5 The Search for Appropriate Charges for Land
Policymakers and economists have long debated the method of charging for rights of access to those who extract minerals. The concerns focus on economic rents—the extra profits of a superior resource. Many alternative terms exist for this extra income, such as excess profits, surplus, and windfalls. Whatever the name, it consists of the differences between revenues and the social costs, including the necessity to earn the required rate of return on investment.
For a mineral deposit, there are rent-generating advantages with a better location, higher quality material, easier mining conditions, and similar attractive features. This applies more broadly to all natural resources. Thus, a charge on these rents allows “the public” to share in the bounty of naturally superior resources without distorting resource allocation. Therefore, policies that transfer rents to the public are often deemed desirable. However, a paradox prevails. The charges can be imposed using a classic textbook example of a tax with no effects but, in practice, the charges employ a method that follows an equally classic textbook approach that clearly discourages desirable activity.
Economic analyses of rents concentrate on securing as much government revenue as possible without inefficiently reducing production. A transfer of rent has no effect on effort if the terms are independent of any action of the payer. The relevant classic textbook case is a lump-sum charge, a payment that is a fixed amount that is not alterable by the buyer's actions. The preferable approach is to impose a charge only at the time of transfer of rights to avoid the temptation subsequently to impose distortionary charges. The arrangement may be an outright sale or a lease in perpetuity with neither control over end use nor any ability to alter charges.
A lease bonus, a single payment made when the lease is implemented, is the quintessence of such a preset total payment. The bonus, by definition, cannot be altered by any action of the firm, and no subsequent decisions can be affected by having paid a bonus. In economic jargon, the bonus is a sunk cost. That fixed unalterable decision at the time of sale is administratively feasible is demonstrated by the history of U.S. public land sales and by the millions of outright sales that occur in the private sector.
In the case of land grants, competitive bidding to pay a fixed sum before production begins would capture rents. The maximum anyone would pay is the (present-discounted) value of the expected rents. Vigorous competition would force payments of the maximum.
Rent transfers thus seem ideal for tax collectors. The rents are excess profits that can be taxed without affecting output, and the transfers are seen as fair because the rents, in principle, provide rewards unnecessary to produce the effort.
In practice, deliberate decisions are universally made not to realize the potential for efficient transfer of income. As economics textbooks routinely warn, basing payments on output or its sale creates a disincentive to produce. Since the severance taxes used on minerals are sales taxes by another name and royalties have the same impacts, the analysis applies to royalties and severance taxes. Funds that consumers wanted to give producers are diverted to the imposer of the tax. This revenue transfer discourages producers from acting. The amount ultimately purchased by consumers declines because of these disincentives. This is a violation of the central economic principle that every expansion of output that costs less than its value to consumers should occur. The technical language is that all outputs with marginal costs (the cost of expanding output) less than price should be undertaken. Therefore, the charges imposed by federal land agencies, other governments throughout the world, and private landlords differ greatly in practice from ideal rent taxes and take a form that eliminates the differences from reliance on established tax collection agencies.
Moreover, royalties and severance taxes also create difficult collection problems and thus increased administrative cost. Requiring more payments means more compliance efforts by government and land users. DOI administration can and has encountered efforts to conceal production. A percentage of revenue royalty can be difficult to administer because of lack of satisfactory data on market prices. Lump-sum payments eliminate the expenses of monitoring.
The imposition of output-related charges is justified by claiming that because of imperfect competition, the defects of linking the payments to activity are outweighed by the income gains.
A further complication is that U.S. fossil fuel leasing policy involves both bonus payments and royalties. The drain of royalties will lower the amount of an initial payment. At a minimum, this hinders the evaluation of the adequacy of bonus bids. The residual after payment of royalties is necessarily less than the present value of untaxed rent. It is a residual of a residual—namely, the rent.