Corruption in Tapping the Oil Rent
In the US, the Minerals Management Service has been lax in tapping the oil rent
December 1, 2006
Fred Foldvary, Ph.D.

Land rent is recognized by enlightened economists as the supremely equitable and efficient source of public revenue. Rent is a social surplus, and tapping it involves no excess burden, unlike taxing productive activity.

One type of land commonly tapped for government revenue is the economic rent of material natural resources such as minerals and oil. Oil royalties from extraction, referred to as severance taxes, are important in petroleum-producing economies, including some states such as Alaska in the USA. There are also federal royalty revenues on oil via leasing rents in federal territory. Some 2600 companies paid federal royalties of $12.8 billion on 27,800 leases in 2005.

In the US, the Minerals Management Service (MMS), a bureau in the U.S. Department of the Interior, is responsible for monitoring the oil companies that operate in federal territory and collecting the revenue. The MMS has been lax in tapping the oil rent.

An investigation of the MMS by the Interior Department's inspector general reported that the MMS had audited only a fifth of the companies during the past three years. The investigation, conducted at the request of the U.S. Senate Committee on Energy and Natural Resources, found that since the year 2000, the MMS has reduced the number of auditor positions by some 16 percent. The number of audits fell from 595 in 2000-01 to 461 in 2004-05.

According to this report, published in December 2006, the MMS mostly relies on data provided by the oil companies, rather than from effective audits and site visits. Some of the audits that it does conducts have been found to be incomplete. Moreover, some off-shore drilling leases signed between 1998 and 1999 lack the price thresholds needed to determine the amount of royalties, a deficiency which has reduced federal royalties by $10 billion.

This lack of oil rent collection does not benefit the economy. It increases the federal deficit, which then requires more borrowing and interest payments by the government. Properly done, tapping the economic rent of oil production is economically neutral. The costs of exploration, extraction, and normal returns to investors are subtracted from gross revenues to obtain the economic rent, the revenue not needed for efficient production. While the economic rent is an estimate, it is nevertheless not a wild guess, since oil has a common world price, and the companies with low costs get a producer surplus relative to those with higher costs. That surplus is economic rent.

The director of the Minerals Management Service has promised to develop a comprehensive plan to remedy the failures detailed in the inspector general report. While we can hope that these problems will be corrected, in the long run the effectiveness of the oil royalty collection depends on the incentives of the agency and of Congress and the federal administration. Evidently, incentives for effective royalty collection have been lacking for many years, and the incentives have been reduced in recent years.

Energy companies are big contributors to politicians who run or stand for office. The web site Open Secrets operated by the Center for Responsive Politics provides data on the millions of dollars paid by oil and gas interests to candidates for federal offices.

According to the Open Secrets web site, "This industry, which includes multinational and independent oil and gas producers and refiners, natural gas pipeline companies, gasoline service stations and fuel oil dealers, has long enjoyed a history of strong influence in Washington, thanks to the more than $182 million it has contributed to candidates and parties since the 1990 election cycle, 75 percent of which has gone to Republicans." You can also see which companies and their political action committees (PACs) are the top contributors.

We should not blame the oil company chiefs, since they are playing the game set up by the structure of government. The rules of the game let such companies contribute millions in order to reap rewards of billions. Mass democracy creates an inherent demand for millions of dollars in campaign money, and the incentive of politicians is to accept special-interest money if they want to get elected. The very structure of mass democracy is inherently corrupting.

Because of the recent investigation, there could be some near-term improvement in the oil royalty collection, but in the long run, government revenues fall mostly where there is the least political resistance, on the millions of workers who lack the means and incentives to actively resist being fleeced.

Until people recognize that the structure of government biases the system against their interest, powerful interests will shift the tax burden to the masses who sheepishly keep voting for the conventional lesser evils rather than for righteous radical reformers. When will the voters learn better? Not until there is a mass movement to reform mass democracy.

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Fred Foldvary, Ph.D.

FRED E. FOLDVARY, Ph.D., is an economist and has been writing weekly editorials for since 1997. Foldvary's commentaries are well respected for their currency, sound logic, wit, and consistent devotion to human freedom. He received his B.A. in economics from the University of California at Berkeley, and his M.A. and Ph.D. in economics from George Mason University. He has taught economics at Virginia Tech, John F. Kennedy University, Santa Clara University, and currently teaches at San Jose State University.

Foldvary is the author of The Soul of LibertyPublic Goods and Private Communities, and Dictionary of Free Market Economics. He edited and contributed to Beyond Neoclassical Economics and, with Dan Klein, The Half-Life of Policy Rationales. Foldvary's areas of research include public finance, governance, ethical philosophy, and land economics.

Foldvary is notably known for going on record in the American Journal of Economics and Sociology in 1997 to predict the exact timing of the 2008 economic depression—eleven years before the event occurred. He was able to do so due to his extensive knowledge of the real-estate cycle.