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. 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. 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. 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 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, whether it be hardrock minerals, coal, or oil and gas. Most states with mineral resources imposed ad-valorem royalties at rates ranging from 2-10%. On the other hand, the hardrock mining industry has been booming over the last four years. 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. Federal Tax Treatment of the Hardrock Mining Industry

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. Effectively, the deduction is equivalent to a reduced marginal tax rate. 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 percentage depletion allowance is also subject to several limitations. Deduction for Mine Closing and Reclamation Costs

The Deficit Reduction Act of 1984 ( P.L. 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 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 sites; 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.
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.