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Mine Games: How Federal Coal Program Loopholes Can Cheat Taxpayers

The federal government may be missing out on millions of dollars in revenue each year, but a proposed rule from the Department of the Interior could help change that. The Department is planning to modernize the way it collects royalties from companies that mine coal from federal lands, potentially closing a loophole that may have been cheating the federal government—and the taxpayer—out of money for over 25 years.

Coal Mining on Federal Lands Affects All Americans

Federal lands belong to all Americans, and the Department of the Interior acts on behalf of the public to manage these lands and the natural resources found there. When companies extract coal from federal land, regulations require them to pay a royalty to Interior ranging from 8 percent of the value of production (for underground mines) to 12.5 percent of the value of production (for surface mines). Revenues from natural resources such as oil, gas, and coal account for one of the federal government’s largest sources of non-tax income—over $13 billion in 2014. The public ultimately benefits from royalties because the federal government disburses the revenue to state governments, the U.S. Treasury, and funds for environmental cleanup.

While the public can see the total amount of money federal coal brings in, the calculations that go into determining the amounts that individual companies pay are far more opaque, and industry uses this lack of transparency to its advantage.

How Industry Games the Federal Royalty System

Under federal regulations dating from 1989, a coal company pays royalties to the federal government based on the amount of money it receives from the coal’s first point of sale. However, while the federal government sets royalty rates, the market dictates the value of coal. This means that a coal company can game the system by selling its coal for cheap to an affiliate or subsidiary company, thereby paying a low royalty fee to the federal government. Then, the affiliate or subsidiary can sell the coal for a considerable profit to a nonaffiliated company, making a hefty profit that’s not subject to royalty payments. While it is difficult to estimate how widespread the practice is, over one-third of U.S. coal was sold in such “captive sales transactions” in 2013, which includes sales between affiliates or subsidiaries.

By contrast, when a coal company and a buyer are nonaffiliated, it is more likely that the buyer is paying the fair market value for coal, and the American public is getting a fair return of royalties.

A New Rule to Help Ensure Americans Receive “Every Dollar Due”

In January, the Interior Department unveiled a proposed rule that would value federal coal based on the “gross proceeds received from the first arm’s-length sale,” meaning the price a company pays to buy coal from an unaffiliated company. Rather than being able to pay low royalty rates based on sales to affiliates or subsidiaries, coal companies would pay royalties based on this price, which Interior calls the “best indication of market value.”

According to Interior, one of the main goals of this rule is to ensure “that companies have paid every dollar due” in royalties. But estimates of just how much money that will be vary. In supplemental material to the proposed rule, Interior claims the new coal valuation method would have little impact on companies’ bottom lines, saying that instances of companies selling coal to affiliates and then reselling the coal to an unaffiliated company are rare.

However, policy experts from Headwaters Economics and the Center for American Progress, and the federal government’s own watchdogs, the Government Accountability Office and Interior’s Inspector General, have raised concerns that Interior has ignored the high prices that American coal can fetch overseas, thereby letting companies get away with undervaluing coal in the U.S. And, according to a 2012 Reuters investigation, the practice of reselling coal to the then-booming Asian market was widespread enough that the federal government missed out on an estimated $40 million in royalties in 2011 from the Powder River Basin, a coal field straddling Montana and Wyoming that accounts for nearly half of the country’s coal production.

…But It’s Only a Start

Interior’s proposed rule would close a potentially costly loophole that’s existed since 1989. But this loophole is far from the only way that the government is missing out on revenues from natural resources on federal lands.

For instance, in 2013, Interior’s Inspector General identified over $62 million in lost revenue that resulted from the Department allowing coal companies to lease land for less than it was worth. Earlier this year, the analysis by Headwaters Economics determined that, while companies that extract coal from surface mines are meant to pay a royalty rate of 12.5 percent, deductions for things such as transportation mean that companies pay much lower royalty rates—about 5 percent in Wyoming, and as low as 0.7 percent in North Dakota. What’s more, the royalty system suffers from a lack of transparency that allows Interior and companies to hide the fact that the coal industry should be paying more than it is.

Additionally, Interior has a poor track record of managing other federal resources. The Government Accountability Office has long considered Interior’s management of oil and gas to be a “high risk” area for “waste, fraud, abuse, and mismanagement,” saying the Department is not reasonably sure that it’s collecting the amount of revenue it should be collecting from federal oil and gas.

Perhaps Interior’s largest potential source of missed revenues comes from an 1872 mining law that’s still on the books. The law allows companies that extract hard rock minerals—which include gold, copper, and iron ore—from federal lands to pay no royalties at all. Instituting a royalty rate for hard rock mining companies could generate millions of dollars in revenue each year, according to government estimates.

The Bottom Line for Americans

The extraction of federal resources is an important source of revenue for American taxpayers. In 2014, the federal government disbursed over $2 billion in royalties to states, which used that revenue to fund schools, local governments, and infrastructure projects.

This means that, when the federal government allows coal companies to game the system, it’s cheating Americans out of significant revenue, and, ultimately, out of a fair return on public resources.