The Economics of Western Coal Severance Taxes

Abstract

The recent upheavals in fuel markets have altered competitive relationships between fuels. Rising prices and government regulations have eliminated oil and gas from consideration as fuels for new electric utility plants. Further, public acceptance of nuclear power has diminished to the point that coal is the only practical alternative source of energy for new base-load generation facilities. This change in market structure creates opportunities for those with market power. The demand for coal has become less elastic, and those in a position to exert market power can take advantage of the situation to raise prices. The coal industry itself is competitive. Coal producers will, in the long run, be forced to sell at long-run marginal cost where marginal cost reflects the cost of production as well as the competitive rent accruing to owners of depletable resources. Labor supply is, to an extent, controlled by the United Mine Workers union, yet competition from nonunion miners limits the union's ability to act.1 Other elements of the inIncreases in oil and gas prices and the decline of nuclear power have led to an increase in the competitiveness of coal. This change in relative economics has been particularly great for the six western coalproducing states where large low-cost deposits of environmentally acceptable low-sulfur coal are found. Montana and Wyoming have responded to this situation by raising severance taxes substantially, and other states are considering similar actions. This has led to congressional attempts to limit state coal taxes. Using an integrated model of the U.S. coal and electric utility industries, this paper estimates how high coal severance taxes might rise with and without such legislation. Competition and incentives for cooperation between Montana, Wyoming, and other western states are examined. Efficiency and distributional implications are discussed. * An earlier and much different version of this paper was issued as Hoover Institution Working Paper E80-9. We are indebted to George Rozanski and Carol Bugbee for help in implementing the model described herein and to an anonymous referee for helpful suggestions. We are also indebted to the M.I.T. Center for Energy Policy Research for the support that allowed us to complete this revised version and to the Hoover Institution for its initial support. 1. Western coal production has expanded most rapidly and miners there are largely nonunion.