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sidizing mineral capital, the provision came to subsidize gross income and hence sales value of the minerals extracted.

The basic algebra of the depletion allowance is quite simple. Imagine a mineral corporation with

Y gross income from the mine (sales),
C costs of production,
t tax rate (48%),

d percentage depletion allowance. Its tax payment is

(tax rate). (taxable income)
t. Y-dY-C)=tax payment;

and hence its after-tax profits are

net income-tax paid

(Y-C) -t(Y-dY-C). Now imagine that the depletion allowance is eliminated and in its place a subsidy on sales is offered. Let s be the per unit subsidy on sales. How large must this subsidy be to be equivalent to the depletion allowance? To answer this question, we first write down the tax payment with the sales subsidy:

(tax rate)(taxable income)
t.(Y+sY-C)=tax payment with sales subsidy

and the after-tax profits

net income-tax paid (Y+sY-C)-t.(Y+sY-C)=after-tax profits with sales subsidy Then we equate the two after tax profits and solve fors:




(1) When s equals td/(1-t), s is just large enough to make the direct sales subsidy exactly equivalent to the percentage depletion allowance. If the tax rate were .5 instead of .48, the depletion allowance would be equivalent to a subsidy on sales of the same nominal rate. That is, a 22% depletion allowance would be equivalent to a 22% negative sales tax. The mining corporation would be just as well off if the allowance were eliminated and replaced by a subsidy of 22¢ for each dollar's worth of sales.

There are several qualifications which make the algebra much more complicated but which leave the result above essentially correct. First, of course, the corporate tax rate is not 50%. With a 48% tax rate, s becomes equivalent to 92% of d. Second, there is a 50% of net income limitation to percentage depletion. By this limitation, if

1/2 (Y-C)<DY

the allowable percentage depletion is not dy but half of net income

or 12 (Y-C). The purpose of the limitation is to prevent the percentage depletion allowance from sheltering more than half of net income from the income tax. Because of this limitation the percentage de pletion allowance, in the absence of other provisions which make it more favorable, can do no more than halve the effective tax rate.

In the Treasury depletion study of 1963the Treasury found, for domestic properties, that about three-quarters of depletion taken by all minerals produced was based on percentage depletion, one-fifth on the 50% of net income limitation, and the rest on cost depletion. For its survey of 1960 tax data, the Treasury found the following relation between depletion actually taken and the statutory rate.

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In some cases, for example, anthracite and bituminous coal, the effective rate of the depletion allowance is considerably below the statutory rate; however, for most of the minerals important for recycling the two rates are rather close. The 50 percent of net income limit explains part of the divergencies, though not the cases, such as sulfur, where actual depletion taken is greater than the statutory rate of percentage depletion. Timing and cost depletion help explain such cases as these. In 1969 the percentage depletion rate for oil and gas was decreased from 2712 percent to 22 percent and the rates for many other minerals were decreased by a percentage point. These changes reduced the frequency in which the 50 percent of net income limitation becomes operative. For this reason one would expect that a survey after 1969 would find that the effect of the present depletion allowance is more like that of a negative sales tax than the pre-1969 depletion allowance.

Elimination of the 15 percent depletion allowance on iron ore does not mean that iron ore will suddenly become (48/52) · (15%) higher in price, however. There are several complications:

1. Just as in the case of any price subsidy, the benefit of a price subsidy is transferred partly into lower prices, but also into higher profits and higher rents. Thus elimination of a percentage point of the effective subsidy (s= (48/52) (15%)) will increase the price of iron, but not by the full amount of s. This point is illustrated in figure 3. In panel II the price subsidy translates B downward

7 President's 1963 Tar Message, Hearings before the Committee on Ways and Means, Part 1. February 1963.

$ Cost depletion is analogous to depreciation for other property.

by s% or S units, but after adjustments the final change in price is T which is smaller than S.

2. If the statutory rate of percentage depletion were decreased, mineral companies would shift in part to capital gains and cost depletion alternatives, diminishing somewhat the impact of a reduction in percentage depletion. To be effective a reform of percentage depletion must be linked to changes in capital gains provisions with respect to minerals. Cost depletion, on the other hand, becomes less valuable with lowered percentage depletion rates. This is because favorable tax treatment by percentage depletion makes mineral rights and lands more valuable. Hence, with percentage depletion, Jease costs are bid up, and lease costs are the major component of the cost depletion basis. With lowered percentage depletion rates, lease values are bid down, making the cost depletion alternative to percentage depletion less attractive.

3. It is often thought that percentage depletion is applied to the value of a mineral at the mine. However, the point where percentage depletion is taken is generally not at the mine mouth but considerably further along in processing. Minerals are often crushed, ground, concentrated, and even transported 50 miles before the sales value is computed and percentage depletion taken on that value. Thus it appears that not much value is added from the point in processing where percentage depletion is taken and the point where the primary material competes with the secondary. The question of where the allowance is taken is important because in order to compute the effect of percentage depletion on the amount of recycling, it is necessary to estimate the price effect of percentage depletion on the primary material at the point of processing where secondary can be substituted for primary.

We take, for illustration, the price equivalent of the depletion allowance for iron ore to be (48/52) · (15%) 14%. Assume iron ore worth $20 a ton at the mine mouth and $10 at the blast furnace, due to further processing and transportation. Then the price subsidy would be worth only 7%, half of the 14%, at the point of competition between primary and secondary, if depletion were computed on value at the mine mouth. But if depletion were computed on the value of ore at the blast furnace, which seems to be more nearly the case, the price subsidy is worth the full 14% at the point of competition.

The case for aluminum is somewhat different. There is considerable processing from the point where bauxite gets the depletion allowance to the point where primary aluminum substitutes for scrap aluminum. This means that the value of aluminum content at the point where depletion is computed is lower than the value of primary aluminum at the point of competition. As a result the effective price subsidy on primary aluminum is considerably less than (48/52) · (227) domestic origin or (48/52) · (14%) foreign origin. The effective price subsidy for aluminum might be in the range of 4-6%.

* The rate is generally somewhat higher for minerals mined in the U.S. than minerals mined abroad by U.S. companies. Domestically mined aluminum bearing ore has a rate of 22% while foreign mined aluminum bearing ore has a rate of 14%. Critics of the allowance have pointed out that not only does the allowance increase the rate of depletion, but also they have charged that the higher rate for extraction of a mineral in the U.S. is a policy "to deplete America first."

There are few, if any, studies which systematically evaluate the effects of the depletion allowance. In the absence of studies on the environmental consequences of the depletion allowance with respect to recycling, only crude guesses can be made. Suppose, for example, that the 15% iron ore depletion allowance translated into a 10% equivalent price subsidy. Suppose the allowance were eliminated. Prices, rents, profits, and cost depletion all change. After these adjustments have worked themselves out the price of iron ore becomes permanently higher, in a range say of 2 to 8%. By Sawyer's and Russell's estimates the resulting increase in sales of scrap iron might be rather large even for the low end of the range, in the neighborhood of 10 to 40%. It is conceivable, then, that elimination of the depletion allowance could double the market for scrap iron. However, it should be remembered that the required empirical work has yet to be done and this is only a

The effect of the depletion allowance is illustrated in figure 3, which is labeled in the same way as figure 2. Without the depletion allowance there would be s; material supplied, of which s, is secondary and sz is primary.

crude guess.

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Imposition of the depletion allowance is equivalent to a negative sales tax S, per unit of primary material supplied. This subsidy pushes down the supply curve B by proportion rate S to B'. The aggregate supply curve becomes C'. With the depletion allowance total material bought is siia with s-s, less secondary material and s-sz more primary material. The depletion allowance not only encourages more depletion of primary material and less utilization of scrap material, but also it encourages greater total material throughput (se) in the economy and hence larger total waste flows (A, B and C in figure 1).


The provisions below are considerably less easily converted into equivalent price subsidies. Without translating the subsidies below into equivalent price subsidies there is no sure way to analyze their effects on recycling, increased solid waste costs, and conservation. Nonetheless, some commentators have surmised that either foreign tax credits or expensing of exploration and development expenditures alone may equal the effects of percentage depletion upon recycling, waste costs and conservation. Because of the difficulties involved in

translating the subsidies below into equivalent price subsidies little effort will be made in this paper to compute these equivalencies. Exploration and Derelopment Costs

Section 617 of the Internal Revenue Code permits all domestic exploration costs to be expensed as long as these costs occur before the mine reaches its development stage. In the absence of this provision, exploration expenditures would be recoverable through the depletion allowance, cost or percentage. In order to prevent a double deduction for exploration expenditures, the amount expensed is recaptured for tax purposes by adding it to later gross income or subtracting it from later depletion allowance deductions. The net effect of the provision is to advance the timing of the deduction for exploration costs. Without this provision exploration costs would otherwise be matched against future income and deducted later. The value to the mineral company of a deduction now rather than later is determined by how much the company discounts future income. At a 15% discount rate, a deduction today is worth twice that same deduction five years from now.

Although the provision is a little different, Section 616 offers the same type of advantage for development expenditures. The two provisions together have much the same effect for hard minerals as expensing of intangibles, which are up to 80% of the development costs in the oil and gas industry. C'apital Gains

Nearly all the income of timber producers and much of the income of coal and iron lessors is subject to favorable capital gains treatment. Coal and iron also receive percentage depletion. By using capital gains rates, timber producers are able to lower their income tax rate from the 48% ordinary rate to roughly 30%.10 The Treasury estimates that the tax loss for timber alone was $150 million in 1972 and $175 million for 1973. It is not known how much of this advantage goes to paper production and what the effect of it is on the price of wood pulp at a point where it competes with scrap paper. Near the product level of competition between primary and secondary paper, Sunley tentatively estimates that the price effect is less than one percent. For a comparison closer to the raw material stage of unbleached fibers the price effect may be somewhat larger, perhaps several percent. At this point the impact of capital gains treatment on paper, scrap iron and steel, and energy recovery is still an unsettled question. Foreign Tax Credits

In brief, the foreign tax credit allows companies to subtract the tax paid to foreign governments from the Federal tax liability. Of the $t billion in foreign tax credits claimed by U.S. corporations in 1969, most of the subsidy went to extractive industries. Often the tax credit is defended on the grounds that it is a device to prevent double taxation by achieving the same total tax burden for foreign and domestic operations.

However, taxes paid to foreign governments are of a different nature than taxes paid to governmental units inside the U.S. From the

19 Emil Sunley. "The Federal Tax Subsidy of a Timber Industry," in The Economics of Federal Subsidy Programs, a compendium of papers submitted to the Joint Economic Committee, Part 3_Tax Subsidies, July 15, 1972.

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