** & W •" /\ '-.®-V^ 'fife /V--^- ,^\ : .?W /~\ .A. \llif. : ^V ^«l: .A, °* •~~-*V V'-^\»* 'V^-'V V-^V V'^*'**' V >° *.diit. ^ *^.:W:..%. y.iife.^ ^.:i"A..%. .*" • "P. A* * • * \.J> /,>^'X .^,.^it.% ./\w^X ^.^Sk.* / c°*,^>>o A <*\.i£:/V g**,^>o y»^> » «7 «0k < v ***** •■ H o o 2 I 20 o" I 10 3 1.00 2 90 5 *> KEY 15- percent rate of return 0- percent rate of return JT 4 8 12 16" 20 24 28 32 36" 40 TOTAL RECOVERABLE COPPER, million metric tons FIGURE 1. — Potential total copper production from currently producing properties at various prices and rates of return— base case. TABLE 2. — Potential total copper production from currently producing properties at various prices and rates of return— base case Copper price, U.S. dollars per pound 1 Number of properties Potential total Cumulative production, number of million properties metric tons Cumulative total production, million metric tons BREAK-EVEN RATE OF RETURN to 0.94 0.94 to 1.07 .. 1.07 to 1.84 .. 11 11 11 16.949 11 12.348 22 10.835 33 16.949 29.297 40.132 15-PERCENT RATE OF RETURN to 0.94 0.94 to 1.07 .. 1.07 to 1.84 .. 8 11 14 14.699 8 10.289 19 15.144 33 14.699 24.988 40.132 Price equals average total cost, Includes byproduct credits. 2.60 • 2 40 ! 2.20 i 2J0O > l 80 f j, 1*0 r \ 1.40 : '- 20 ! '00 I > .80 I I 1 1 1 KEY 18 - percent rate of return 15- percent rate at return 4 6 8 10 12 14 16 16 20 TOTAL RECOVERABLE COPPER, million metric ton* FIGURE 2. — Potential total copper production from nonproducing properties at various prices and rates of return— base case. TABLE 3. — Potential total copper production from nonproducing properties at various prices and rates of return- base case Potential Cumulative Copper price Number total Cumulative total U.S. dollars of production, number of production, per pound 1 properties million metric tons properties million metric tons 15-PERCENT RATE OF RETURN to 1.29 .... 1.29 to 1.58 .. 1.58 to 2.17 .. 11 5.689 11 11 6.459 22 11 9.518 33 5.689 12.148 21.666 18-PERCENT RATE OF RETURN to 1.45 .... 1.45 to 2.00 .. 2.00 to 2.56 . . 11 4.152 11 11 9.309 22 11 8.205 33 4.152 13.461 21.666 Price equals average total cost, includes byproduct credits. quire long-run market prices of at least $1.58 per pound to ensure operation at the minimum level of profitabili- ty. To achieve an 18-percent rate of return, a long-run price per pound of $1.99 would be required to enable two-thirds of the deposits to operate, and prices as high as $2.55 per pound would be required to ensure produc- tion from all 33 deposits. It is the nonproducing proper- ties that will most likely provide additional domestic availability for the duration of this century, and as such, it is the economics of these deposits which is most cen- tral to a discussion of long-run copper resource avail- ability. Any tax legislation that alters the economics of these deposits in a negative way serves to lengthen the time frame for their eventual development. Figure 3 and table 4 presents the results of the "base case" total availability analysis for all producing and nonproducing properties. The producers were evaluated at a rate of return of 15 percent, nonproducers were evaluated at an 18-percent rate of return. These rates were assumed sufficient to maintain adequate profita- bility over the long run and provide for a risk premium on nonproducers high enough to induce investment and development. This analysis indicates that at a long-run copper price per pound of $1.00, approximately 20.6 mil- lion metric tons of copper are potentially recoverable. At this price, 17 properties could produce and earn the stipulated rate of return on the total investment. Of these 17 properties, 15 are current producers. The re- maining two potential producers account for 0.357 mil- lion metric tons, or 1.7 percent of the total copper resource availability estimate. 14 At a long-run copper price per pound of $1.25, approx- imately 37.1 million metric tons of copper are potential- ly recoverable. At this price, 35 properties could pro- duce and earn the stipulated rate of return on invested capital. Of these 35 properties, 28 are current pro- ducers. The remaining seven potential producers ac- count for 2.170 million metric tons, or 5.8 percent of the total copper resource availability estimate at this price. ' For a detailed discussion of the availability of domestic copper, see reference 12. 3 UU 1 1 1 1 1 1 ■ ■ - 2 50 - - m o o ■o ! f 5 0> 7? oo -. J _ £ U 6 z / o z ,^J 3 i so l"-^ a J Ul E u U - * 1.00 - a - u i o . u - 30 " - - - 1 1 1 1 1 1 10 20 30 40 50 60 70 TOTAL RECOVERABLE COPPER, million metric tons FIGURE 3. — Potential total copper production from producing and nonproducing properties at various prices (evaluated at 15- and 18-percent rates ot return, respectively) —base case. At a long-run price of $1.50 per pound, the total avail- ability estimate increases to approximately 44.0 million metric tons of recoverable copper. Of the 43 properties that could produce at this price, 31 are currently pro- ducing. The remaining 12 potential producers now ac- count for 6.127_raJllion metric tons, or 13.9 percent of the total availability estimate. At a long-run price per pound of $2.55, an additional 2 producing and 21 nonproducing properties, with esti- mated recoverable copper reserves of 17.753 million metric tons, could produce. This increases the total copper availability estimate to approximately 61.8 mil- lion metric tons, with the 33 currently nonproducing deposits accounting for a total of 21.666 million metric tons, or 35.0 percent of the overall total availabiiity estimate. TABLE 4. — Potential total copper production producing and nonproducing proper- ties at various prices (evaluated at 15- and 18-percent rates of return, respectively)— base case Number of properties Potential Cumulative Copper price total Cumulative total U.S. dollars Producing Norv production, number of production, per pound 1 producing million properties million metric tons metric tons to 1.01 .... 15 2 20.654 17 20.654 1.01 to 1.26.. 13 5 16.481 35 37.135 1.26 to 1.51 .. 3 5 6.910 43 44.045 1.51 to 2.01 .. 2 14 11.559 59 55.084 2.01 to 2.56 . . <0 7 6.194 66 61.798 1 Price equals average total cost, includes byproduct credits. Annual resource availability curves for selected years are illustrated in figure 4. The curves are cumulative over each year at a given price. Thus, in 1981, at a cop- per price per pound of $1.55, approximately 1.620 mil- lion metric tons of copper are potentially available from 32 currently producing properties. By 1987, total annual availability at this price increases to 1.8 million metric tons as 14 nonproducing properties come on line to replace eight current producers whose recoverable re- serves, as defined previously, have been exhausted by that year. Holding production levels constant for all properties producing at this price, in each successive year, would cause production to decrease to aDDroxi- mately 1.7 million metric tons by 1990 and 1.140 million metric tons by the year 2000. This is the result one would expect from a static analysis employing a fixed reserve base estimated under current price-cost rela- tionships and technology conditions. The analysis in- tends not to suggest exhaustion in the absolute sense, only exhaustion of this fixed reserve base. As both the price-cost differential and technology change, and as new deposits are discovered, the reserve base as de- fined, changes as well. Taking these availability results as the base case of this analysis, the effects upon potential availability from replacing the current depletion allowance option (the greater of cost or percentage depletion) with an al- lowance for cost depletion only can be investigated. REPEALING THE PERCENTAGE DEPLETION ALLOWANCE QUANTIFYING THE TOTAL DEPLETION DEDUCTION AND FEDERAL INCOME TAX EXPENSE The major difference between cost and percentage depletion lies in the definition and application of the two capital recovery methods. "Cost depletion is based upon the cosf of a mineral property, the number of units of mineral or contained metal sold during the year, and the number of units of mineral or contained metal re- maining in the deposit at the end of tne year" (0, p. 3.46). The ultimate size of the total cost depletion deduction is based upon the determination of the "cost basis." This cost basis establishes the maximum deduction under cost depletion for which the property is eligible over its producing life. The original cost basis. 18 once determined, is reduced In each successive year by sub- 16 The cost basis herein employed was defined as the total of explora- tion and acquisition expenditures incurred during all preproduction and production years. o T3 CO o o z o o. EC LU 0. HI O EC CL cr iii Q. Q- o o ij.au 1 1 1 i i - 1981 2.00 - r - 1.50 - ; ^^J ; 1.00 : r— ^ : .50 ^-T i i i i — i — 2.50 2.00 - 1.50 - 1.00 - 12 16 20 24 4 8 12 ANNUAL RECOVERABLE COPPER, million metric tons 24 FIGURE 4. — Potential annual copper production from producing and nonproducing properties in selected years- base case. tracting from it the depletion taken, whether it be cost or percentage. This "adjusted" cost basis thus de- creases, eventually reaching zero. Table 5 illustrates the difference between cost and percentage depletion and the corresponding difference in Federal income tax expense. 18 "Federal income tax expense is defined as 46 percent of taxable in- come. As the data clearly indicate, the base case allows for a substantially larger total depletion deduction, ulti- mately in excess of the total allowable cost depletion deduction for both producing and nonproducing proper- ties. As a result, the total Federal income tax expense increases with repeal of percentage depletion. The end result is a potential minimum income transfer from cop- per producers to the Federal government of approxi- mately $304 million and a potential transfer, given a TABLE 5. — Total depletion allowance and Federal income tax expense— base case and cost depletion only (Million 1981 dollars) Property Total depletion Total Federal income status deduction' tax expense' Base Cost Base Cost Difference 5 case 3 depletion only case depletion only Producing: 0-pct DCFROR 1,047 106 399 703 304 15-pctDCFROR 2,525 106 1,100 2,593 1,493 Nonproducing: 15-pctDCFROR 9,749 259 5,007 11,353 6,346 18-pct DCFROR 11,738 259 7,134 15,212 8,078 ' Summed over all production years for all properties in undiscounted dollars. ■ As defined in "The Depletion Allowance: Rationale and Operation" section. ' Direct correlation between these numbers should not be construed due to the interactive complexities of the tax structure (i.e., tax loss carry, investment tax credits, etc.) 15-percent rate of return, of approximately $1.5 billion from currently producing deposits. Since these analyses determine commodity price and revenues they also determine the ultimate size of the total depletion deduction for all properties. This further underscores the greater value to the minerals industry of percentage depletion. Cost depletion deductions are not proportional to total revenue, percentage depletion deductions are. Therefore, the larger the revenues, the larger the potential percentage depletion deductions and conversely, the larger the potential minimum in- come transfer from its repeal. In the case of the producing properties, the analyses determined for each deposit, that price necessary to generate sufficient revenues to cover all costs and pro- vide a 0-percent rate of return, and the price necessary to generate revenues sufficient to cover ail costs and provide a 15-percent rate of return. As a result, the total depletion deduction was limited to a minimum of ap- proximately $1,047 billion and a expected value of $2,525 billion. In these analyses, the difference between price and average total cost is zero. Each deposit is assumed to sell all output at a price that is equal to its average total cost of production. Therefore, the pro- ducing deposits in total would receive no less than this minimum $1,047 billion depletion deduction estimate and the corresponding $304 million tax savings it represents. In all probability, however, the minimum total depletion deduction can be expected to approach $2.5 billion and the Federal tax savings to approach $1 .5 billion since these minimum estimates correspond to the analysis of a 15-percent return over the long run. In the case of the nonproducing deposits, the total percentage depletion deduction is substantially larger because most deposits analyzed would require per pound prices of $1.50 to $2.50 (hence larger total revenues) in order to cover total costs and obtain the desired rate of return. Thus, the question of retention or repeal of the allowance assumes even greater signifi- cance. Assuming that 15 percent represents a minimum ac- ceptable rate of return to initiate exploitation, then a minimum total percentage depletion deduction of ap- proximately $9.7 billion (table 5) is determined with each deposit selling all output at a price equal to average total cost. At 18 percent, the total depletion deduction increases to $11.7 billion. Thus, with repeal of the per- centage depletion deduction, the total Federal income tax expense would increase by approximately $6.3 to $8.0 billion over the total producing lives of all deposits, with $6.3 billion representing a minimum. MEASURING THE WEIGHTED AVERAGE TOTAL COST OF PRODUCTION The end result of repealing the percentage depletion allowance would be a reduction in profitability. This is demonstrated here by the determination of higher nec- essary prices to allow for production at the stipulated level of profitability. Table 6 illustrates this economic effect, for all pro- ducing and nonproducing deposits analyzed, from re- pealing the percentage depletion allowance. The prop- erties are separated into three price (average total cost) ranges according to their base case price determina- tions. The weighted average total cost per pound of re- coverable copper was then calculated for the properties in each price range with and without percentage deple- tion. The average total cost was presented on a weighted basis in order to obviate a comparison be- tween individual deposits on the basis of size, quality, or composition, and instead adopt a more general and unbiased measure. With repeal of the percentage depletion allowance, the projected increase in weighted average total cost per pound of recoverable copper for nonproducing prop- erties is much greater than for current producers. This is due primarily to the loss of an additional $7 to $9 bil- lion in potential depletion deductions, proportionately TABLE 6. — Economic effects of removing the percent- age depletion allowance upon producing and nonproducing properties within various base case price ranges Property Number Base case No percentage Percentage status of weighted depletion change from properties average total weighted base case cost average total pet per pound' cost per pound' Producing, 15-pct ROR: to 0.51 .... 3 0.401 0.412 2.7 0.51 to 1.26 . 25 1.031 1.060 2.8 1.26 to 2.01 . 5 1.451 1.485 2.3 Nonproducing, 15-pct ROR: to 0.51 .... 1 .410 .530 29.2 0.51 to 1.26 . 9 1.100 1.231 12.0 1.26 to 2.01 . 21 1.654 1.822 10.2 2.01 to 2.51 . 2 2.143 2.494 16.4 Nonproducing, 18-pct ROR: to 0.52 .... 1 .510 .670 31.4 0.52 to 1.26 . 6 1.130 1.312 16.1 1.26 to 2.01 . 19 1.596 1.771 11.0 201 to 2.56 . . 7 2.211 2.501 13.1 ' Weighted average total cost represents the long-run market price per pound of copper necessary to cover full costs from all deposits in each price range. higher Federal income tax expenses, higher total capital costs, and the resultant determination of total revenues large enough to cover these total costs. The producing properties, for the most part, have recouped their initial (historical cost) investments, thus they have lower total costs relative to the nonproducing deposits which require huge capital investments in order to initi- ate exploitation. Therefore, for producing properties, both the absolute size of the depletion deduction and the economic effects of its repeal are to be interpreted as minimums, whereas the size of the total depletion deduction and the economic effects of its repeal upon nonproducing properties represents the expected future results since these properties represent current resource replacement costs. For the nonproducing deposits, the increase in cost from removing the percentage depletion allowance, as noted in table 6, is quite large. The importance of this in- crease to minerals availability lies in the fact that feasi- bility studies performed with the assumption of no per- centage depletion allowance will render these proper- ties less economic. This could result in the postpone- ment of development decisions and the resulting post- ponement in the economic availability of copper and its associated by-products and coproducts to the domestic economy from these deposits. For the nine nonpro- ducing deposits in the 15-percent rate of return base case price range of $0.51 to $1.26, the weighted average total cost of production per pound of recoverable cop- per was $1.10. Repealing the allowance would result in an average increase in the necessary price of recover- able copper of $0,131 per pound (12.0 percent) to $1.23 per pound. For the 21 deposits in the $1 .26 to $2.01 price range, the effect is similar. Repeal of the percentage depletion allowance would result in an average increase of $0,168 per pound of recoverable copper (10.2 percent) to $1.82 per pound. At an 18-percent level of profitability, the economic effect of repeal upon nonproducers is even greater. Only six properties could operate at this profitability level, in a price range of $0.51 to $1.26, with the per- centage depletion allowance in effect. Repeal of the al- lowance raises their weighted average total cost from $1.13 to $1.31 per pound or 16.1 percent. Further ex- amination of the data in table 6 demonstrates quite clearly that regardless of the arguments raised concern- ing the efficiency and rationality of the percentage depletion allowance, its importance to profitability and economic viability is certain. COPPER PRICE AND AVAILABILITY Figures 5 and 6 and tables 7 and 8 show the price ranges and availability estimates corresponding to indi- vidual producing and nonproducing properties, respec- tively, from repeal of the percentage depletion allow- ance. As in the base case analyses, producers were evaluated at break-even (0-percent) and 15-percent rates of return, nonproducing deposits at 15- and 18-percent rates. The producing properties at the 15-percent rate of return level require an overall necessary price increase of $0.03 per pound, to $1.86, in order for all 33 individual deposits to produce the total copper availability esti- mate of 40.132 million metric tons. These individual deposit results (fig. 5) are comparable to the aggregated results presented in table 6. The price ranges for nonproducing properties deter- mined with no percentage depletion allowance widen considerably. At the minimum 15-percent level, an over- all increase of $0.40 per pound to $2.56, relative to the base case price of $2.16, is required to allow all proper- ties to produce and earn the minimum rate of return. At the 18-percent level, an overall increase of $0.53 per pound to $3.08, relative to the base case price of $2.55, would be required to allow all properties to produce at this level. Figure 7 and table 9 illustrate the total potential re- duction in future supply availability, at each price level, for all 66 properties from repeal of this allowance. In order to estimate what the expected reduction would be, the total availability curves presented (base case and no percentage depletion) are those determined at the minimum and necessary rates of return (15- and 18-percent) for producing and nonproducing properties I 90 «. ISO | 1.70 •S 1.60 5 1.50 en ~ 140 " 1.30 o 2 I 20 o" 1. 10 => 1.00 O o- 90 E 80 — i 1 1 1 r KEY 15-percent rote of return 0- percent rate of return TOTAL RECOVERABLE COPPER, m 28 12 M I lion metric tons FIGURE 5. — Potential total copper production from currently producing properties at various prices and rates of return— no percentage depletion. TABLE 7. — Potential total copper production from currently producing properties at various prices and rates of return— no percentage depletion Copper price, U.S. dollars per pound' Number of properties Potential total Cumulative production, number of million properties metric tons Cumulative total production, million metric tons BREAK-EVEN RATE OF RETURN to 0.94 .... 0.94 to 1.07 . . 1.07 to 1.65 .. 11 11 11 16.949 11 12.348 22 10.835 33 16.949 29.297 40 132 15-PERCENT RATE OF RETURN to 0.94 0.94 to 1.07 .. 1.07 to 1.87 .. 7 10 16 14.617 7 10.151 17 15.364 33 14.617 24.768 40.132 1 Price equals average total cost, includes byproduct credits. 10 — i 1 1 i r KEY 18- percent rote at return 15- percent rate ot return ¥ Y 2 4 6 8 10 12 14 16 18 20 22 TOTAL RECOVERABLE COPPER, million metric tone FIGURE 6. — Potential total copper production from nonproducing properties at various prices and rates of return— no percentage depletion. 3.VJ 1 1 1 1"" KEY -1 1 - Cost only . Base cose r - 3.00 r ■ 2.50 - 2 00 r 1 r-* If if - ; - i-' J " - - jf ■ - r ") - .-'' r- — ^ - _ j l"^ - — '•r- r ~ — - _y ! - - ,-j~ i * - — JLi= - , i| KEY : M Cost only Base case I I i i ■ i - 1990 i i i i •" — r J - - j" 1 i - _r ,J r J - — ' s - r->' | !r— ^ - T_..r - i 1 1 1 1 1 - 2000 1 I I l - , i r - r f'~" \ - i* j ip — - .rjj - — c£~ — - - . . ■ ' i i 12 16 20 24 4 8 12 ANNUAL RECOVERABLE COPPER, million metric tons 16 20 24 FIGURE 8. — Potential annual copper production from producing and nonproducing properties in selected years- base case and no percentage depletion. 12 the analysis indicates that only a marginal effect would have been felt. In that year only producing properties provide availability. The properties that would be af- fected most are those in the high-cost range. By 1987, however, a definite reduction in availability is apparent. Those nonproducers that could operate would require significantly higher market prices to cover their average total cost of production if they were to obtain an 18-per- cent rate of return. At a price of $1.55 per pound, approx- imately 1.6 million metric tons of recoverable copper would be available in that year. This is an annual reduc- tion of approximately 200,000 metric tons. By 1990, as- suming a constant price-cost differential and reserve base, annual availability would decrease to 1.5 million metric tons from 1.7 million metric tons that was poten- tially available at this price with the percentage deple- tion allowance provision retained. By the year 2000, an- nual availability further declines to 1.00 million metric tons from 1.140 million metric tons in the base case. To place these availability estimates in perspective, in 1980, total domestic comsumption of copper was 2.767 million metric tons. Total domestic mine produc- tion accounted for 1.172 million metric tons (42 percent), with secondary production and imports accounting for the remainder/The price per pound of copper ranged from a low of $0.89 to a high of $1.33. Therefore, a total availability reduction of 4.403 million metric tons of cop- per at a long-run price per pound of $1.25 represents 159 percent of apparent 1980 consumption, and 375 percent of mine production in that year (16). THE INCOME LIMITATION AND THE MINIMUM FEDERAL TAX Under current tax law, the total allowable percentage depletion deduction is limited to 50 percent of before- tax income (as defined in footnote 11). In addition, the excess of percent over cost depletion is considered a tax preference item and is subject to a 15-percent mini- mum Federal tax (6, p. 3.41). These two provisions effectively limit the amount of benefit that may be derived from the percentage deple- tion deduction. The 50-percent limitation places a ceiling upon the total amount of taxable income that can be shielded from normal income tax payments. It is an industry-specific tax provision and can be raised, lowered, or removed to affect just this industry. The minimum Federal tax is not specific to the mining in- dustry and as such cannot be considered solely in the context of mineral taxation. The two provisions are interdependent. Raising or lowering the depletion limit, in turn, raises or lowers the amount of tax preference items, which causes minimum Federal tax payments to increase or decrease accord- ingly. Numerous analyses were performed to ascertain the trade off between higher depletion limits and higher minimum Federal tax payments. For producing properties, removing the limit entirely resulted in substantially larger minimum Federal tax payments, as well as increased tax payments to State and local governments, that more than offset the reduc- tion in corporate Federal income tax payments ob- tained from removing the limit. For nonproducing deposits, it was found that the economic effect from re- moving the income limitations, although resulting in iower weighted average total costs, was not large enough to significantly improve the economics of these deposits. Conversely, removing the minimum Federal tax that applies to the excess depletion deduction, re- sulted in a more economically significant decline in weighted average total cost. These results are presented in table 10. The significance of these results vary according to the time frame in which they are viewed. Although a decrease in the weighted average total cost for 25 pro- ducing deposits of one cent per pound, as a result of re- moving the minimum Federal tax on excess depletion, seems quite insignificant, when viewed over the long run its significance assumes its proper proportion. It has been estimated that approximately 40 million metric tons of recoverable copper are contained in the 33 producing deposits analyzed in this study. If the average total cost per pound of production for each of these deposits were to decline by one cent it would re- sult in a cost reduction of approximately $882 million over the total life of these deposits. The nonproducing deposits posted an overall decline of approximately 10 percent in weighted average total cost from repealing the minimum Federal tax. This is comparable in magnitude to the increase in cost as a re- sult of repealing the percentage depletion allowance. Indeed, this recognition of the importance of the mini- mum Federal tax as a limiting force to the complete uti- TABLE 10. — Economic effects of removing the deple- tion limit and minimum Federal tax upon producing and nonproducing properties within various base case price ranges Property Number Base case No depletion No minimum status of weighted limit Federal tax properties average weighted weighted total cost average total average total per pound' cost per pound' cost per pound' Producing, 15-pct ROR: to 0.51 .... 3 0.401 0.418 0.401 0.51 to 1.26 .. 25 1.031 1.076 1.021 1.26 to 2.01 .. 5 1.451 1.457 1.446 Nonproducing, 15-pct ROR: to 0.51 .... 1 .410 .400 .390 0.51 to 1.26 .. 9 1.100 1.088 1.070 1.26 to 2.01 .. 21 1.654 1.643 1.630 2.01 to 2.51 . . 2 2.143 2.130 2.067 Nonproducing, 18-pct ROR: to 0.51 .... 1 .510 .510 .490 0.51 to 1.26 .. 6 1.130 1.100 1.101 1.26 to 2.01 .. 19 1.596 1.591 1.572 201 to 2.56 . . 7 2.211 2.201 2.177 ' Weighted average total cost represents the long-run market price per pound of copper necessary to cover full costs from all deposits in each price range. 13 lization of the incentive provided by percentage deple- tion has led the American Mining Congress to petition for its repeal (73). Although perhaps politically difficult, it would be relatively easy administratively to remove the so-called excess depletion deduction from the list of tax preference items subject to this minimum tax. The cost reductions thus generated would significantly improve the economics of the nonproducing copper properties, ensure wider profit margins, and increase in- ternal cash flow. CHANGING THE STATUTORY PERCENTAGE DEPLETION RATE ON COPPER The first reductions in statutory rates of percentage depletion occurred with passage of the tax reform act of 1969 (19, p. 6). Although the allowance for copper re- mained at 15 percent, the rates on a number of associ- ated commodities were reduced. As was the case with the initial setting of percentage depletion rates on min- erals, these reductions bore no relationship to the level of imports, domestic reserve position, or criticality of the commodities in question to the domestic economy. This section quantifies the effects of both a 50-per- cent reduction (to 7.5 percent) in the statutory rate on copper and a 50-percent increase (to 22.5 percent) in order to ascertain the sensitivity of the total depletion deduction to the established rate. As before, the results are presented on a weighted average total cost basis in order to measure the general effect upon the industry. Table 11 details these results. What is immediately apparent from an examination of table 11 is that the most important factor is the provi- sion limiting the total percentage depletion deduction taken in any given year to 50 percent of before-tax in- come. This is clearly demonstrated by the absence of change in weighted average total cost for the producing properties. A 50-percent reduction in the rate applicable to copper effects no change because 7.5 percent of gross income in virtually every year is greater than 50 percent of before-tax income and taxpayers are required to deduct the lesser of the two sums. This Jaeing^he case, then an increase in the rate applicable to copper to 22.5 percent will also be greater than 50 percent of before-tax income and result in no change as well. The nonproducing properties do show a reduction in weighted average total cost in response to an increase in the rate on copper. However, the change is quite small relative to the size of the increase in the applica- ble rate. The 30 properties in the base case price range of $0.51 to $2.01 (at the 15-percent level) show a de- crease in weighted average total cost per pound of ap- proximately $0,005. The reasoning is the same as that for current producers; 50 percent of before-tax income for almost all years is less than 22.5 percent of gross in- come. This is particularly the case with these high cost properties. Reducing the rate to 7.5 percent would raise the weighted average total cost of production for all non- producing properties except one, since in this case 7.5 percent of gross income would be less than 50 percent of before-tax income and the taxpayer would then deduct the lesser sum. The increase in cost itself increases as higher rates of return are sought. This is most apparent in the $1.26 to $2.01 price range where 19 properties, in order to ob- tain an 18-percent return on investment, require price in- creases of approximately $0,044 per pound as opposed to a $0,039 per pound increase for the 21 properties in this price range at the 15-percent level. TABLE 11. — Economic effects of changing the statutory rate of depletion allowance applicable to copper upon producing and nonproducing properties within various base case price ranges Property status Number of properties Base case weighted average total cost per pound' 50-pct rate reduction weighted average total cost per pound 50-pct rate increase weighted average total cost per pound Producing, 15-pct ROR: to 0.51 3 25 5 1 9 21 2 1 6 19 7 0.401 1.031 1.451 .410 1.100 1.654 2.143 .510 1.130 1.596 1.211 0.401 1.032 1.451 .410 1.116 1.693 2.162 .520 1.141 1.640 2.301 0.401 0.51 to 1.26 1.031 1.26 to 2.01 1.451 Nonproducing, 15-pct ROR: to 0.51 .410 0.51 to 1.26 1.095 1.26 to 2.01 1.650 2.01 to 2.51 2.143 Nonproducing, 18-pct ROR: to 0.51 .510 0.51 to 1.26 1.126 1.26 to 2.01 1.585 201 to 2.56 2.178 ' Weighted average total cost represents the long-run market price per pound of copper necessary to cover full costs from all deposits in each price range. 14 The importance of this analysis is to underscore the point that reduction or increase of the statutory rate it- self is less important than the income limitation which is placed upon the percentage depletion deduction and the provision which stipulates that the lesser of the two sums be deducted. Of course, here also, feasibility studies performed under the assumption of only a 7.5-percent depletion rate on copper would render the nonproducing properties less economic although cer- tainly not to the extent that complete elimination of the percentage allowance would. CONCLUSIONS This study has quantified the minimum long-run de- pletion deduction potentially available to the domestic copper industry. Based upon constant March 1981 prices and costs, and assuming a 15-percent return on investment, a potential depletion deduction of approxi- mately $2.5 billion is available to currently producing properties. The nonproducing properties, analyzed under similar assumptions, showed a potential avail- able depletion allowance of approximately $9 to $12 bil- lion accruing over their total producing lives. Repeal of the percentage depletion allowance would result in a minimum income transfer from the domestic copper industry to the Federal Government of approxi- mately $1.5 billion for producers and a potential $6 to $8 billion transfer from nonproducers. The weighted average total cost of production for both producing and nonproducing properties was shown to increase significantly in response to repeal of the percentage depletion allowance. In addition, it was demonstrated that a 50-percent reduction in the per- centage depletion rate applicable to copper would also result in a significant increase in average production costs for nonproducing properties. For producing prop- erties, the statutory rate itself was shown to be much less important than the income limitation that is placed upon the percentage depletion deduction. Conversely, repeal of the minimum Federal tax provision was shown to be significant in reducing average production costs for both producing and nonproducing deposits. It can be concluded that the depletion allowance does operate both as a production subsidy and a method of capital recovery. However, the fact that a mineral producer must have positive before-tax income to receive any depletion deduction favors highly profit-* able producers over marginal producers. Repeal of the percentage depletion allowance to correct this inequity would only result in reducing profit margins for all cur- rent producers and postponing the eventual- develop- ment of currently nonproducing properties. Certainly a legislatively induced increase in domestic mining costs would result in increased imports and supply vulner- ability. Such a repeal would also be undesirable in light of the fact that profits, as a percent of sales for the domestic mining industry in general, averaged only 5 percent since 1974 (7, p. 94, 8, p. 359) and current Government environmental and safety regulations of the copper industry alone are expected to result in cop- per price (cost) increases of 43 percent through 1987 (8, p. 339). In addition, it has been conservatively estimated that cumulative -financing requirements for just the domestic copper industry will exceed $20 billion by the year 2000 (11, p. 40). 17 It is important to stress that this analysis has ad- dressed the potential size and effect of the income transfer from domestic copper producers to the Federal Government that could result from repeal of the per- centage depletion allowance. But given the increase in production costs and the subsequent increase in cop- per importation that would result from this repeal, it is quite clear that from a national income point of view the ultimate income transfer would be from domestic cop- per producers to foreign copper producers. The loss of domestic mining income and employment and the asso- ciated loss in domestic tax revenues that this implies, as well as the explicit cost of the additional copper im- ports for the U.S. balance of payments, would more than offset any gain in corporate income tax revenues that the Federal Government may obtain from repealing this allowance. In addition, there are other benefits from domestic copper production, such as the availability of byprod- ucts, help in attaining national defense stockpile goals, and the assurance of domestic supply which also need to be considered. Finally, given the importance of the depletion allow- ance as a tax provision, consideration should be given to redesigning the allowance to more equitably dis- tribute the benefits among mining firms and more easily administer and account for the cost of the allowance in the Government budget while maintaining the incentive it provides to the mining industry. This could possibly be accomplished by adoption of a per-ton production al- lowance. In light of the importance now being placed upon mining industry profitability and long-run viability, research into such a restructuring of the depletion al- lowance is warranted. ' Certainly all industries need capital and have a claim to tax relief. The above points are not intended to down play these concerns nor to set the mining industry apart from all others; rather they are intended only to underscore the impact of repealing this particular tax provision as it applies to the domestic mining industry. 15 REFERENCES 1. Berg, A. W., and F. V. Carrillo. MILS: The Mineral Industry Location System of the Federal Bureau of Mines. BuMines IC 8815, 1980, 24 pp. 2. Brooks, D. B. (ed.). Resource Economics. Selected works of Orris C. Herfindahl, pub. by Resources for the Future, Inc., Baltimore, Md., 1974, 316 pp. 3. Davidoff, R. L. Supply Analysis Model (SAM): A Minerals Availability System Methodology. BuMines IC 8820, 1980, 45 pp. 4. DeYoung, J. H., Jr., and P. N. Yasnowsky. Capital Forma- tion in the Nonfuel Mineral Industries - A Literature Survey. U.S. Geol. Survey, January 1980, 56 pp.; available from Na- tional Technical Information Service, Springfield, Va., PB 80-147549. 5. Feikowsky, S. Taxation and the Depletion Allowance. Materials and Society, v. 3, 1979, pp. 209-215. 6. John W. Whitney, Inc. (Reno, Nev.). Investment and Risk Analysis in the Minerals Industry. 1978, 229 pp. 7. McGraw Hill Publications. Business Week. May 4, 1981, 178 pp. 8. . International Minerals/Metals Review. Second Edition, 1980, 547 pp. 9. National Commission on Materials Policy. Material Needs and the Environment Today and Tomorrow. June 1973, 286 pp. 10. National Commission on Supplies and Shortages. Gov- ernment and the Nation's Resources. 1976, 211 pp. 11. O'Neil, T. J. The Minerals Depletion Allowance: Its Effect on Future Supply and Financing. Min. Eng. v. 26, No. 11, November 1974, pp. 39-42. 12. Rosenkranz, R. D., R. L. Davidoff, and J. F. Lemons, Jr. Copper Availability — Domestic: A Minerals Availability Sys- tem Appraisal. BuMines IC8809, 1979, 31 pp. 13. Seidman, L. W. Taxation. Am. Min. Cong. J., v. 67, No. 6, June 1981, pp. 32-34. 14. Stermole, F. J. Economic Evaluation and Investment Decision .Methods. Investment Evaluations Corp., Golden, Colo., 1974, 449 pp. 15. Tannewald, R. Analysis and Evaluation of Arguments For and Against Percentage Depletion. Library of Congress, Con- gressional Research Service, March 1978, 60 pp. 16. U.S. Bureau of Mines. Minerals and Materials/A Monthly Survey. August 1980 through March 1981. 17. . The Bureau of Mines Minerals Availability System and Resource Classification Manual. BuMines IC 8654, 1974, 199 pp. 18. U.S. Geological Survey and U.S. Bureau of Mines. Princi- ples of a Resource/Reserve Classification System for Miner- als. U.S. Geol. Survey Circ. 831, 1980, 5 pp. 19. U.S. Government Accounting Office. Domestic Taxes and Minerals Availability: A New Method for Understanding Their Relationship. 1980, 139 pp. 166 82 vv V * *q. *&- c? ^.j«i..% ./\-^-\. o*'.^:.*»o ./ bK r^o^ .•*&&•• \/ ••»"• %/ #• *,/ V^ 1 fc %„♦♦ :'M£: \.S -'Jfe-- **.«♦♦ .'isS&'. V.# • G* \9 *'T?T* A ^ . "of »°"t. -sipv *<°- : .«§ip-' *■***. '-sup* s°* ■■*w?. : , ! °^ *' * *bv* :£m>*~ *W :*o»a*. r ov^ r ^Cr ^0 T ^ -•-• , ,-?> * . . » «, ••/V V.--. h u ' ,,, >* .•■••X'-V