginal product, a difference that reflects the sacrifice of future profit due to present
production. This causes the extractive firm to produce at an output level consistent with
minimum average cost rather than the point where price equals marginal costs. Some
economists believe the stock or reserves of hardrock minerals is so large relative to
production or supply that the present value of sacrificed future profit due to present

factor payment, the type of royalty that most closely is intended to capture the rents
from mineral lands whose future productivity cannot be precisely determined due to
risk — variability in output price, unknown quantity and quality of mineral, etc. —
is the ad-valorem royalty based on the value or price of the mining firm’s output.
Under such a royalty, payments are made in installments over the life of the mine,
rather than partially up front, and the economic rent is based on the amount of the
mineral produced, and the market value or price of the mineral at the mine.29 Lands
producing minerals of higher quality and value, gold for instance, pay a higher
royalty amount; those producing lower quality or value minerals, lead for example,
pay a lower amount.
It would be inconsistent with the concept of sharing and with the concept of a
factor payment in a competitive market for a royalty to be based on other than market
value minus the costs of obtaining it. For example, if instead of payments in kind
(deer or crops or precious metals) the landowner were to be paid in money, one
would expect him to receive the monetary equivalent of the value of the output.
Rational landowners would not settle for less than what the deer, crop, or metal is
worth because they could always have the deer, crop, or metals taken to market and
sold for at least market value. If they wanted less rent, then presumably that would
have been negotiated as a smaller share (instead of 1 deer out of 5, it would perhaps
be 1 out of 6). Likewise it would not be rational for the renter to pay to the landowner
a royalty based on more than market value.
Alternative Bases for Royalty Payments
Although the ad-valorem royalty appears to be economically the most efficient
type of royalty, the question becomes to what base specifically should the royalty rate
apply? The aggregate value of a commodity being the product of a price (value/unit)
and a total output, the questions are: At what point can the value of a mine’s output
first be determined? Further, since throughout the production stage value is added or
increased, at what stage does mining value end, and non-mining value begin?
Production of valuable mineral products from raw hardrock minerals (e.g.,
metals such as iron, copper, aluminum, gold, lead) generally involves various stages:
extraction or quarrying of the raw minerals (e. g., iron ore, bauxite, galena, and non-
metals such as barite, uranium, diatomite, fluorspar, clay, calcium carbonate, etc.,
that exist in the hard formations of the earth), delivery to a plant or mill in order to
prepare for the initial processing, beneficiating or concentrating to derive an ore
concentrate (generally the first valuable product), smelting or refining (i.e., additional
processing) of the ore concentrate in order to derive the marketable metal or mineral,

28 (...continued)
production is very small, so that the difference can be disregarded. Regardless of which
solution actually applies, it is the market price of the mineral product that governs the
demand for land and other factors of production. See Sweeney, James L. “The Economics
of Depletable Resources.” Review of Economic Studies. Vol.44, No. 136. February 1977.
pp. 125-141.
29 As is discussed below, it is not always easy to define what is “at the mine,” nor to
determine when value is first defined and created in the case of hardrock minerals.

and the actual marketing or selling of that metal or mineral.30 These production
stages are shown for the typical case or mineral in Figure 1.
Figure 1. The Various Production Phases for the Typical Hardrock

Within these production stages, from extraction to the first sale to
manufacturers, there may be various points at which there is created a valuable
output, depending on the type of mineral, and the structure of the industry — there
may be several different types of mineral products with value, and it is not always
clear what is mining output and what is non-mining output. Does the mine produce
the raw mineral ore, the ore concentrate, or the final metal or mineral sold to
wholesalers? Further, even if the output of the mine can be determined, there is the
problem of what is the value or price of that output. For example, copper is traded in
many forms that relate to different stages of processing: at the mine, copper may be
sold as ore, concentrate, or precipitate. This question is further complicated when the
firm or industry is vertically integrated. In such cases, there may not actually be a sale
throughout the mining-production-processing-marketing (sale) stage, and any price
or value would have to be constructed, i.e., estimated or derived, from values further
upstream when they are first determined or identified.
Percentage Depletion’s “Gross Income” Measure of Mineral Value
Under the Tax Laws. One measure of the value of mining output is gross income
from mining as defined under the income tax laws for purposes of determining the
percentage depletion allowance, one of several tax preferences or subsidies available
to a mining firm.31 This royalty base has been suggested many times in the current
and past royalty debates and is the base proposed in H.R. 2262. The main reason for
suggesting this royalty base is that not only is gross income under the tax depletion
rules consistent with the economic concept of an ad-valorem royalty, but the legal
and regulatory apparatus has been in place since 1932, the year that percentage
30 The mining portion of the total production involves extraction and milling. Mines extract
the raw mineral ore; and mills — which are usually near the mine and are considered part
of the mining operation — undertake the initial processing, mainly beneficiating to produce
a concentrated ore.
31 As discussed in more detail in the last section, the percentage depletion allowance is a
deduction for part of the mining firm’s capital costs of doing business.

depletion first became available to the hardrock mining industry.32 This would tend
to reduce the costs of industry compliance and government administration of the
royalty system.
Before discussing this royalty base in more detail, it should be explained that the
term “gross income” as used for purposes of percentage depletion is somewhat
confusing. There are two reasons for this. While the term is intended to measure only
sales revenue from mining operations, income in the context of a business generally
refers to profits and not sales. Second, the term “gross” may be misleading because
it may suggest a larger percentage depletion deduction, and therefore a larger royalty
payment than a “net” royalty. But, in fact, whether a gross royalty base is smaller or
bigger than a net royalty base depends on the point in the production stage the price
is measured, and the deductions allowed. Because value is added as mining
production moves from the extraction or quarrying state to the smeltering stage —
the market price, if one existed, would increase throughout these stages — a net price
(such as net smelter return) further downstream, would generally be greater than a
gross price further upstream.
Definition of Gross Income from Mining. Under Internal Revenue Code
(IRC) §613, mining companies are allowed a depletion deduction, at varying
percentages, based on the gross income from mining. Under IRC §613(c)(1) and
(c)(2), the term gross income from mining means sales revenue from the extraction
of the ores or minerals from the ground and any treatment processes necessary or
incidental to the mining process, specific treatment processes and also generally the
costs of transporting the ores or minerals from the point of extraction to the plant or
mill in which the treatment processes are applied. More specifically,
!The term “mining” includes not merely the extraction of the ores or
minerals from the ground but also the treatment processes
considered as mining described in paragraph (4) (and the treatment
processes necessary or incidental thereto), and so much of the
transportation of ores or minerals (whether or not common carrier)
from the point of extraction from the ground to the plant or mills in
which such treatment processes are applied thereto as is not in
excess of 50 miles unless the Secretary [of the Treasury] finds that
the physical and other requirements are such that the ore or mineral
must be transported a greater distance to such plants or mills.
Subparagraph (4) of IRC §613(c) defines, for the different categories of
minerals, the treatment processes that when applied by the mine owner or operator
are considered as mining (meaning that the costs of such processes are included in
the value or price for purposes of percentage depletion):

32 The idea of using the current tax definition of gross income as the basis for the royalty on
locatable minerals appears to have originated with Dr. Sandra L. Blackstone, a mineral
lawyer and economist. See Blackstone, Sandra L. Royalties for Locatable Minerals on
Federal Lands: A Proposed Approach. Statement by Dr. Sandra L. Blackstone, before the
Mineral Resources Development and Production Subcommittee of the Senate Committee
on Energy and Natural Resources. September 13, 1990.

!“In the case of iron ore, bauxite, ball and sagger clay, rock asphalt,
and ores or minerals which are customarily sold in the form of a
crude mineral product — sorting, concentrating, sintering, and
substantially equivalent processes to bring to shipping grade and
form, and loading for shipment [613(c)(4)(C)];”
!“In the case of lead, zinc, copper, gold, silver, uranium, or fluorspar
ores, potash, and ores or minerals which are not customarily sold in
the form of the crude mineral product — crushing, grinding, and
beneficiation by concentration (gravity, flotation, amalgamation,
electrostatic, or magnetic), cyanidation, leaching, crystallization,
precipitation (but not including electrolytic deposition, roasting,
thermal or electric smelting, or refining), or by substantially
equivalent processes or combination of processes used in the
separation or extraction of the product or products from the ore or
the mineral or minerals from other material from the mine or other
natural deposit [IRC §613(c)(4)(D)];”
!In addition, “and so much of the transportation of ores or minerals
(whether or not by common carrier) from the point of extraction
from the ground to the plants or mills in which such treatment
processes are applied thereto as is not in excess of 50 miles unless
the Secretary finds that the physical and other requirements are such
that the ore or mineral must be transported a greater distance to such
plants or mills [IRC §613(c)(2).”
Also under subparagraph (5) of IRC §613(c) the following treatment processes
are not considered to be mining processes (and are thus NOT included in gross
!“Electrolytic deposition, roasting, calcining, thermal or electric
smelting, refining, polishing, fine pulverization, blending with other
materials, treatment effecting a chemical change, thermal action, and
molding or shaping.”
It seems fairly clear from these statutory provisions that gross income from
mining is the mining company’s revenue from the sale of the first marketable mineral
product created as a result of mining and before any non-mining processes (e.g.,
manufacturing processes such as refining or smeltering) are applied. Generally, for
most hardrock minerals extraction produces a raw mineral ore, which of itself has
little value and is generally not marketed. For most minerals, after the ore is mined
it is sent to a mill or plant to be crushed and ground, and in some cases (lead, for
example) is beneficiated to the point that it is saleable as a metal concentrate (e.g.,
aluminum oxide from bauxite or copper concentrate from copper ore, etc.).33 At this
stage, there is a demand for the mineral ore concentrate as an input into the
smelting/refining process for final sale in the wholesale commodities or
manufacturing markets (e.g., gold into jewelry, copper for automobiles and piping).

33 Some metals are produced from recycled metals.

Consider gold, for example. Gold refiners are generally the primary market for
miners. Raw gold is usually delivered to the refiner where it is purchased from the
miner, processed, and refined. At the point of sale to the refiner, funds received are
considered gross income to the miner.
After the milling or mining processing stage, the ore concentrate has value due
to the value of the mineral to be derived therefrom: copper from copper ore
concentrate, aluminum from aluminum oxide, etc. In general, such ore concentrates
are either sold to a broker or to a smelter refiner, or they are tolled, which means the
ore is not sold, but is rather sent for refining/smelting (and other processing) only —
the mining company still owns the ore. If the miner’s output is sold in an arm’s-
length transaction (this would generally occur for certain iron ores sold by
independent, i.e., “small” mining companies), then there is a sale of the mineral and
that is the actual price used to determine gross income. Thus under IRS regulations,
gross income for depletion purposes is defined as “the actual price for which the ore
or mineral is sold where the taxpayer sells the ore or mineral as it emerges from the
mine before application of any processes other than a mining process or any
transportation, or after application of only mining processes, including mining
transportation.” The price of the ore concentrate would depend on the (wholesale)
price of the final metal (including related metals) on commodities markets, and the
percentage of the metal in the ore.
If the mining firm is an integrated producer, i.e., it has smelting/refining
operations, and also applies non-mining processes to the ore concentrate before the
mineral is sold, there may be no sale of either the raw ore, or ore concentrate, and
hence no price for the mineral firm’s output until the final metal (gold, for example)
is sold in the commodities markets or for use in manufacturing. In these cases,
percentage depletion is based not on actual gross income but what is called
“constructive” gross income, i.e, income derived from or approximated by using
representative market prices elsewhere in that particular market. Finally, in cases
where there is no representative price from sales of the same ore concentrate (the
mining output) in other markets, then gross income from mining is estimated by
multiplying gross sales by the ratio of mining to total costs or one of various other
methods to estimate the price of the mining output.
As a hypothetical example, assume that the market price of the final cast copper
on the commodities exchanges is $3.60/lb, which is $7,937/metric tonne of pure
copper.34 Also assume that one metric ton of copper ore concentrate contains 30%
pure copper and no other valuable minerals — the remaining 70% is sulfur, iron, and
other impurities that have no value.35 And finally, to simplify further, assume that
mining costs represent 75% of the total costs of producing the final pure copper.
Then, under the constructive gross income method, gross income per tonne from
mining operations — the average sales revenue per unit from the sale of copper
concentrate — would be calculated as follows:

34 This is the average price in October 2007 on the commodities exchange. See Table 3 on
p. 29.
35 Copper ores may also contain gold, silver, and other valuable minerals, which would
affect the value of the ore concentrate per tonne (or per lb).

$1,786 = ($7,937/tonne) x (0.30) x (0.75)
If the mining company produced 100,000 tons of copper ore concentrate (equivalent
to 30,000 tonnes of pure copper, which would eventually be refined into copper
ingots or bars) total gross income from mining in this one year would be $178.6
million. At 8%, the royalty on this would be $14.24 million.
Net Smelter Return (NSR) Royalty. Another possible royalty base — one
which is used in many private, and most state, royalty contracts — is “net-smelter
Net smelter return is a common term used in the mining industry to refer
essentially to the net average revenue per unit of the smelted mineral product sold by
the miner. It is essentially an estimate of the price the miner receives, or equivalently,
the price paid by the smelter, for the ore concentrate produced, based on the price for
the pure metal (or mineral) received by the refinery or smelter when it is sold in the
commodities market. This estimate is based on the (gross) price received by the
smelter/refiner for the marketable metal (e.g., the price on the London Exchange or
the Chicago Commodities Exchange), less the costs of smelting/refining and other
costs (typically treatment charges, penalties for impurities, and transportation charges
from the mill to the smelter). According to Cartright (2007),
The Net Smelter Return is the amount of money which the smelter or refinery
pays the mining operator for the mineral product and is usually based on a spot,
or current price of the mineral, with deductions for the costs associated with
further processing. In non-metal mines the selling price is usually ‘fob mine site’
because of the transportation costs involved in delivering the mineral product to37
the buyer.
In Canadian law, net smelter return is defined in the same way. According to Barten
(1993), a net smelter return is
... the amount received by the mine or mill owner from the sale of the mineral
product to the treatment plant that converts the output of the mill to marketable
metal. From the gross proceeds received there may be deductions for costs
incurred by the owner after the property leaves the mine property and before sale,
such as costs of transportation, insurance, or security, penalties, sampling and

36 As with the term gross income, net smelter return is somewhat misleading because it does
not really refer to a return as in rate of return. In normal business parlance, rate of return
refers generally to profits (i.e., gross revenue less all costs, including capital cost), while
net smelter return refers to a net price, i.e., a gross mineral price less certain operating and
processing costs, but not all costs. Note, however, that while there is a generally accepted
standard definition of net smelter return, in fact the precise definition — and the deductions
(what gets subtracted) from the gross smelter sales price — is particular to each royalty
lease contract.
37 Cartwright, Michael. R. Mineral Production Royalties. Available on
[]. Note: fob denotes “free on board,” which
means that the price of the mineral does not include the cost of insurance or freight or other
delivery charges.

assaying, refining and smelting, and marketing. No deductions are made for the38
operating costs of the mine-mill complex.
Finally, Baldwin (2003) writes:
A net smelter return will be ... the net value of minerals from the property, where
Net Value is Gross Value less certain permitted expenses. Gross value will
usually be defined with reference to the spot price of an average weekly or
monthly spot price on specified markets for the commodity. The permitted
deductions will include all charges by the smelter, such as smelting and refining
charge as well as penalties for impurities in the ore, and the cost of transportation
to the smelter and insurance. In some cases deductions may also be made for
taxes except income taxes and, depending on the nature of the commodity, for
marketing costs. If the operator ships to its smelter, charges should not exceed
those that would be charged by an arm’s length smelter in similar39
The similarity of these definitions of net smelter return (gross price less non-
mining costs) times output to the gross income base under the percentage depletion
rules is readily apparent. Each of the above definitions is very specific that smelter
and refining charges are to be deducted, just as in the tax definition of gross income.
The following two examples, from contracts or royalty deeds between a
landowner (the vendor) and the mining company (the purchaser), illustrate the legal
language used in defining a net smelter return:
As additional consideration for the Vendor entering into this Agreement, the
Purchaser acknowledges that the Claims shall be subject to a royalty or charge
in the amount of two percent (2%) of net smelter returns payable to the Vendor.
For the purpose of this clause “Net Smelter Returns” shall mean the actual
proceeds received by the Purchaser from a smelter or other place of sale or
treatment in respect of all ore removed by the Purchaser from the Claims as
evidenced by its returns or settlement sheets after deducting from the said
proceeds all freight or other transportation costs from the Claims, to the smelter40
or other place of sale or treatment, but without any other deduction whatsoever.
For the purposes of this Agreement and the payment of the Net Smelter Return,
net smelter returns shall mean the actual proceeds received by Warren or any of
his respective assignees or successors in interest to the Claims from any mint,
smelter, refinery or other purchaser from the sale of concentrates, metals
(including bullion) or products from the Claims and sold, after deducting from
such proceeds the following charges levied by third parties to the extent that they
are not deducted by the purchaser in computing payment: a) assay costs and
umpire assay costs charged by any mint, smelter, refinery or other purchaser; b)
smelting and refining charges, penalties, and the cost of transportation and

38 Barton, B.J. Canadian Law of Mining. Calgary: Institute of Resources Law, 1993. p. 461.
39 Baldwin, Christopher G. Understanding Royalty Structures. Paper written for the
Conference Board of Canada. 2003. p. 6.
40 Anglo American Uranium Corporations SEC Filing of Form 20F12G, February 8, 2007.
Available from the Securities and Exchange Commission (SEC) website.

handling of such concentrates, metals (including bullion) or products from the
Claims to any mint, smelter, refinery or other purchaser; and c) related insurance41
on such concentrates, metals (including bullion) or products from the Claims.
Thus, continuing with the above hypothetical copper example, the net smelter
return would be the price at which cast copper could be sold after the costs of
smelting and refining the copper ore are subtracted (so as to deduct any non-mining
value). Using the same figures as before, the market price of the final cast copper is
$3.60/lb, and thus one metric tonne (2,205 lbs) of pure copper would be valued at
$7,938. However, one ton of copper ore concentrate contains only 30% pure copper,
so that the value of one tonne of that ore concentrate is 30% of that, or $2,381.42 To
calculate smeltering and refining costs assume that these are 10% or $0.36/lb of the
price of the cast copper. Then costs would be $238/tonne of copper concentrate
(equal to $0.36 x 0.30 x 2,205) the net smelter return would be:
$2,143 = ($2,381) - ($0.36) x (0.30) x (2,205)
Multiplied by the tonnage of ore concentrate shipped to the smelter/refiner, it would
equal the actual (or constructive) sales revenue to the mining company of the ore
concentrate. If annual sales were 100,000 metric tonnes of copper concentrate, total
net smelter return revenues would be $214 million. At 8%, the royalty on this would
be $17 million.
Note that in this example, net smelter return is greater than gross income for
depletion purposes and would thus yield a greater royalty. This is because final metal
prices are high relative to smelting/refining costs. In general, the higher are metals
prices relative to costs (in which case mineral producers earn extra or windfall
profits) the more net smelter returns diverge from gross income.
Net Profit Royalty. Another royalty base that has been mentioned in the
General Mining law debate is net profit. Here the royalty would be a certain
percentage of the miner’s net after-tax profit or income, which is essentially gross
revenue less all costs (operating, capital, and tax costs). For any mining company
(indeed for any business) net profit is, of course, less than sales revenue by the costs
of doing business, thus resulting in a smaller royalty base from which to calculate
royalty payments. Reducing royalty payments to the federal government might be a
major reason that it is supported by much of the hardrock mining industry and its
supporters. Not only are net profits notoriously variable, difficult to measure, and
susceptible to accounting manipulations, but this method could create incentives for
mining companies to claim significant deductions from their income such that there
would rarely be a profit against which to levy the royalty. Thus depending upon the
royalty rate this could lead not only to smaller royalty payments than either a gross
income or net smelter return royalty, but perhaps to no royalty at all. Some advocates

41 Open Energy Corporation’s SEC Filing of Form SB-2/A on December 2, 2002. Available
from the SEC website.
42 To simplify the calculations, the figures are all rounded to the nearest whole number. As
before, the remaining 70% of the copper ore concentrate comprise sulfur, iron, and other
impurities that have no value.

of the net after-tax profit type of royalty, for example the 1993 bill S. 775, would
have measured net profits at the mine mouth, which would generally (depending on
the rate) result in even lower royalties. Further, a net profit royalty at the minemouth
creates complications in allocating costs between extraction and other mining
Another effect of a net-profit type of royalty on hardrock minerals would be to
expose the federal government to the risks of an investor — much like investors in
stock are as owners subject to risks — rather than the rewards of the much less risky
status of landowner. Such an arrangement would not serve to impose the market-
determined factor costs (royalties) on the mining operations. In other words, if net
profit were to mean net before-tax profits, then the royalty would essentially operate
like an income tax. This would not be consistent with mainstream economic theory
that a royalty is not a tax, but a factor payment.
The Fixed Royalty. Yet another royalty base, one which is used less
frequently, is the royalty based on a constant rate per unit, say $5/ton, of mineral
output (i.e., the ore concentrate). This was the type of royalty instituted under the
Mineral Leasing Act of 1920, the law which first introduced a federal leasing system,
including a royalty, for coal.43 As a factor payment, this type of royalty makes little
economic sense, being equivalent to charging fixed interest payments on capital
regardless of the value of the capital loaned. Being assessed on only one variable —
output, rather than price and output — it does, however, avoid the usual complexities
associated with determining value (price), costs, or even profits.44
Comparison With Oil, Gas, Coal, and Geothermal Royalties. For oil,
gas, and coal, federal royalties are calculated on the gross proceeds (or gross sales
revenues) from the contract sale. For oil and gas this generally occurs close to the
wellhead, and so the contract price is used to determine gross proceeds. Typically,
for example, oil and gas is sold at a posted price to a pipeline company, and that is
the price on which the royalty is based. In situations where oil is not sold in an arm’s-
length transaction, or is sold without a contract, royalties are based on various types
of benchmarks such as comparable sales or even local spot-market oil prices,
adjusted for any quality differences and transportation costs. In situations where the
oil or gas is transported before it is sold, then transportation charges are generally
deducted to determine gross proceeds for royalty purposes.45

43 Prior to this law, royalties on coal were not an issue since the federal government sold,
rather than leased, federal coal-bearing lands. This policy was codified by an 1864 statute,
and continued as an exception to the locatable minerals policy of the General Mining Law
of 1872. See Leshy, John D. The Mining Law: A Study in Perpetual Motion. Resources for
the Future, Washington, DC. 1987. p. 30.
44 Additional detail on the various pros and cons of various royalty bases is discussed in:
Otto, Andres, Cawood, Doggett, Guj, Stermole, Stermole, and Tilton. Mining Royalties:
A Global Study of Their Impact on Investors, Government, and Civil Society. The World
Bank. 2006. pp. 49-70.
45 Code of Federal Regulations (C.F.R.). Title 30 Vol.2, Part 206 (Revised 7-1.2007).

Royalties on coal extracted from federal lands, at the 8% or 12% royalty rate,
are also assessed on the “gross proceeds” from the sale of the coal. This is essentially
the price of the coal in a free-market transaction between unaffiliated parties at
arm’s-length. The price is determined at the point of sale, which for coal is typically
at or near the mine-mouth when the coal is weighed and loaded (i.e., at a scale or
batch loading facility). Transportation and washing costs, and other costs not
deemed to be mining or production costs, are generally deductible. These rules for
oil, gas, and coal clarify that value is determined as close to the mine as possible, and
that non-mining or extraction costs after a marketable product is created are
deductible. 46
For geothermal resources, the Geothermal Steam Act of 1970 (as amended)
instituted a 10%-15% royalty on federal leases based on the value of the steam or any
other form of heat or energy produced and sold.47 However, under amendments made
by the Energy Policy Act of 2005 (P.L. 109-58), if the geothermal energy is not sold
but is instead used to generate electricity — in most cases it is — the royalty is
between 1% and 2.5% and it is based on the gross proceeds from the sale of
electricity rather than the value or volume of geothermal energy used in the
generation of electricity. In some cases, a deduction against gross proceeds for
transmission and wheeling costs is allowed.48
What Would Be the Appropriate Royalty Rate?
With regard to a specific royalty rate, economic theory is less clear beyond the
implication that a royalty rate determined in the competitive marketplace is generally
the most economically efficient rate — the rate that is most likely to maximize social
welfare. In the case of privately owned mineral lands, markets generally exist that
determine the royalty type and rate for a wide variety of minerals.
In most types of private royalty arrangements in the early 1990s (the latest data
readily available), the most common type of royalty was the ad-valorem royalty at
rates ranging from 2-8%, with an average rate of 5%.49 In the case of publicly owned
lands, laws determine the return on the resources, although competitive market rates
may be a determining factor in establishing such rates. Most states with mineral
resources imposed ad-valorem royalties at rates ranging from 2-10%.50 For leasable
energy minerals on federal lands, the statutory royalty rates range from 5%-16.67%.

46 Ibid.
47 U.S. Department of the Interior. Minerals Management Service. MMS Minerals Revenue
Management: General Federal and American Indian Mineral Leasing Terms. September

2006. p. 4.

48 Federal Register, Vol. 72. No. 84, May 2, 2007. Department of Interior. Minerals
Management Service. Geothermal Royalty Payments, Direct Use Fees, and Royalty
Valuation: Final Rule. 30CFR, Parts 202, 206, 210, 217, and 218. pp. 24448-24469.
49 U.S. Department of Interior. Economic Implications of a Royalty System for Hardrock
Minerals. August 16, 1993.
50 U.S. General Accounting Office. Mineral Royalties: Royalty in the Western States and in
Major Mineral Producing Countries. GAO/RCED-93-109. March 1993.

For oil and gas, the royalty rate is either a 1/8 (12.5%) or 1/6 (16.67%) share of the
value of the mineral, depending upon whether the oil or gas is shallow (1/6 share
because costs are lower) or deep (a 1/8 share because costs are higher). On some
leases, the rate could be higher than 1/6. Also, the royalty could be paid “in-kind”
(either a 1/8 or 1/6 share of the output rather than of the price). For coal, the royalty
rate is either 12% (surface mines) or 8% (underground mines). Note that the 8% ad-
valorem rate proposed in H.R. 2262 is the same as the royalty rate on underground
coal mines. Even for hardrock minerals on acquired lands (as opposed to public
domain lands, which are governed by the 1872 Mining Law), the Congress has
established an ad-valorem royalty rate of 5%.51 Finally, in international lease
transactions, mineral royalties are predominantly of the ad-valorem type with rates
ranging typically from 2%-12%, depending on the country, and the mineral type.52
External Benefits. There may be conditions under which the government
might not want to use the royalty rate established by the market. If there are sufficient
positive economic and social effects from the use of public lands for mining, there
might be an economic rationale for charging the mineral producer a lower than
market rate.53 Such externality arguments — the stimulation of an infant industry and
the development of mineral resources, and the settling of the American West — were
apparently a principal rationale for the location system involving no royalties and
other rent payments established in 1872. But these arguments may not be valid in
today’s economy. The hardrock minerals industry is not an infant industry, and there
is no longer a need for settling the American West.
Arguments are made that the economic stimulus to the industry resulting from
royalty-free treatment produces benefits; it is argued that imposition of a federal
royalty on hardrock mining would damage most of the American hardrock industry,
which, it is argued, suffers from fierce, heavily subsidized foreign competition. Some
argue that there is a national security aspect to subsidizing certain hardrock minerals,
although there is no presumption that royalty-free treatment is the appropriate way
to address these concerns. It is also pointed out that damage to the industry would
harm those western communities that are economically dependent upon it.
These arguments are contested on various grounds. Subsidies for hardrock
mining clearly produce economic benefits to the industry receiving the subsidy and
to the communities dependent upon that industry. But these benefits are not external
benefits that the markets are not capable of taking into account; they are not “market
failures,” which may justify either a tax (in the case of external costs) or subsidies in

51 U.S. Department of the Interior. Minerals Management Service. Mineral Revenues 2000:
Report on Receipts from Federal and American Indian Leases. p. 134.
52 Otto, Andres, Cawood, Doggett, Guj, Stermole, Stermole, and Tilton. Mining Royalties:
A Global Study of Their Impact on Investors, Government, and Civil Society. The World
Bank. 2006.
53 To be technically correct, at least from an economic perspective, a lower royalty rate
would be justified if the external benefits would derive from consuming the mineral, if they
were proportional to price, and if they were invariant with the level of output. In some cases,
re-mining a prospect with remediation of damage from earlier mining may be in the public

the case of external benefits. Rather, the benefits are private benefits that are taken
into account by the normal working of the market system. Further, it can be argued
that the private benefits to the hardrock mining industry occur at the expense of
private damages to other American industries; the private benefits to mining-
dependent regions of the United States may occur at the expense of private costs to
other regions of the United States. When resources are scarce, a condition that affects
all economic systems and all countries alike, the use of resources in one sector means
the loss of the resource in another sector — the subsidy to hardrock mining is not
costless. The loss of economic efficiency implies that the private benefits to the
hardrock mining industry are smaller than the private costs to other sectors. This
suggests that removal of the subsidies would produce a net welfare gain to citizens
of the United States.
As to the national security argument, there are minerals that are often referred
to as “strategic minerals” — cobalt, columbium, chromium, manganese, platinum,
and others.54 Excessive dependence upon foreign producers of these and other
economically vital minerals might pose an economic disruption or national security
threat to the United States, although the nature of the relationship between imports,
domestic production, and national security is not a simple one. These arguments are
similar to those made about the U.S. dependence upon imported oil, and often used
to justify subsidies for the domestic oil industry. Some argue that the threat of a
domestic supply disruption might be better met with a stockpiling of that mineral.55
It seems clear also that not all hardrock minerals are of U.S. national security
concern. In any event, if a financial subsidy for certain strategic hardrock minerals
industries was appropriate, a tax subsidy would probably be more efficient than total
forgiveness of royalty payments. (The current tax subsidies for the hardrock mineral
industry are discussed in the section “Federal Tax Treatment of the Hardrock Mining
Industry,” below).
External Costs. There is another side to the externality concept: external
costs. It appears that some external effects associated with hardrock mineral
production — economic effects not taken into account in the normal business
decisionmaking — are net “external costs” rather than net external benefits. The
external costs from hardrock mineral production are the degradation of the
environment and the damage to the utility of the land for other potential uses.
Without land reclamation, there would presumably be damage to the environment,
which is an external cost to society. This is a cost that the typical profit-maximizing
hardrock mineral producer does not usually account for in the normal business
decisionmaking process. Consequently, since the accountable business costs are
lower than the real costs (including external costs) prices are lower than they should
be, causing output to be higher than it should be. Under this reasoning, if the
presence of external benefits is dismissed and the presence of external costs is

54 See National Research Council. Minerals, Critical Minerals, and the U.S. Economy.


55 The U.S. oil stockpile is called the Strategic Petroleum Reserve. Under the authority of
the Strategic and Critical Materials Stock Piling Act of 1979, as amended, the Department
of Defense maintains a stockpile of about 35 strategic and critical materials to supply the
military, industrial, and essential civilian needs of the United States for national defense.

considered significant, the appropriate federal policy would be a tax rather than to
impose no royalty on the use of the land. This is the economic rationale for the
abandoned mineland reclamation fee under SMCRA, the Surface Mining Control and
Reclamation Act.56
Absence of Competition. Two other conditions might mitigate against the
use of the market-determined royalty rate: First if the market for the leasing of
mineral lands between landowners and mining companies is not competitive, and
second, if the mining industry itself is not competitive. In the first case, if private
landowners exercise monopoly power or some other type of market power, then it
would be possible to extract from the mining companies higher than competitive
royalty rates — monopoly rates. In the second case, if the mining industry is
concentrated and exercises market power — control over prices, for example — it
might lead to underpayment of royalties — the market-determined royalty rates might
actually be too low.
These are complex issues which are difficult to analyze. Much of the land from
which hardrock minerals are produced is owned by the federal government, which
might be in a position to take advantage of its power to obtain royalty payments
above the competitively determined rates. Such payments, combined with the bonus
bids, would appropriate for society the economic rents — the abnormal or excess
profits (i.e., windfalls) — from the production of scarce natural resources. In reality,
of course, the federal government policy is just the reverse: It charges a royalty rate
of zero, which is definitely below the market-determined rate. On the other hand,
much land is also privately owned or owned by state or local governments or Indian
tribes, which suggests that the market-determined royalty rates might be a reliable
indicator of competitive rates.
As to the hardrock mineral industry structure, available data suggest that the
industry, both in the United States and throughout the world, is somewhat
concentrated. Hardrock mining is a highly capital intensive business and large
enterprises can operate more efficiently. In the United States, many of the mining
firms are large multinational mining conglomerates — five of the top ten claim
holders (who hold more than 16% of all claims on western public lands) are foreign
corporations. Internationally, the hardrock mining industry is dominated by about 40
companies and the top four account for 35% of total market capitalization.57 This
would suggest that the market-determined royalty rate might actually be too low. On
balance, however, it might be the case that the above two opposing forces tend to
offset each other and the government would want to use the more appropriate
competitive rate, which would be more consistent with economic efficiency, and
social welfare, than a zero rate.

56 P.L. 95-87, Title IV. 30 U.S.C.1231 et. seq. U.S. Library of Congress. CRS Report
RL32993, Abandoned Mineland Reclamation Fee on Coal, by Nonna A. Noto.
57 The largest of these is BHP Billiton, which has operations in the United States. In 2006
this multinational had a market capitalization valued at nearly $120 billion. See
PricewaterhouseCoopers. Mine, Riding the Wave: Review of Global Trends in the Mining
Industry, 2007. Available at its website, [].

Should Royalties Rates Differ by Mineral Type?
Economic theory is also unclear whether the same royalty rate should apply to
all hardrock minerals or whether the rate should vary by type of mineral in some
logical way — according to some acceptable rational criteria. On the one hand, a
variable rate is unnecessary because the base is ad-valorem, so the royalty amounts,
in absolute dollars, automatically vary in proportion to mineral value: more valuable
minerals pay greater absolute royalties per unit. Table 2 gives an illustration for
metals. Note that the royalty in column (4) is based on the gross value of the metal
in the commodities markets and does not allow deductions for smeltering costs and
other costs — in other words, the figures do not represent either net smelter returns
or gross income from mining, both of which would be less by the amount of such
costs. A constant royalty rate also tends to minimize both economic distortions —
intra-industry resource allocations among mineral types — as well as administrative
costs. On the other hand, private royalty agreements, which are negotiated on a case-
by-case basis, have widely varying royalty rates. These can range from 1-10%, and
differ by mineral types.
Under one possible structure that has been suggested, the royalty rate itself
would be a function of — it would vary positively with — the mineral’s price.
Column (6) of Table 2 shows one hypothetical schedule of such rates beginning at
8% for platinum, the most valuable metal, and declining in steps of 1 percentage
point to 1% for aluminum. With such a schedule the absolute amount of royalty
payments declines even more rapidly as the value of a mineral declines.
Another possibility would be to vary the royalty rates in direct proportion to the
percentage depletion rates applicable to gross income from mining as shown in Table
3. Such a royalty rate structure would produce a different pattern of absolute royalty
payments than either a constant royalty rate or a royalty rate in direct proportion to
the minerals value. For example, lead and zinc, which qualify for a 22% depletion
rate, would have a higher royalty burden than gold or silver, which are significantly
more valuable than either lead or zinc but which qualify for a 15% depletion rate.
Effects on the Mining Industry
Introducing a royalty payment system for locatable minerals could have an
adverse economic and financial effect on the producers of these minerals, particularly
on marginal producers. Both average and marginal costs would increase, and profits
and employment in the hardrock mineral industry would decrease. Hardrock mineral
production would be lower as marginal mines closed. This would also adversely
affect those parts of the United States that rely on these industries. The payment of
royalties combined with higher fees could also alter the competitive balance among
mineral producers both domestically and internationally: The competitive
disadvantage that royalty-paying mineral producers currently have would be lessened.
The hardrock mineral industry generally would be less competitive in relation to
other domestic mineral producers and with international mineral producers. Hardrock
mineral prices would probably not increase very much because for most minerals,
prices are determined in the international market — they cannot be shifted. This

would further add somewhat to financial pressures for the marginally profitable
mining company.
On the other hand, the hardrock mining industry has been booming over the last
four years. One indicator of this is the growth in metals and minerals prices, which
have increased overall and have contributed to industry profitability. Table 2 shows
this increase between 2002 and October 2007 for selected metals. According to the
Department of Commerce, relative to its size in the economy, the mining industry
group generally was the largest contributor to growth in the Gross Domestic Product
price index in 2006, accounting for 6.6% of price growth, more than three times its58
share of current-dollar GDP. According to PricewaterhouseCoopers, 2006 was
another spectacular year for the global mining industry.59 It also predicted that 2007
should bring with it both record financial results and further consolidation within the
industry. Finally, rates of return on capital for the U.S. mining industry have also60
been higher as compared with many other industries.
Table 2. Illustration of Ad-Valorem Royalty Calculations Based
on Recent Minerals Prices
MineralPrice inPrice on 10-ConstantConstantVariable
Type200217-2007RoyaltyRoyaltyRoyalty Rate
($/lb)($/lb)at 8%at 4%(% and $/lb)
(1)(2)(3)(4)(5) (6)
Platinum$6,516.00$17,400.00$1,392.00$696.008% = $1,392.00
Gold$3,732.00$9,000.00$720.00$360.007% = $630.00
Silver$55.00$174.00$13.92$6.966% = $10.00
Tin$1.95$9.70$0.78$0.395% = $0.49
Copper$0.75$3.60$0.29$0.144% = $0.14
Lead$0.44$2.00$0.16$0.083% = $0.06
Zinc$0.38$1.50$0.12$0.062% = $0.03
Aluminum$0.64$1.10$0.09$0.041% = $0.01
Sources: U.S. Department of the Interior. U.S. Geological Survey. Mineral Commodity
Summaries: 2007; and the Wall Street Journal, October 17, 2007. p. C8.

58 U.S. Department of Commerce. Bureau of Economic Analysis. New Release: Gross
Domestic Product by Industry, 2006 (advance). April 24, 2007.
59 Op. Cit. Mine, Riding the Wave: Review of Global Trends in the Mining Industry, 2007.
Available at its website, [].
60 U.S. Department of Commerce. Economics and Statistics Administration. U.S. Census
Bureau. Quarterly Financial Report for Manufacturing, Mining, and Trade Corporations:

2007. AFR/07/Q1. June 2007.

Other Economic Implications of Imposing a Royalty
These negative industry and regional effects would be a natural and unavoidable
part of the transition from a policy of resource subsidization to a policy of resource
neutrality. As the above discussion suggests, however, the policy of introducing a
royalty payment system for locatable minerals would be expected to have positive
economic effects in other sectors (the non-mining industry) and in the remaining
parts of the country. Less land would be mined and fewer U.S. hardrock minerals
would be produced and more imported than under a no-royalty system, but more of
other, higher-valued commodities would be produced. This would likely contribute
to a more economically efficient use of the nation’s resources, which would tend to
promote the welfare of society — a greater good for a greater number of people.
Thus, the current policy of free access (i.e., royalty forgiveness) involves a
trade-off: Policymakers choose the benefits to the hardrock mineral industry above
the benefits that would accrue to another domestic economic sector. A policy of
royalty (or other rental) payments would be more neutral; it would let the markets be
the arbiter of the relative size of the various economic sectors. And even if the health
and competitiveness of the domestic hardrock mineral industry is of sufficient
concern to warrant federal subsidies, there may be more economically efficient ways
of providing these subsidies than the total forgiveness of a factor payment.
Revenue Effects
The payment of a royalty to the federal government for the services from the
mineral land would increase federal revenues, although revenue generation is not the
primary rationale for the imposition of a royalty. The Congressional Budget Office
has estimated the budgetary effects, revenue and spending, of H.R. 2262. The
estimates are replicated in Table 3, which shows both revenue effects of the 8% and

4% royalty and from the proposed higher fees.61

As noted, H.R. 2262 would establish, beginning after its enactment, a 4%
royalty on existing claims, and an 8% royalty on new claims. The 4% royalty on
existing claims would generate revenues early, although no royalties would be paid
in 2008 due to a provision in H.R. 2262 that would defer royalties during the first 12
months after enactment. Most of the revenues estimated under H.R. 2262 would
come from existing claims. The 8% royalty on new claims is unlikely to generate
significant revenues during the forecast period (2008-2017) because after a claim is
staked, it typically takes at least 10 years for a hardrock mine to begin production.
H.R. 2262 would also reauthorize and raise both the claim’s location fee and the
annual maintenance or holding fee, from $30 to $50 per claim, and from $125 to
$150 per claim respectively. The projected revenue effects from the proposed higher
fees are shown in Table 3.
The revenue estimates are net of federal income taxes — there would be some
decline in income tax revenues due to the deductibility of royalty payments and fees
against business taxes. Also, note that under federal budget rules fees collected by

61 The fees currently charged the hardrock mining industry are discussed later in this report.

federal agencies, such as the Department of the Interior, are considered as offsetting
budget receipts, or negative spending. Such receipts reduce the agencies’ outlays.
Table 3. Revenue Effects of a Royalty on Hardrock Minerals Under H.R. 2262
(dollars in millions)
Type 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2008-2017
Roya lties 0 70 30 30 30 30 30 30 30 30 310
Fees 10 55 51 47 43 40 37 35 33 31 382
Tot a l 10 125 81 77 73 70 67 65 63 61 692
Source: Congressional Budget Office. H.R. 2262: Hardrock Mining and Reclamation Act of 2007. CBO Cost Estimate.
October 29, 2007.
Federal Tax Treatment of the Hardrock Mining
The U.S. hardrock minerals industry is subject to the same income tax laws
which apply to all other for-profit businesses, paying federal income, payroll, and
other federal taxes. The federal corporate income tax applies a 35% rate to most
corporate taxable income, defined generally as gross revenue (sales) minus interest,
wages, the cost of purchased inputs, and an allowance for depreciation. Reduced tax
rates, either 15%, 25%, or 34%, apply to “smaller” corporations, those earning less
than $10 million of income.62 In addition, corporate stockholders pay individual
income taxes on their corporate-source capital gains and dividends.
As business entities, hardrock mining companies benefit from many different
types of untargeted tax incentives, provisions that are generally available to non-
mining businesses, as well as some tax provisions specifically targeted toward
mining. Two untargeted or general tax benefits are the §199 manufacturing deduction
and accelerated depreciation. Under IRC §199, “manufacturing” businesses are
allowed a deduction, as a business expense, for a specified percentage of the qualified
production activity’s income subject to a limit of 50% of the wages paid that are
allocable to the domestic production during the taxable year. The deduction was 3%
of income for 2006, is currently 6%, and is scheduled to increase to 9% when fully
phased in by 2010.63 For the domestic mining industry (which includes the oil and
gas industry), the deduction applies to any primary product “manufactured, produced,
or extracted in whole or in significant part in the United States.” Note that extraction
is considered to be manufacturing for purposes of this deduction, which means that

62 The 15% rate applies to the first $50,000 of profits, 25% to the next $25,000 of profits,
and 35% to profits from $75,001 to $10,000,000. Small “non-corporate” mining companies
would be taxed as sole-proprietorships.
63 However, there are proposals to repeal this deduction as part of the Congress’s tax reform

domestic firms in the business of extracting hardrock minerals from underground
reservoirs or deposits qualify for the deduction.64 Effectively, the deduction is
equivalent to a reduced marginal tax rate. For example, at the top marginal corporate
tax rate of 35%, which typically applies to large corporations such as hardrock
mining companies, the current deduction of 6% is equivalent to a marginal corporate
income tax rate of 32.9% (35% x 0.94) rather than 35%.65
Another untargeted or general tax provision that is important to the hardrock
mineral companies is accelerated depreciation — the rules that determine how much
a business may deduct for the depreciation of its capital equipment and structures.
This deduction is intended to provide a business reasonable allowance for the
exhaustion and wear and tear (i.e., depreciation) of business property. It is analogous
to the cost depletion allowance for investment in a mineral deposit (as discussed
below). The present depreciation treatment is known as the Modified Accelerated
Cost Recovery System (IRC §168). Generally, under this system, assets are
depreciated for regular tax purposes over a specified recovery period, and by applying
one of the accelerated depreciation methods prescribed for each class of property,
including the 200% declining balance method (the double declining balance method)
or the 150% declining balance method or formula.
The annual depreciation deductions are determined by applying this formula to
the assigned recovery period. The applicable recovery periods are prescribed for each
property class. Mining equipment, assets used in the mining, quarrying, milling, and
beneficiating of metallic and nonmetallic minerals, are assigned a seven-year
recovery period. This system also allows producers to use a depreciation method (as
opposed to the recovery period) that maximizes the value of the deduction over time.
This is more advantageous than the theoretical treatment, which would call for a
depreciation schedule based on the actual economic depreciation — a longer recovery
period and a less accelerated formula, which increases the tax value of the deduction
(or equivalently, reduces the effective marginal tax rate on the income generated by
the equipment). Given that hardrock mineral producers are highly capital intensive
and that the equipment used (stripping shovels, drills, bulldozers, drag lines, and
haulers) can cost tens of millions of dollars, the accelerated depreciation provision
can be relatively important.
Three Special Tax Preferences or Subsidies
In addition, at the federal level there are three special, or targeted, tax
preferences available to the mining industry generally, that are also available to
hardrock mining firms.

64 This deduction was enacted under the American Jobs Creation Act of 2004 (P.L. 108-
357, also known as the “JOBS” bill). It was originally a substitute for repeal of the export
tax benefits under the extra-territorial income tax exclusion, which was ruled to be in
violation of trade laws. See CRS Report RL32652, The 2004 Corporate Tax and FSC/ETI
Bill: The American Jobs Creation Act of 2004, by David L. Brumbaugh.
65 Corporations are currently taxed at 15% of the first $50,000 of taxable income, 25% of
the taxable income from $50,001 to $75,000, 34% of the taxable income from $75,001 to
$10 million, and 35% of taxable income above $10 million.

Expensing of Mine Exploration and Development Costs. One
important special tax break available to the hardrock mineral industry is expensing
of exploration and development expenditures, i.e., the deduction in the year incurred
of costs that are essentially capital in nature (IRC §616 and §617).
Before a mine reaches the producing stage, mining companies incur geological
and geophysical (or surveying, and reconnaissance investigation) costs, costs for
ascertaining the existence and location of a mine, and costs for determining the
quantity and quality of the deposit. These include the costs of staking the claim,
removal of property line obstructions, limited removal of overburden (the removal
of large amounts of overburden would indicate that a deposit may have already been
found and the mine may be in a different stage), and limited sluicing. Exploration
expenditures include the costs of surveying, test pitting, trenching, drilling, driving
of exploration tunnels and adits, and similar types of work. The costs of exploratory
drilling to ascertain the extent of commercially marketable ores are treated by the tax
law as a mineral exploration cost. Expenditures for exploratory drilling from within
a producing mine to ascertain the existence of what appears (on the basis of all the
facts and circumstances known at the time of the expenditure) to be a different ore
deposit are also considered exploration expenditures. These types of costs are all
deductible rather than capitalized.
Expenditures made after the existence of ores or minerals in commercially
marketable quantities has been disclosed are considered mine development
expenditures, and these also qualify for expensing treatment. These are costs
associated with bringing the mine to production. For example, the costs of
constructing or sinking a mine shaft, or the costs of driving tunnels and galleries, are
development costs, which may be expensed. Activities associated with development
are building roads, clearing the land, and other activities to prepare a site for the
production stage.
There are several limitations to expensing of mine exploration and development
costs. First, expensing applies only to domestic mines; exploration and development
cost of foreign properties must be either depleted or amortized over a 10-year period
using straight-line amortization. Second, corporate mining companies may only
expense 70% of the exploration and development; the remaining 30% must be
amortized over five years, i.e., deducted evenly over 60 months (IRC §291 (b)).
Third, both exploration and development costs must be recaptured (i.e, taken back)
once the mine is opened and production commences (for exploration expenses) or
when the mine is sold (for development expenses). Recapture is accomplished by
either including the amount expensed as ordinary income or by subtracting it from
the percentage depletion allowance. This makes it especially important for mining
companies to determine when exploration ends and development begins.
The Percentage Depletion Allowance. Once a mine reaches the producing
stage, a producer may deduct a certain percentage of the gross income — as specified
by law — as an allowance for depletion. The percentage depletion allowance is a tax
deduction against the federal income tax available to a mining firm for the costs of
depleting a mineral reserve, which is part of the total production costs deductible to
derive net taxable income. The depletion allowance or deduction is intended to give
the mineral producer a deduction for the depletion of the investment in the mine, to

account for the loss (depreciation) of capital, to reflect the physical and economic
depletion of the mineral reserve as the mineral is being extracted (i.e., the wasting of
the asset). It is analogous to the allowance for depreciation of equipment and
structures and other assets that is available to all businesses. In theory the depletion
allowance should be based on the actual investment cost of the mine, and the annual
deduction should be based on the actual output of the mine (its actual rate of
depletion). This is called cost depletion.
Unlike the annual depreciation deduction, however, which is calculated based
on a taxpayer’s actual investment cost of the property (equipment and structures), a
recovery period corresponding to that property, and an annual rate of deduction over
that recovery period, the percentage depletion deduction for a mine is calculated as
a percentage of “gross income” (annual sales revenue) irrespective of the actual
investment in the mineral reserve (the mine). That is why percentage depletion is a
tax subsidy, preference, or tax expenditure. Any depletion deduction in excess of cost
depletion is considered by economists to be a tax subsidy or incentive because the
present value of the total amount deducted typically exceeds the initial investment.
In other words, the total amounts that can be recovered through percentage depletion
generally exceed the total investment cost of the property. This is true even with the
net-income limitation, which limits the deduction to 50% of the taxable income from
the mine (IRC §613 (a)). Using cost depletion, the total cost recovered cannot exceed
the actual investment in the property.
Table 4 shows percentage depletion rates for most minerals, including hardrock
minerals. As this table shows, the allowance is available to virtually all mineral
producers except integrated oil and gas producers, although the highest rates
available are for the hardrock minerals. Percentage depletion rates range from 5% for
stone and clay to 22% for uranium and beryllium. Most of the hardrock minerals
have a depletion rate of 22%, and several have either a 15% or 14% rate.
The percentage depletion allowance is also subject to several limitations. First
the amount of deduction is limited to 50% of the net income (essentially, the net
profit) from the property. Second, for iron ore (and coal) mined by corporations (as
opposed to noncorporate firms) the allowance must be reduced by 20% of the excess
of percentage depletion over cost depletion (IRC §291). This limitation was
introduced by the Tax Equity and Fiscal Responsibility Act of 1982 (P.L. 97-248).
In effect this limitation reduces the 22% depletion rate to an effective depletion rate
of between 17.6% and 22%, depending upon the amount of cost depletion.66

66 If the statutory depletion rate is 22%, and if this were to be reduced by 20%, then the
effective depletion rate would be 17.6% (22% minus 22% times 0.2). Because the statutory
rate is reduced not by the full 20% but by 20% of the excess of percentage over cost
depletion, the effective rate is somewhat higher than 17.6%. The specific effective depletion
rate, therefore, depends upon the cost depletion amount.

Table 4. Percentage Depletion Rates for Minerals
22% Depletion Rate
Any....If from deposits in United States:The following metal ores:
Sulfur, and uraniumAnorthosite, asbestos,Antimony, beryllium,
bauxite, block steatite, talc,bismuth, cadmium,
celestite, chromite, clay,cobalt, columbium,
corundum, fluorspar, graphite,lead, lithium, manganese,
ilmenite, kyanite, laterite, mica,molybdenum, nickel,
nephilite syenite (to the extentplatinum, platinum group
that alumina and aluminummetals, tantalum,
compounds are extractedthorium, tin, titanium,
therefrom), olivine, quartztungsten, vanadium, and
crystals (radio grade), rutile, andzinc
15% Depletion Rate
Oil and gasGold, silver, copper, iron ore, and oil shale from deposits
located within the United States
14% Depletion Rate
All metal mines not inRock asphalt, and vermiculite,If not mined in the United
the United States, andgranite, limestone, dimension orStates, bauxite, fluorspar,
all metal mines in theornamental stone, and all othermost types of ball clay,
United States, but notminerals not listed in this tablebentonite, china clay,
qualifying for thesagger clay, and clay used
22% rateor sold for use for purposes
dependent on its refractory
10% Depletion Rate
Asbestos not mined inBrucite, coal, lignite, perlite, sodium chloride, and
the United Stateswollastonite.
7.5% Depletion Rate
Clay and shale usedClay, shale, and slate used or sold for use as sintered or burned
or sold for use in thelightweight aggregates
manufacture of sewer
pipe or brick
5% Depletion Rate
Clay used, or sold forGravel, peat, pumice, sand,Bromine, calcium chloride,
use, in thescoria, shale and stone (exceptand magnesium chloride
manufacture ofoil shale and stone describedfrom brine wells
drainage and roofingelsewhere in this table)
tile, flower pots, and
kindred products
Source: Internal Revenue Code Section 613(b).
The Interaction Between the Percentage Depletion Allowance and
the Royalty. As noted above, the imposition of a royalty, where none existed
before, would increase a mining firm’s operating costs and reduce profitability.
Further, due to the deductibility of the royalty (as an operating cost of doing business)

against the federal income tax, the deduction reduces tax liability and therefore
lowers the tax costs — the after-tax cost of the royalty is effectively reduced.
However, there is an important interaction between a royalty and the percentage
depletion allowance that limits that effect, i.e., that increases the after-tax cost of the
royalty somewhat. Under IRC §613, royalty payments (and other rental payments)
are deductible from gross income to determine the percentage depletion allowance.
This means that if a royalty were to be imposed on hardrock mining from federal
lands, it would have the effect of simultaneously reducing the amount of the
percentage depletion deduction. Thus, while the imposition of a royalty would
increase deductible expenses and reduce the mining company’s tax liability, the
reduced percentage depletion allowance would reduce tax deductions and would raise
a mining firm’s tax liability. The net effect on tax liability of these two simultaneous
considerations are shown in the following equation, which shows the total increase,
after tax burden, for every dollar of royalty paid:
(1)= r (1-t) + r t d
(2)= r - r t + r t d
(3)= r - rt (1- d)
wherer = the royalty rate,
t = the marginal corporate (or business) tax rate,
d = the applicable percentage depletion allowance rate.
The first term in (1) shows how the burden of a royalty is reduced by its tax
deductibility; and the second term shows how the burden of a royalty is increased by
its subtraction from gross income. For example, an 8% royalty without the gross
income offset is effectively a 6% royalty at a 25% marginal tax rate; the same royalty
however is effectively a 6.44% royalty with a gross income offset if the percentage
depletion allowance is 22%. Similarly, a 4% royalty without the gross income offset
is effectively a 3% royalty at a 25% marginal tax rate; the same royalty, however, is
effectively a 3.15% royalty with a gross income offset if the percentage depletion
allowance is 15% (say, for gold).
Equations (2) and (3) are the same as equation (1). Expressed as equation (3),
the effective royalty is shown as a gross royalty, the r term, and the offset term - rt (d-
1). So in the previous example when the gross royalty is 4%, the revenue offset is a
negative 0.85% [0.04 x 0.25 (1 - 0.15) = - 0.85]. This shows that under current tax
laws, and given the current percentage depletion rates, the costs of gross income
deductibility of the royalty could, in certain cases, offset the benefits from royalty tax
deductibility — which, for these cases, is effectively equivalent to not allowing tax67
Deduction for Mine Closing and Reclamation Costs. The Deficit
Reduction Act of 1984 (P.L. 98-369) included a provision that gives preferential tax
treatment to the mining industry in the area of mine closing and land reclamation.

67 These calculations ignore the effects of the 50% taxable income limit on the percentage
depletion allowance.

This provision (IRC §468) allows mining companies to deduct the costs of mine
closing and land reclamation in advance of the actual closing and reclamations, i.e.,
before the occurrence of the activity giving rise to the expenses. This provision is
contrary to the general tax rule under both the cash method of accounting and the
accrual method of accounting, which state that expenses to be incurred in the future
cannot be deducted currently. Under the cash method of accounting, expenses can
only be deducted when the payment is actually made. Under the accrual method of
accounting, future expenses may be deducted in advance of actual payment but not
in advance of the economic activity that gives rise to the expenses — they must be
deducted in the year in which the economic activity takes place.
Revenue Losses from Special Tax Preferences
The Joint Tax Committee estimates the revenue losses from the above three
special tax preferences or subsidies (formally called “tax expenditures”). The latest
five-year estimates (from FY2007-2011) are as follows: $0.5 billion for expensing
of mine exploration and development costs, $1.1 billion for the excess of percentage
over cost depletion, and $0.2 billion for mine reclamation reserves deduction.68 Thus
the total revenue loss from these three provisions over five years is $1.8 billion, an
average of $360 million/year. This is the amount by which the industry lowered its
tax burden, or conversely, the loss in tax revenues to the federal government. The
bulk of these preferences is claimed by corporations — only a small share is claimed
by proprietorships and partnerships.
Alternative Minimum Tax
There is another provision of the current IRC that attempts to limit the benefits
from the special tax breaks available to the mining industry and other industries: the
alternative minimum tax. This alternative minimum tax is an additional tax on items
of tax preference, which are a list of ten tax breaks or subsidies that have been
identified as potentially able to reduce a business’s or individual’s tax liability to
little or nothing. The intent is to assure that all taxpayers — individuals and
businesses — pay some tax, which is not assured if taxpayers are able to claim a lot
of special tax breaks.
In effect, the alternative minimum tax imposes an additional tax above and
beyond the normal or regular income tax on the total amount of these ten items of tax
preference. This is important for the mining industry because two of the ten
preference items are tax breaks that are important to the mining industry: the excess
of percentage depletion over cost depletion, and the excess of the exploration and
development cost deduction over a hypothetical deduction that would have been
allowed if the costs had been amortized ratably (deducted evenly) over a ten year
period. A third item of tax preference that the mining firm would have to include in

68 U.S. Congress. Joint Committee Print. Estimates of Federal Tax Expenditures for Fiscal
Years 2007-2011. Prepared for the House Committee on Ways and Means and the Senate
Committee on Finance by the staff of the Joint Committee on Taxation. September 24,


its list of tax preference items is the excess of accelerated depreciation over straight
line depreciation.
To the extent to which mining companies uses these and other items of tax
preference, this could trigger the minimum tax, and thereby reduce the value of the
special tax provisions.
Effective Tax Rates
These special tax preferences or subsidies, combined with accelerated
depreciation (a significant tax benefit for highly capital intensive business such as
hardrock mining) have historically resulted in relatively low effective average and
marginal tax rates. Thus, firms that mine hardrock minerals on public domain lands
pay no royalty, and benefit from fairly significant tax subsidies. For example, CBO
recently published a study of effective tax rates on different types of assets, and those
used in mining (mining and oil field machinery, and mining structures such as mine
shafts) generally ranked fairly low, relative to assets used in other industries.69
Fees Paid by the Hardrock Mining Industry
Finally, mining companies pay a variety of claims fees (location fees, Bureau
of Land Management processing fees, annual maintenance fees). These are charges
for specific types of administrative services provided by the BLM. The claims
location fee is presently $30 per claim, which is about 20 acres. This fee is charged
for first-time locators to locate and record a claim. The annual maintenance (or
holding) fee, necessary to hold a claim on public land, is presently $125 per claim.
This fee applies to claim holders with 11 or more claims (those with 10 or fewer
claims are exempt). Both the location fee and the annual maintenance fee are
adjusted for inflation. The BLM also assesses a processing fee of $15. These fees
help the BLM cover its costs of administering the mining law and regulations. They
cover costs for such actions as processing and recording applications, certain
exploration permits, name changes, and corporate mergers, as well as lease
consolidations, transfers, and reinstatements.

69 U.S. Congress. Congressional Budget Office. Taxing Capital Income: Effective Tax
Rates and Approaches to Reform. October 2005. Table 2, pp. 10,11.

Appendix: Description of H.R. 2262
On November 1, 2007, the United States House of Representatives approved a
substitute version of H.R. 2262 (with amendments), the Hardrock Mining and
Reclamation Act of 2007.70 This bill would:
!establish a new regulatory framework for administering permits to
develop hardrock minerals;
!permanently end the sale or “patenting” of public lands for mining,
which has been under moratorium since the early 1990s;
!establish royalty payments for hardrock mining operations on federal
lands and use 75% of the proceeds for the cleanup of abandoned
!impose an 8% gross income royalty future hardrock mining
operations, and an 4% royalty rate on current mining operations;
!require miners to seek additional permits to explore for and develop
mineral resources and meet certain standards related to reclamation
of mined lands;
!create an abandoned mine reclamation program similar to the one
currently in place for coal sites;
!make the income from hardrock mining fees and royalties available,
subject to appropriation, to support reclamation programs and to
provide assistance to certain state, local, and tribal governments;
under an amendment to the Committee-approved bill, 50% of the
cleanup funding would be directed to the state in which the royalties
were generated;
!direct the Secretary of the Interior to prioritize reclamation projects
that protect public health and safety, particularly from water
pollution, and for projects that restore wildlife habitat; under an
amendment to the Committee bill, watershed areas would be
designated as eligible reclamation projects and among the top
priorities for receiving cleanup funds;
!establish environmental standards specific to the hardrock mining
industry. Environmental standards in the substitute version of H.R.

2262 would be less prescriptive and more performance-oriented than71

those in the original bill;
70 See H.Rept. 110-412.
71 Note that hardrock mining operations already have to comply with the National

!establish a new definition of “undue degradation” of public lands
and resources and give the Secretary of the Interior broader authority
to block mining operations that would cause such harm;
!allow Native American tribes to petition the federal government to
withdraw federal lands with cultural and religious values from
mining activities (similar language has been in place for states and
!set guidelines for administrative and judicial review of actions
authorizing mining on public lands and allow citizen lawsuits
challenging federal decisions.

71 (...continued)
Environmental Policy Act, the Clean Water Act, and several other environmental laws.