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Oil and Gas Leasing: a Study in Pseudo-Socialism

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br />1983; rev. 2/93
Paper delivered at Annual Conference, Western Tax Association
Queensway Bay Hilton, Long Beach, CA, June, 1983

I pose three questions.
I) What is Socialism?
II) What is pseudo-Socialism?
III) How should we administer public lands bearing oil and gas?

"Socialism," in common usage, is a Protean word, slippery and shifting. Many use it without
defining it, whether from innocence, negligence, or cunning. These many include not just the
vulgar, but most economists: semantic care is weak in the traditions of the profession.
"Rigorous" model-builders today are among the offenders: the premium is on gilding the
superstructure, neglecting the foundation. Indeed, foundations are not even needed for models
that float in outer space, vouching for and communing mainly with each other.
Those who do define Socialism, explicitly or implicitly, use the word for different things. A
major difference, treated here, is between Managerial Socialism (who decides) and Distributive
Socialism (who gets). These may overlap, but are independent of each other and often conflict.
For example, Riverside, CA, owns its own electric utility (on whose Board I sit, losing battles).
This is Managerial Socialism, municipal style. Its traditional rate structure includes large
elements of cross-subsidy, mainly taking from the lower middles for the rich, tempered by
crumbs thrown to the very poor. The same is true of our water system, and of most municipally
owned and managed utilities around the nation. Water and sewer service are common examples
of Managerial Socialism (from which the mnemonic "sewer socialism"). They have little in
common with Distributive Socialism.
At higher levels of government, also, Managerial Socialism may play reverse Robin Hood. In
British Columbia the "Socred" (right-wing) party in the 1960s socialized the ferry service, the
provincial railroad, and the electric utility (now B.C. Hydro), using them in schemes to enrich
land speculators. To boost along B.C. Hydro they raided the teachers' pension fund, borrowing
from it at rates near zero. The New Democratic Party (NDP) (left-wing), taking power in 1972,
ended the raid on teachers, but not the cross-subsidy. In California, the State Department of
Water Resources (DWR) designed, built, and operates the California Water Plan (CWP) for the
primary gain of a handful of giant landowners. They, too, raided education, taking certain State
oil revenues (known as the COPHE fund) previously earmarked for The University of California.
Such examples could, of course, be extended at length.

Another form of Managerial Socialism is direct administration of public lands. Our National
Forests are an example. The track record is not good. The Forest Service manages a national
asset worth over $100 billions, from which it generates no positive cash flow. Latent surpluses
die a-borning. At one time this was from an excess of ideological commitment to slow cutting
cycles and "community stability," as exemplified by Congressman James Weaver's dedication to
Roseburg, OR. More recently it is from internalizing profits and plowing them into roading
submarginal forests for premature cutting. Either way it soaks in revenues from other sources,
yielding nothing back. Even if one likes the model, it could not be universalized.
More commonly, public landlords lease lands to private firms, limiting their managerial input
to dirigisme expressed in regulations and guidelines. The Bureau of Land Management (BLM)
thus administers its vast empire as mainly a passive landlord. Its main task is just collecting rents.
To the extent The Bureau does a good job, or Congress lets it do a good job, this evinces more of
Distributive than Managerial Socialism. To the extent it does a bad job it is "Pseudo-Socialism,"
to be discussed presently.

Distributive Socialism, in contrast to Managerial, means tapping surpluses in the private
sector and using them for the public good. The revenues may provide public services that are
available to all, like schooling and social security; or be used to abate regressive taxes; or be used
to finance social dividends paid in cash, as in Alaska. Revenues may also be used to finance
public works, even though these benefit only a few specific landowners. This becomes
Distributive Socialism when the enhanced land rents are tapped to recoup more than the allocated
expenditure. (If only expenditures are recouped, it is more like a contract between the state and
the landowners.)

Interjurisdictional transfers are not properly "Socialism," but a reshuffling of rents among
landowners. These transfers are called "horizontal balancing" in the lingo of fiscal federalism.
They are a long step removed from the social dividend paid to individuals as such. They are
properly decried for "taxing poor people in rich places to help rich people in poor places." These
"poor places" include developmental regions and local districts, poor today but prospectively
rich, where landholdings are large and speculative. Horizontal balancing devices thus fall in a
class of artful dodges, seductions, and diversions leading from Distributive Socialism to Pseudo-

Distributive Socialism also means administering public lands pro-actively, affirmatively, to
maximize revenue, in the manner of private landlords. Not to do so is to let private lessees keep
and privatize the surpluses generated by resources in the public domain. The NDP in B.C. earned
its Socialist stripes by raising rents on Crown lands owned by the Province ("The Crown
Provincial," in Canadian terms). The Minister of Lands did this directly by renegotiating timber
and other leases, on a site-specific basis.
The NDP Administration tried to socialize the surpluses in gas production by joining Managerial and Distributive Socialism in the B.C. Gas export monopoly, a Crown Corporation. It was to levy a tax in the form of a monopoly profit on gas transmission and export. Here they stumbled by failing to recognize the differential, site-specific nature of rent. They made it too easy, thinking it was just a matter of buying low and selling high, across the board. They set a uniform field price. It was, naturally, too low not to stifle high-cost producers, and yet too high to tap most of the rent taken by low-cost producers. They failed to rifle in on the source of the surplus.

Thus, to define Distributive Socialism we need to define "surpluses." These are primarily
rents from lands and resources given by nature. In an open tax jurisdiction, labor and capital are
mobile and their supply is elastic; only land is fixed. Land rent is the basic taxable surplus.
Where there is no land rent, an attempt to levy any tax can only abort production and land use,
rather than collect the tax. Where is there no land rent? First, there is no rent generated on
"marginal" land that is just barely worth using at all. Second, and more generally, there is no rent
generated by marginal increments of labor and capital applied on any land, from the best to the
worst. Otherwise, all production on land generates some rent, which is a taxable surplus.
The statement above expresses "The Physiocratic Doctrine" of tax incidence, harking back to
Francois Quesnay, and even earlier writers like John Locke and Jacob Vanderlint. The Doctrine
has staying power: it is used, for example, by Bogart, Bradford, and Williams writing in the
National Tax Journal, December, 1992, on tax incidence in New Jersey.
Capital, unlike land, migrates among taxing jurisdictions. The return to reproducible,
depreciable capital is not, therefore, generally a surplus. Capital differs from land. Capital has to
be attracted, and, if domestically generated, dissuaded from emigrating. It is true that in the short
run existing capital, if affixed to land, cannot be exported. Its returns thereby become a
temporary taxable surplus - hence the name "quasi-rent." Capital can still be dissaved, however,
through neglect of maintenance, and will not be replaced. The demonstration effect of
disappointing old investors' earlier expectations will have a high cost in repelling future investing
by them and others. Old buildings, unmaintained, will shed blight on their surroundings. Nonreplacement,
in a dynamic world, guarantees early obsolescence. Capital finds many subtle ways
of emigrating, or being disinvested and consumed. Its yields are not really a taxable surplus when
we factor in the consequences of trying to tax them: withering away of the community.1
The Physiocratic rule, which may seem novel and subtle in tax discourse, stands out nakedly
whenever landowners, public or private, negotiate leases. If a lessee is required to pay a share of
his gross sales (a royalty), he compensates by offering that much less on the "bid variable," (often
a "bonus" paid up front). Lessors and lessees understand this well: it is central to all their
negotiations. Whatever the twists and turns, the rule of compensation applies: take more here, get
less there. The lessee is to supply labor and capital at full cost; acquiring use of land will yield
him a surplus above costs. That surplus is all he can and will pay for. The maximum of economic
surplus is the rent of land in its highest and best legal use.

Distributive Socialism, then, means tapping land and resource rents for the public. On the
public domain, acknowledged to be public property, the institutional basis of Distributive
Socialism is fully in place. We need only apply a good leasing system, keeping rent payments up
to current values. On fee simple lands, Distributive Socialism means and requires modifying tax
systems to rifle in on rents.

Rifling in is essential. Recall, the Physiocratic rule of compensation says all taxes are shifted
to rents anyway; some take that to mean any tax will do. However, "broad-based" taxes like VAT. These strictures apply a fortiori when the substance of capital, along with the yield, is taxed away or a general sales tax sterilize lands that would be just marginal before tax. They also abort all marginal and near-marginal activity on all lands, for marginal inputs (where marginal cost equals price) generate no rent. That in turn forces rates to be kept low, to avoid destroying half the economy. Such taxes socialize all the rent from lands that are now made marginal after-tax, but leave most rent untapped on the most rentable lands and resources. Taxes that rifle in on rent, on
the other hand, inherently exempt marginal activity. They may be set at very high rates, tapping
more of the taxable surplus, or rent.

Analogously, recall the case of the B.C. Gas Corporation cited earlier. This is a public agency
set up to extract rents from gas resources by monopolizing export, buying low and selling high.
Its fatal initial error was to set a uniform field price. This price must remain fairly high to avoid
stifling the high-cost (marginal) producers. As a result the price is high above that needed for the
low-cost producers, leaving them enjoying the rent of the resource.
Let's look at a simple numerical example, to make the point. Say the uniform field price is set
at $1/mcf, while costs of production range from 20 cents to $2 per mcf. All producers with costs
over $1 are wiped out; all those with costs under $1 are left taking a surplus per unit of $1 less
their respective costs. The example is useful to understand how taxes work, too. The B.C.
monopoly cut is just like a tax levied on each unit of production.
Whether on public domain or fee simple lands, Distributive Socialism has three compelling
attractions. One is, it requires no Managerial Socialism; it may work through the free market. It
does not preclude elements of Managerial Socialism, where these are otherwise desirable; it
simply does not require them.

The second attraction is that it lets taxes be progressive without impairing incentives. Taxes
that rifle in on rents are progressive and distributively socialistic because the ownership and
control of rent-bearing lands is highly concentrated in a few hands.
The third attraction is that taxes on rent may be heavy without impairing incentives, precisely
because rent is a surplus. The land-tax component of the existing property tax is a good model.
With this tax, there is no "taxable event" required. Taxes are simply due periodically, based on
an external assessment of the land's market value, which in turn derives from rent of its highest
and best prospective use.

Most political leaders live and orate in a world of dismal choices and trade-offs. To them,
there is no cutting the deficits, either state or federal. We must cut taxes or lose jobs. We must
make taxes regressive or destroy useful incentives. On the other hand, once we define, identify,
and rifle in on rent as taxable surplus, those hard choices vanish. We can have higher taxes and
more jobs, both at once. We can tax progressively while simultaneously enhancing incentives to
produce and save.

Likewise, on lands still in the public domain, we can rifle in on rent by framing and
administering a good leasing policy. Leasing does have some transaction costs, but the private
market does it anyway. There is a reasonable, if less than perfect, track record. Ground leases are
common in downtown real estate, nationwide, even under imposing structures like the Empire
State Building, and Rockefeller Center. The Irvine Company, holding 20% of Orange County,
California, has long declined to sell land, but only lets it for intermediate terms. Much of Hawaii is developed on the same terms. Most oil and gas is developed by lessees on private land, yielding large rents to the lessors.
Why cannot the U.S. Government as lessor do what private lessors do, extracting the surplus
for the owner? Here we meet the obstacle of Pseudo-Socialism, to which we turn.

Pseudo-Socialism is what happens when resources in the public domain are leased below a
market rental, giving away part of the public interest. That has the effect of installing the lessee
as though he were the owner. The BLM, leasing grazing privileges on Federal lands in the west,
has fallen into this pattern conspicuously and notoriously, subject to pressure from western
Senators who have the power of many votes in the U.S. Senate relative to their state populations.
The dollar values are small, but the object lesson is visible, depressing, and cautionary.
Some other bad examples are school section lands in the middle states. These originated as
Federal land grants intended to support local schools. Some of them are corruptly let to insiders
in "sweetheart deals" for token rents. Another bad example is the County of Los Angeles, which
owns lands in the Marina del Rey district. One parcel lay idle for 25 years in the control of a
politically well-connected developer who finally went bankrupt and walked away from it, leaving
unpaid even the token rent charged. A third bad example is ironic: Fairhope, AL, founded and
chartered specifically as a "single-tax colony," to exemplify the principles of Henry George. The
Fairhope Corporation owns the land and collects the ground rent for public purposes. However,
when a new generation arose "that knew not Joseph" it proved politically impossible to keep
colony ground rents up to market.

Another aspect of Pseudo-Socialism, practiced by Interior Secretary James Watt, is to offer for
immediate sale, for spot cash, much more than the current market can absorb. For example, in
April, 1982, Interior leased out coal reserves in the Powder River Basin of Wyoming and
Montana. The sale comprised 1.6 billion tons, at 3.5 cents/ton. Leases were for 50 years, with
few development requirements. The industry already had a 200 year supply under lease, with the
result that few bid, and they bid low. The winning bidders were a tiny number of huge
corporations, those with slack money to buy reserves for the far future.
Meantime, on the Outer Continental Shelf (OCS), a billion acres (ten times the area of
California) was to be leased before 1984. Before that, major oil firms had about 1/5 of that area
under lease, looking many years or several decades ahead of need. This helps explain why a
recent Alaska sale, an old Naval Petroleum Reserve (NPR 4), fetched only 14% of the anticipated

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Mason Gaffney first read Henry George when a high school junior , and became notorious among his classmates for preaching LVT to them . H e served in the S.W. Pacific during W.W. II, where he observed the results of land monopoly in The (more...)

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