chinery and equipment and so on. To that extent, it is a special benefit to the industry and indeed to many other industries.

However, as I look at it from my peculiar perspective, my costs of my company have increased tremendously, particularly since 1977, that was the year, of course, the Surface Mining Act was adopted, the black lung benefit amendments were adopted, and since that time, there has been intensified regulation of the coal industry. We do have one surface mine, but three underground mines. I know of nothing that is subject to more regulations than that industry.

That regulation, although it is sometimes hard to quantify in terms of costs, we know it is there, and we know it is substantial. So from my perspective, what I am looking at is something where in the last 8 years the cost of this business has increased tremendously, and in the meantime our profit has been steadily eroding, and I am faced very shortly with the necessity of deciding where to go with our operations because we do need to very soon consider whether to open additional properties.

Those properties are very, very expensive to build. We have estimated it would cost us about $65 per ton of capacity if we look at a million-and-a-half-ton mine, which would be about normal for an underground mine in our area. We are talking about something in the neighborhood of $100 million. Now, this is a tremendous investment in terms of the past and in terms of today.

In order to justify that kind of investment, it seems to me we have to have some ground rules on tax policy. Only last year the Congress adopted a provision with regard to accrual of mine closing and mine reclamation expenses. Particularly the closing expenses because those are the expenses that are so large when you cease operations and yet at a time where your income may collapse to

zero.

However, in the space of only 1 year, tax policy has changed. It seems to me we have to make up our minds as to whether or not we are going to have something upon which a person, like myself, can base an investment decision, and one of those decisions, of course, that is going to be very, very important to me is percentage depletion. This does provide a tax benefit to me. I recognize that, and I realize it.

But at this point in time, I state that it is a very necessary tax benefit to me. If I am deprived of that, my return on investment will drop to the point where a further investment is very speculative at that point. The risks are high enough, particularly in the Illinois basin. Because of the sulfur content of our coal, we are subject to tremendous risks which are not being accounted for in terms of return on investment, particularly if the depletion allowance is withdrawn.

With that, I think I will close my remarks and say thank you for the opportunity to testify.

[The prepared statement follows:]

STATEMENT Of George KelM, PRESIDENT, Sahara Coal Co., ON BEHALF OF THE MINING AND RECLAMATION COUNCIL OF AMERICA

SUMMARY

1. Several elements of the President's proposals for tax reform will directly impact the coal industry and result in-(1) increased coal and oil imports into the U.S. for power generation; (2) increased electricity imports from Canada; (3) a decline in the U.S. share of the world coal markets and a reduction in coal's contribution to the balance of trade deficit; and (4) higher prices for domestically produced coal than would otherwise have occurred.

2. The proposed changes in the tax treatment of coal, particularly the modifications to the depletion allowance for coal, will dramatically reduce available working capital for investment in new technologies for more cost-efficient environmental compliance and mining technologies and new mines; and, result in increases in the cost of obtaining capital in the equity and debt markets for the coal industry. As a consequence, the current 7-year trend of productivity increases in the coal industry will not continue and the coal industry will, as a result, become less competitive with competing fuels, and imported coal and electricity in domestic markets and less competitive with foreign coal in world markets.

3. Over the past several years, many coal mines have been only marginally profitable. The increased tax burden on the coal industry will decrease the after-tax return on investment (ROI) for existing and future mine projects. This reduction in ROI will both decrease the attractiveness of the coal industry to outside investors and substantially reduce the availability of internally generated working capital for new investments. As a consequence, the cost of capital for the coal industry will increase; the industry will stagnate and begin to shrink; and, the number of highlypaid skilled jobs in the mining industry will be reduced as investment capital and operators leave the industry and pursue ventures which promise a higher ROI.

4. The proposed tax changes for the coal industry would have a particularly adverse impact on smaller-independent coal operators. These operators are almost exclusively independent upon internally generated working capital for the necessary cash flow to expand their existing operations and opening new mines.

5. The proposed treatment of exploration and development costs for the coal industry will further decrease internally generated cash flow; is basically inequitable vis a vis other industries; and, is inconsistent with the policies of the Interior Department to develop exploration data for future coal development on federal lands. 6. The proposed repeal of capital gains treatment of coal royalty income abrogates an agreement reached between the Congress, the Treasury Department and the coal industry in the 1984 Tax Act. Repeal jeopardizes the economics of contracts already entered into which were grandfathered by the 1984 Tax Act and will increase the cost of acquiring new coal properties by decreasing the after-tax return of landowners who lease their mineral rights for development.

7. The proposed repeal of the statutory provisions enacted in 1984 for accrual of reclamation reserves abrogates an agreement reached between the Congress, the Treasury Department and the coal industry in 1984 and is directly inconsistent with the general treatment of accrual basis taxpayers and the policies of the Federal Surface Mining Act to promote contemporaneous reclamation of surface mined areas. 8. The proposed changes will precipitate a decline of the projected growth of the domestic coal industry; a decline in number of available skilled jobs in the relatively high wage coal industry; a decline in economic activity in the historic coal mining regions of the Nation; and, a restructuring of the highly competitive coal industry resulting in a further decline in numbers of independent coal operators.

9. The provisions of the tax code proposed to be changed for coal are an integral part of our Nation's industrial, economic, and energy policies. Any modifications of these provisions must be closely scrutinized in light of the ramifications these tax policy changes will have on other national policies and national security.

STATEMENT

Mr. Chairman, members of the Ways and Means Committee. I am George Kelm, President of Sahara Coal Company, Chicago, Illinois and appear today on behalf of the members of the Mining and Reclamation Council of America (MARC).

MARC is a national trade association of coal producers and ancillary industries from every producing region of the United States. Through its company members and 31 affiliated state and regional coal associations, MARC represents over 60 percent of the nation's coal production this past year.

Sahara Coal is a privately owned company with offices in Chicago and four coal mines, three underground and one surface mine, in Saline County, Illinois. Sahara Coal, which has contributed to the economy of Southern Illinois for over 85 years, employs 650 individuals-500 union and 150 non-union-in its mines. Using a standard multiplier for the coal industry. Sahara's operations are responsible for over 1600 jobs in the Illinois Basin coalfields.

The President's tax proposals for "Fairness, Simplicity, and Growth" contains a series of provisions designed to raise billions of dollars over the next few years. Several of these will adversely impact the coal industry. While overall the proposal is a laudable attempt to impart "fairness" to the tax code, the reforms would reverse a number of longstanding industrial policies.

Much of the revenue needed for the tax redistribution components of the plan would be raised by taking back production and capital formation incentives for basic industries as coal. Those incentives are critical to enabling the U.S. to continue to be the most efficient, safe, and environmentally sound coal producer in the world. At the outset it must be noted the coal industry already pays more than its fair share of taxes. In addition to its federal income taxes the coal industry also pays over $700 million per year to the federal government in special taxes on the coal industry-the black lung and surface mining tax-in addition to royalty payments on federal coal and state income and severance taxes

For the past several years many of the coal industry's capital investments have been only marginally profitable-in part due to the one or two major tax provisions that encourage exploration and development. In this regard, the coal industry is acutely concerned by the President's proposal to phase out percentage depletion for coal and practically eliminate expensing of exploration and development costs. Changes to these provisions would compound the tax burden on the coal industry as would proposals, to a lesser degree, to eliminate the capital gains treatment for coal royalties and the accural of reclamation reserves.

Coal's effective 8.5% depletion allowance is already low compared to other minerals, which receive allowances as high as 20%. While all domestic minerals are extremely important to the Nation's welfare, none are more important to the economy and our energy independence than coal. As the Committee is well aware, the Congress, through the decade of the 1970's-in response to major "oil shocks"-established a national policy to utilize domestic resources and reduce the importation of energy from abroad to the maximum extent feasible. This policy would be seriously jeopardized by the President's proposed changes in tax treatment of the coal industry.

The coal industry has been severely impacted by the current worldwide recession. Both domestic and foreign production are down in 1985. Hundreds of mines are closed and thousands of miners continue to be out of work. Artifically low gas prices, the oil glut, and high transportation and environmental compliance costs for coal are making coal less competitive with other fuels. Any additional tax burden or change in percentage depleton will exacerbate the problems facing the entire coal industry. Both small and large producers will be impacted, since depleton is figured on a mine-by-mine basis.

In spite of the current downturn in coal markets, the coal industry must begin now to accomodate expansion and growth for the future to meet the Nation's projected needs. By conservative estimates, the coal industry will require capital investments of at least $30 billion in constant dollars between now and the year 2000. This amount is inordinately larger than the current total industry capitalization of $20 billion. As outlined below, the proposals under consideration will make the needed capital increasingly scarce and far more expensive.

While capital costs vary according to the terrain and the depth of the seam, it is generally accepted that the capital cost to install a new mine, exclusive of the cost of coal, averages about $65 per ton of annual production. This figure does not include the substantial administrative costs prior to start-up, such as securing permits, surveys, feasibility studies, and other related costs. Thus, a medium-sized mine, with a capacity of one million tons a year, represents well over a $65 million capital expenditure by the time it actually begins commercial production. These new mines will mean thousands of additional jobs for miners.

Production costs are also skyrocketing. Total industry production costs increased over 100 percent during the period 1975 to 1984. The cost of machinery alone was up over 125 percent during that period. In spite of this trend, prices for coal have increased by a smaller percentage. In fact, in constant dollars the national average minemouth price of coal has declined by 18 percent over the same period. The coal industry has survived this shrinking margin between costs and prices by making the necessary investments to increase productivity. Over the past seven years pro

duction per man hour has increased 175 percent in underground mines and 145 percent at surface mines. This impressive record of productivity increases is largely the result of investing internally generated working capital in improved technologies for extracting coal and the acquisition of more productive equipment to be used in the mines. Elimination of percentage depletion for coal would directly and significantly reduce the availability of working capital for such investments in the future, thereby threatening future productivity increases in the coal industry.

Coal must compete in the money market for its capital requirements. Given the high risk nature of coal mining, the industry's cyclical nature, and the present low profit margin, any reduction in tax incentives that have a current or future adverse impact on profits will make capital for opening new mines less available and more expensive.

Coal operators, as any other business, look at their potential return on investment (ROI) in determining whether to invest in a new mine and related facilities, and, as any other businessman, the coal operator's bottom line is making a decision based on the after-tax ROI. Percentage depletion, and the other incentives mentioned earlier, are significant components of ROI and a major source of cash flow for investments in productivity improvements, research in more cost efficient environmental compliance and mining technologies, and new mines. By itself, and in conjunction with other proposed tax changes mentioned herein as well as the Administration's proposal to increase the black lung excise tax by 50 percent, the after tax ROI on coal mine projects promises to be substantially lessened and in many cases, eliminated.

This reduction in ROI will both decrease the attractiveness of the coal industry to outside investors and substantially reduce the availability of internally generated working capital for new investments. As a consequence, the cost of capital for the coal industry will increase; the industry will stagnate and begin to shrink; and, the number of highly-paid skilled jobs in the mining industry will be reduced as investment capital and operators leave the industry and pursue ventures which promise a higher ROI.

As investment in technologies to increase productivity and in new mines shrinks, the production cost per ton on coal will increase relative to competitors to the United States coal industry in both domestic and international markets. This will result in (1) increased coal and oil imports into the U.S. for power generation; (2) increased electricity imports from Canada; (3) a decline in the U.S. share of the world coal markets and a reduction in coal's contribution to the balance of trade deficit; and (4) higher prices for domestically produced coal than would otherwise have occurred.

Mr. Chairman, Energy Secretary Herrington, in testifying recently before the Senate Finance Subcommittee on Energy and Agricultural taxation stated that: "The net effect of the President's tax proposal on the coal industry. . will mean a higher level of tax liabilities for both existing and future coal mines, with an eventual price increase of perhaps 5-10% on coal from new mines

The Secretary's observations, based upon an analysis we have not had the opportunity to review, would appear to be generally accurate. They reflect, however, a fundamental misunderstanding of the coal market. The price of coal is determined by the economic law of supply and demand. So long as oil is available for base and peak load power generation at stable or declining prices; foreign coal is available at prices as much as 30% below domestically produced coal in selected markets; and imported electricity is available at prices below the cost of power generation domestically, the prices for coal cannot rise since the market will not purchase it at a higher price.

As a consequence, coal operators will have to absorb the "higher level of tax liabilities" the Secretary noted. Both their tax margins and internally generated working capital will be reduced with the effects, outlined above, the expected result. The impact of these changes, while they will effect all coal operators, will be acutely felt by the small, independent coal operators MARC represents. Generally, these operators, which comprise the overwhelming majority of operators in the industry are privately owned and almost exclusively dependent on internally generated cash flow for capital. The President's proposals will dramatically decrease the cash flow available to such operators.

As a consequence, should the proposed changes be effected, the Committee should anticipate an acceleration of the trend toward concentration in the coal industry. According to the Energy Information Agency, small companies have suffered a dramatic decline in nationwide production share in recent years. Between 1977 and 1983, companies producing less than 200,000 tons realized an overall production share decline of 35%. Producers in the 200,000 to 500,000 ton range lost nearly 9%

of production share, while companies mining 500,000 tons and up realized a 45.3% increase in their percentage of overall production. During this six-year period, nationwide coal production grew by over 13%. Ten years ago there were over 7,000 producing companies in the U.S. .. today there are less than 3,600.

Other elements of the President's proposal, mentioned earlier, will also have a disproportionate impact on small operators. The deduction of exploration and development costs, which are expenses that a coal industry must pay at the time they are incurred and largely labor intensive, are also a significant source of cash flow. It makes no sense that a high-tech company can deduct the salary of a scientist to refine a micro-chip while a coal operator is not permitted to fully expense the wages of a worker constructing a road to a new mine. It's ironic that the Interior Department is criticized and chastised for not having obtained sufficient data from the industry prior to leasing federal coal while the Treasury Department promotes tax policies to discourage development of exploration data.

The President's proposal also proposes to repeal what's left of capital gains treatment for coal royalty income and the limited ability of an operator to deduct accured reclamation expenses. Less than one year ago, in this very room, the conferees on the 1984 Tax Act eliminated a 30-year policy of capital gains treatment for coal royalty income between related parties and legislatively reversed a unanimous opinion of the Tax Court that coal operators, as accrual basis taxpayers, are entitled to deduct liabilities when they arise as they are required to accrue income when it is earned.

Both actions contained limited grandfather provisions to avoid destroying the economics of previously entered contracts. The President's proposal would abrogate those agreements in which the Treasury Department was a party. While the dollar impact of those proposed changes may appear insignificant in the context of the President's proposal, their repeal would have a significant adverse impact on many operators and in some situations would make a contract originally negotiated to make a profit into a loss. The repeal of the accural provisions would, as depletion, result in directly reduced cash flow and availability of working capital.

In conclusion, Mr. Chairman, I would like to point out that the provisions of the tax code referred in my statement are an integral part of our Nation's industrial, economic, and energy policy. Any modifications of these provisions must closely be scrutinized in light of the ramifications these tax policy changes will have on other national policies and national security. The proposed changes will result in decline of the projected growth of the domestic coal industry; a decline in number of available skilled jobs in the relatively high wage coal industry; a decline in economic activity in the historic coal mining regions of the Nation, as Southern Illinios where my company has operated for over 85 years; and, a restructuring of the highly competitive coal industry resulting in a further decline in numbers of independent coal operators.

Mr. ANTHONY. Thank you very much, Mr. Kelm.

Mr. Duncan.

Mr. DUNCAN. Thank you, Mr. Chairman.

I want to thank the panel. Did I understand you to say the current depletion rules play a great part in making your decision to proceed with the development of coal deposits?

Mr. KELM. Yes, I would say so. Because of-at least in our past history, percentage depletion has been, of course, taken into account in terms of your basis adjustments, and if we were to be forced to go to cost depletion in our present operations, we would not have any depletion. Therefore, whatever benefit we get from percentage depletion would disappear.

Mr. DUNCAN. If you didn't have that, then the cost of coal products would be-

Mr. KELM. I didn't hear you.

Mr. DUNCAN. If you didn't have the depletion rules as an appropriate incentive of the cost of your product, would there be an increase in price?

Mr. KELM. Yes.

Mr. DUNCAN. Would it impair your ability to meet with imports?