Economic Attributes of the Royalties in S. 776 and H.R. 322
The royalties in S. 775 and H.R. 322 essentially are a net income and a gross income, or gross value, royalty,
respectively. These are more appropriate than a royalty based strictly upon a mine-mouth measure of value, because the
hardrock minerals on the Federal lands are diverse and undergo substantial processing (smelting and, often, refining)
before actually sold (when market value is established). It is appropriate in principle to subtract the costs of such
processing from the value or income subject to a royalty, because that processing adds value to the mineral that is not
part of the use value of the land or of the mineral.
The fact that, in many cases, minerals undergo substantial processing at or near the mine site before arm's-length
transactions take place (and establish a market value) can be a major difficulty in calculating a royalty.
A net smelter return royalty (provided in H.R. 322) is considered a modified gross income royalty because it retains
the gross value of minerals in the base while taking account of non-mining processing costs.
As described earlier, S. 775 would impose a royalty of two percent on the value of the minerals measured at the mouth
of the mine, after subtracting all the direct and indirect costs of mining and processing (including related exploration
and development expenses). H.R. 322 would impose a royalty of eight percent on the net smelter return from all locatable
minerals produced from the claim. "Net smelter return" is the gross value of the sale of the processed mineral less the
cost of smelting and/or refining and the cost of transportation from the mine to the smelter and/or refinery.
Because both the base and the rate of the royalty prescribed by H.R. 322 are larger than that prescribed by S. 775, the
royalty payable under the former would be much larger than that payable under the latter. However, because net income
is more variable in relative terms than net smelter (refinery) return, the royalty in S. 775, the royalty per pound of
copper under S. 775 would increase relative to that under H.R. 322 as net income increases.
To illustrate with a simplified example, selected data for a hypothetical copper mine, mill, smelter, and refinery
operation are shown in table 1, with two assumptions concerning the selling price of refined copper: 85¢ per pound
and 110¢ per pound. The cost data are based upon averages for all operations in the United States. In this simplified
illustrative case, the royalty imposed by H.R. 322 would be 5.0¢ and 7.0¢ per pound under the respective selling price
assumptions, whereas the royalty imposed by S. 775 would be 0.1¢ and 0.6¢ per pound, respectively. The dynamics would
be similar for gold and other minerals.
With respect to economic efficiency, the choice is not clear. Net income more closely approximates the concept of
economic rent than gross income. An attribute of a net-income royalty is that, because it is calculated after production
costs have been subtracted,(27) it does not disproportionately affect marginally economic mines. Also,
the landowner shares in project and market risks. As noted, such risk-sharing may be altered by other types of payments
in the compensation package.
On the other hand, with a net income royalty, unprofitable producers do not pay the land owner for depletion of the
mineral resource or use of the land, while the owner is denied alternative uses of the land that could provide a return.
The latter, however, might be addressed to some extent with some form of "rental" payment. Also, less efficient operations
in effect pay a lower rate than more efficient ones. Partly because of this incentive and partly because a gross income
royalty is to some extent a tax on the level of production, a gross income royalty distorts production decisions more
than a net income royalty.
A gross income based royalty is "economically" appropriate on the grounds that a landowner should be assured of getting
paid for minerals removed. This also is one way of assuring that the landowner is compensated for loss of income on
alternative uses of the land. But, as in the case of a net-income royalty, this might be done by rental payments. A gross
income royalty, without provision for lowering it to avoid shutdown, can disproportionately affect marginally economic
mines, possibly making them uneconomic.
Administrative and Revenue Considerations
With respect to administrative ease, a gross income royalty is preferable, but the degree of preference depends upon how
gross income is defined (including the stage of the production process). Mine production and the selling price are the
only information needed to calculate and verify the royalty payment due when gross income covers only mining operations
and (possibly processed) ores are sold in the market. When the mineral is smelted and refined before sale, information
on those processing costs also is needed. Because the determination of net income is an even more complicated accounting
procedure, administering/monitoring a net-income royalty is more difficult and expensive.
With respect to predictability of revenues, a gross-income royalty is preferable. Gross income, mainly a function of
physical sales volume and of price, is much less variable than net income, which is a residual and is affected by more
factors. A predictable revenue stream can be important to Government when, as is sometimes the case, the funds are
designated for programmatic uses that need stability.
In arrangements pertaining to State and private lands, gross-income royalties or variants are far more common than
net-income royalties.(28)
TABLE 1. Simplified Illustration of Royalties That Would Be Charged to a Hypothetical
Copper-Producing Operation by H.R. 322 and S. 775(a)
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