Jimmy Stewart struck oil at 4,180 feet. Tipped off by a geologist in 1949 to prospect around Vernal, Utah, Stewart, along with associates from the nation’s film and airline industries, sank $75,000 into a wildcat well that ultimately produced eight hundred barrels of crude a day. Even before their discovery, these investors had reason for optimism. The same geologist directing them to Vernal had already pointed Frank Sinatra to an oil field in Wyoming. When Sinatra’s well hit oil, he dubbed it “Crooner No. 1.”Footnote ¹

While Stewart was only beginning his career as an oilman, Gene Autry was already completing his sixth well near Wichita Falls, Texas. This successful strike yielded the “Singing Cowboy” a profitable one thousand barrels a day. Flush with success, he anticipated drilling at least twenty more wells on his land nearby. And Autry was not the only movie star in the Lone Star state. Bob Hope and Bing Crosby pooled their resources and jumped into the oil business together near the town of Snyder. Western lead Randolph Scott operated near Rotan. Not far from either, Don Ameche and friends invested $200,000 into more than 21,000 acres in yet another speculative venture. Of course, not all of Hollywood’s oilmen found success in the oil patch—John Huston, Mervyn Le Roy, and Dennis O’Keefe lost nearly $200,000 of their own in a failed well near Los Angeles. Whether a profitable investment or not, oil fever had returned to Hollywood. “When you see a group of movie people talking on the set,” observed one oil executive, “you don’t know whether they’re discussing an oil well or a movie.”Footnote ²

In many respects, the oil business resembled Hollywood. Both encouraged investors to risk fortunes on prospects of ever larger rewards. Both attracted flamboyant personalities. Both had roots in southern California, which occasionally, as in this instance, intertwined.Footnote ³ But as Stewart, Sinatra, Autry, and the others realized, oil offered something that film never could: tax provisions like the depletion allowance that permitted oil producers—and their film industry investors—to shelter their unusually high incomes from taxation. Since 1926, the depletion allowance, or percentage depletion, had permitted investors to deduct from otherwise taxable income 27½ percent of the gross income earned from oil wells. Percentage depletion proved particularly enticing to some of the nation’s most prominent entertainers in 1949 because in the middle of the twentieth century, their hefty incomes faced marginal tax rates in the neighborhood of 80 percent or more.Footnote ⁴ Experts called this strategic oil investing “drilling with tax money.”Footnote ⁵

For opponents of corporate privilege, by the time Hollywood was drilling with tax money, the depletion allowance had come to symbolize everything that was wrong with American tax policy. The liberal New Republic editorialized in 1951 that it constituted “perhaps, the most scandalous single grab by Big Business extant.” Erwin Griswold, tax scholar and dean of Harvard Law School questioned whether a different system could avoid “granting enormous tax advantages to drones and others who take little or no risk” and was “puzzled why anyone should think that it has a proper place in a fair and equitable tax system.” Leading public figures were similarly critical. “I know of no loophole in the tax laws so inequitable as the excessive depletion exemptions now enjoyed by oil and mining interests,” wrote Harry Truman in his 1950 tax message to Congress, noting that the system allowed “a few to gain enormous wealth without paying their fair share of taxes.” And indeed, Truman proposed dramatically reducing the depletion allowance, as had Franklin Roosevelt before him and would John F. Kennedy after, along with numerous members of Congress.Footnote ⁶ And yet, this controversial 27½ percent deduction was hardly the first policy experiment with a special tax deduction for natural resources industries, and when percentage depletion itself was adopted in 1926, it was framed as “in the interest of simplicity and certainty in administration” and widely seen as a remedy to past tax abuses, not a path to a future tax shelter.Footnote ⁷ This article explores why, tracing the early development of the depletion allowance system and how it was used as a contested tool of natural resources policy.Footnote ⁸

Though technical, the depletion question reflected the challenge facing all architects of modern taxation: could seemingly straightforward economic principles be practically administered? According to economist E. R. A. Seligman, “an ideal principle which is administratively unworkable is not for an instant to be compared with a less elevated ideal which can be actually carried out in practice.”Footnote ⁹ But in the early twentieth century, the boundary between workable and unworkable principles was often rather murky, and determining where to draw it was the challenge faced by the authors of tax policy. By examining precisely how policymakers sought to justify, implement, and administer the depletion allowance, I argue that the Treasury and Congress, along with collaboration from economists, lawyers, industry executives, and especially geologists and engineers, repeatedly struggled to balance two ideals for obtaining objective fairness.Footnote ¹⁰ On the one hand was what Gary Belkin has described as “the technocratic wish,” or the impulse to impart a neutral, objective, and above all scientific status to knowledge claims.Footnote ¹¹ This approach relied on professional experts, here geologists and engineers, not simply to offer reasoned judgments on natural resources taxation, but to argue that science itself provided the only neutral, objective, and fair means to determine appropriate taxation independent of the expert making the judgment. Like many other Progressive Era attempts to depoliticize public policy by grounding it in the authority of seemingly objective experts, this approach ultimately proved a failure.Footnote ¹² Yet instead of abandoning the principle of depletion altogether, policymakers turned to another approach for calculating it: administrative simplicity, or the use of simple formulas, consistently applied. At stake in the choice between each approach were both fairness and the perception of fairness. Which system was more equitable? On what principles would equity even have meaning, and equity for whom? Could abstract economic principles be balanced with administrative realities? Through both approaches, the architects of the depletion allowance sought a tax system that was above politics, but answering these questions would show that any depletion policy remained inherently political.

Beyond its significance in the development of American income taxation, the history of the depletion allowance complicates our picture of American natural resources policies in the early twentieth century. Historians of these policies have customarily focused on conservation, the broad response to industrialization that reoriented the approach to public lands and waters in the late nineteenth and early twentieth centuries away from disposal in the private marketplace and instead toward long-term management by the state. Conservation itself encompassed a range of meanings, perhaps most succinctly what historian Clayton Koppes has characterized as “efficiency, equity, and esthetics.” Pursuing efficiency, many conservationists, particularly scientists and engineers, focused on the orderly development of the nation’s forests, mines, and waterways. Toward equity, conservationists sought the democratic control of and fair access to publically owned bounty. Prizing esthetics, conservationists pursued the preservation of natural wonders for public enjoyment and moral uplift. Taken together, these three impulses, often operating at cross-purposes, help account for both the accomplishments and limitations of American resource policy in the early twentieth century.Footnote ¹³

Oil has long provided a special case for the history of natural resources policy. Outside of public lands, most historians have presented a rather limited role for the federal government in regulating the oil industry, at least until the New Deal, and have instead focused on the burden shouldered by individual states to pursue efficiency and control waste. “Waste” in the early twentieth century oil industry came in variety of forms: oil lost underground, unrecoverable after reckless drilling; oil that seeped away or evaporated or burned following inadequate access to above-ground storage or transportation; and most notably, oil produced in excess of market demand, a consequence largely of the so-called rule of capture. This principle, legally in place since the late nineteenth century, granted ownership of oil to whichever property owner brought it to the surface, regardless of where the physical oil originated underground. In booming oil fields around the country, the rule of capture frequently led to uncontrolled overproduction as landowners pumped “defensive wells” on the borders of their property merely to prevent “their” oil from draining to their neighbors, all regardless of demand and an often diminishing price.Footnote ¹⁴ State action came gradually, usually in response to new discoveries, with Oklahoma and Texas pioneering the use of regulatory agencies to manage production. By the end of the 1920s, Oklahoma’s Corporation Commission and Texas’s Railroad Commission were both restricting statewide production and prorating revenues among oil producers, while petroleum engineers were applying the principles of “unitization” to produce oil based on the boundaries imposed by nature, not property lines.Footnote ¹⁵ Yet until the federal government became involved in crafting the NRA oil code during the New Deal, according to the usual view, it was limited to offering technical advice (from the Geological Survey or Bureau of Mines), leasing federal lands for drilling or withdrawing certain lands from private entry (at least temporarily), developing emergency wartime measures to preserve the flow of oil to Allied armies and industry, providing diplomatic support for overseas exploration or, as in the case of the Federal Oil Conservation Board, holding public hearings and issuing reports. But until the 1930s, direct intervention into domestic oil production, according to most historians, remained largely the responsibility of states.Footnote ¹⁶

This article takes a different tack, examining taxation as an overlooked and essential aspect of American natural resources policy and standing many conventions about these policies on their heads. Where the agencies managing the nation’s forests, rivers, grazing lands, and parks represented the projection of federal power into the management of public lands, the peculiar tax policies for oil, gas, coal, and other minerals demonstrated a new federal reach into private lands and private business. Where conservation relied on the creation of autonomous or semiautonomous bureaucracies within the executive branch and staffed by sometimes thousands of agents in Washington and throughout the country, the effectiveness of natural resources taxation as a policy tool depended more on the development of standard procedures, techniques, forms, data collection, and financial incentives. And at the very moment conservationists began to limit certain kinds of resource exploitation, tax policy enshrined incentives for producing more. As the depletion system developed, tax policy became a tool for encouraging oil exploration and production for World War I, developing standardized methods for corporate accounting and property valuation, and formulating and disseminating scientific techniques for estimating the size of underground oil pools to aid both the government and oil producers.Footnote ¹⁷ Yet throughout the 1910s and 1920s, the difficulty remained developing an administrative structure for realizing these goals.

The result was the crystallization of an overlooked element in the political construction of the marketplace for natural resources. As Paul Sabin has recently shown in the case of California in the early twentieth century, the market for oil was never free but always structured by government policy. According to Sabin, the price of oil in California was not determined by supply and demand alone, but through federal policies toward the disbursement of oil land in the public domain, state authority over coastal drilling, regulatory efforts to thwart rampant overproduction, and tax policies for gasoline consumption.Footnote ¹⁸ Federal tax policies around the depletion allowance played a similar market-structuring role.

The remainder of this essay is divided into five sections. The first describes the origins of the depletion allowance in a push toward science-based Progressive Era state taxation and the obstacles created by the introduction of the federal income tax in 1913. The second traces how World War I catalyzed questions of depletion for the oil industry, and the third, how geologists and engineers struggled to assemble and administer a science-based tax system in response. The fourth section explores the administrative and political challenges that the Bureau of Internal Revenue faced after the war. A final section concludes with a reflection on how the merits of simplicity allowed the development of a tax break that profoundly shaped the political economy of American oil production in the twentieth century.

THE POLITICS OF WASTING ASSETS, 1890–1916

The technocratic wish for scientific taxation began at the state level as an effort to replace politics and uncertainty with the predictable calculations of economists, just then beginning to professionalize. Like the “gospel of efficiency” preached by Progressive Era scientists and engineers to encourage conservation, scientific taxation was a campaign of technical experts asserting their objective authority over an area of public policy.Footnote ¹⁹ Beginning in the 1890s, lawyers, state legislators, academic economists, and engineers argued for centralized state tax assessment and collection, particularly for property taxation, and states like Indiana, Michigan, Wisconsin, and New York became laboratories for innovative tax proposals. The National Tax Association (NTA), a private organization for tax reform founded in 1907, assumed a leading organizational role in developing this movement, facilitating the collaboration between representatives of different states. By 1918, NTA efforts had helped thirty-five states create new, scientifically based tax departments. Under the leadership of economists Allen Ripley Foote, E. R. A. Seligman, Thomas S. Adams, and others, the NTA prospered.Footnote ²⁰

One area of taxation, though, confounded early efforts at rationalization. The NTA discovered that “wasting assets” like coal mines, metal deposits, and oil and gas wells involved peculiar difficulties. Whether states employed a tax on property values, gross output, net earnings or income, or total tonnage produced, tax authorities encountered challenges in dealing with industries of wasting assets, particularly in the essential task of valuation.Footnote ²¹ Valuation had long been central to mining, but precise methods for valuing resource-rich land remained elusive, even for expert mine accountants and engineers. In his classic 1909 textbook, The Principles of Mining, mining engineer and future president Herbert Hoover observed that “it is utterly impossible to accurately value any mine,” citing “the many speculative factors involved.”Footnote ²² Valuation was not a simple science, for these speculative factors included commodity prices, estimates of future supply and demand, and, of course, an approximation of the quantity of minerals available for extraction. Moreover, the very size of mineral reserves under valuation could change, as price increases made more marginal deposits worth extracting. “The best that can be done is to state that the value lies between certain limits,” Hoover explained, “and that various stages [that is, values] above the minimum . . . represent various degrees of risk.”Footnote ²³ Although sufficient for the purposes Hoover described, mine values “between certain limits” failed to satisfy the tenets of scientific taxation, which required an objectively fair, rational, precise, and generalizable method for valuing mineral lands and assessing taxes upon them. Put another way, the tax reformers demanded more certainty.Footnote ²⁴

Local geology, however, made squeezing the infinite variety of nature into a single legal system a formidable venture. Miners typically found minerals underground, unknown in quantity and quality. States nevertheless experimented with various techniques of valuation, hiring geologists and mining engineers to estimate reserves and perform valuations. Some reformers within state tax departments objected that no single geologically based system of mine taxation could apply to all minerals in every state. Such a system, they argued, failed to account for the variation of local terrain—geological details mattered in formulating tax policy. Tax commissioners in Arizona, for instance, claimed that tax laws for mineral land could not be developed in one state and simply transplanted to another, “for the reason that the geological formation, the character of the ore and the other natural conditions would be dissimilar.”Footnote ²⁵ Furthermore, miners encountered different classes of minerals in different configurations. In Utah, the state’s representative to the NTA’s Mines and Minerals committee explained that even if geologists could reasonably estimate the extent and value of coal, iron, and copper deposits, the same techniques failed for gold, silver, lead, and other rare metals, which occurred in peculiar shapes and dimensions that only actual mining could reveal.Footnote ²⁶ These challenges made the reconciliation of geological variation with scientific taxation an elusive goal throughout the 1910s.

Of all the varieties of taxation applied to extractive industries by individual states, none was more complicated than the income tax. Wisconsin had pioneered the adoption of the income tax in 1911, with other states soon to follow.Footnote ²⁷ But applying the tax to mines caused unexpected difficulties. By law and principle, income taxation only applied to net income. But when a company sold a ton of ore or a barrel of oil, how much of the income from the sale represented genuine profit and how much represented the untaxable return of the capital invested in land, exploration, drilling, equipment, and labor? Mining, oil and gas, and timber interests argued that unlike ordinary businesses, industries of wasting assets sold their capital in every transaction. Every ton of ore or barrel of oil brought to market was one ton or barrel less in the ground, thereby “depleting” the value of company land. Representatives of extractive industries thus asserted the need to match the development of tax law with the peculiar aspects of mining, drilling, and lumbering. Separating income and capital, according to attorney and mining industry lobbyist Paul Armitage, represented “the fundamental problems of the business man and the accountant.”Footnote ²⁸

These fundamental problems of taxing wasting assets rose to the federal level with the introduction of the corporate excise tax in 1909 and federal income taxation in 1913. The 1909 corporate excise act (passed as part of the Payne-Aldrich Tariff) levied a one percent tax indexed to income and permitted deductions for the depreciating value of property, but made no mention of resource depletion. The Treasury, responding to pressure from industry, acted on its own administrative discretion in 1911 and permitted extractive industries to deduct a depreciation-like allowance for the “exhaustion of deposits of ore, mineral, etc.” Amid the early twentieth century controversy over income taxation, however, this modest provision did not satisfy everyone. One British gold-mining company operating in Colorado, Stratton’s Independence Ltd., pushed the notion of depletion to its radical extreme: that mining was not a business in the ordinary sense, but merely a process of converting one form of capital (in this case, gold) into another (cash). When the company challenged the excise tax as imposing an unconstitutional tax on their capital, however, the Supreme Court dismissed the claim. Sometimes capital was necessarily depleted to obtain income and mines were hardly unique in this regard—”the same is true of the earnings of the human brain and hand,” according to Justice Mahlon Pitney.Footnote ²⁹ If industries of wasting assets were to have a depletion allowance and thus try to resolve “the fundamental problems of the business man and the accountant,” action was needed from Congress.

And indeed, even before Stratton’s Independence was finally decided, Congress responded to the mine-tax problem by incorporating the principle of depletion into the Revenue Act of 1913, the first income tax after the ratification of the Sixteenth Amendment. This depletion provision permitted the mining and oil and gas industries a modest five percent deduction of the gross value of their products as a depletion allowance. The figure was arbitrary, but it was defendable as an economic principle (accounting for the capital losses of wasting assets) and offering administrative simplicity in its application. Moreover, for the first few years of federal income taxation, mining and oil companies paid only one or two percent yearly in income taxes. Once it was clear that income taxation was to stay, the small five percent depletion allowance offered an acceptable deduction within most of the business community.Footnote ³⁰

WAR AND TAXATION IN THE OIL PATCH, 1916–1918

World War I transformed the depletion question, particularly regarding its application to oil. Ships increasingly required fuel oil, airplanes devoured aviation fuel, and cars, trucks, and tanks needed gasoline. The Allies’ petroleum needs were largely met by the United States, whose exports of oil products rose throughout the war, most notably lubricating oils (up more than 40 percent), fuel oil (more than 130 percent), and gasoline (about 220 percent). European consumption represented between one-half and three-quarters of these increases. By 1917, Great Britain imported fully 93 percent of its oil from U.S. and Mexican sources.Footnote ³¹

Yet as oil production rose, so too did income taxes and specially enacted excess-profits taxes. To pay for the war, the Revenue Acts of 1916, 1917, and 1918 raised the maximum, or marginal, income tax rate from 7 to as high as 77 percent.Footnote ³² Additionally, excess-profits taxes, beginning with a special tax on munitions manufacturers in 1916 and two more general measures in 1917, ultimately levied rates between 20 and 60 percent on business income earned over prewar average profits.Footnote ³³ Taken together, the measures flooded the Treasury with cash. During fiscal year 1918, collections by the Treasury Department’s Bureau Internal Revenue (BIR) ballooned from just over $800 million to more than $3.5 billion, with nearly the entire increase from income and excess profits taxation.Footnote ³⁴ After the passage of the 1917 act, BIR commissioner Daniel Roper boasted that Congress had “created a tax-gathering task of greater magnitude than had ever before been undertaken by any nation.”Footnote ³⁵ Oil industry executives protested, however, that these taxes made drilling for oil uneconomical precisely when oil was needed most for the war effort.

According to one observer, the new laws, especially the excess-profits tax, left operators in Oklahoma “considerably agitated”Footnote ³⁶—agitated because of the unforeseen consequences of what had initially been sought as a liberalization of the depletion allowance. With taxes set to rise to fund military preparedness, representatives of extractive industries had lobbied Congress that the five percent deduction from 1913 was insufficient to account for capital lost to depletion, and the Democratic authors of the Senate’s 1916 revenue bill consented. “We thought that that deduction was too little and that there ought to be a deduction more equitable in its character,” explained Mississippi senator John Sharp Williams.Footnote ³⁷ The revised depletion provision of 1916 thus eliminated the five percent deduction and permitted instead “a reasonable allowance for actual reduction in flow and production” with details appropriate to particular industries to be worked out by the Treasury. But against this apparent liberalization, Congress added a constraint: that the maximum depletion allowance permitted to any well be no greater than the total capital invested in the well.Footnote ³⁸ In the abstract, this principle made eminent sense. If the purpose of depletion was, as had long been argued, to separate income from capital, once invested capital had been recovered, all that remained was profit and the depletion allowance had served its purpose. But with the passage of the 1917 excess-profits tax, oil producers found themselves in the worst possible situation: relatively small investments (in individual wells) leading to huge profits (from new discoveries). The income and excess-profits taxes absorbed most of the profits, while the depletion allowance capped at the cost of investment was far too small to make much difference.

In 1917, about five hundred small producers in Oklahoma organized as the Mid-Continent Oil and Gas Association to represent their common economic interests at the national level.Footnote ³⁹ Traveling to Washington, representatives of the Mid-Continent operators lectured the BIR about the excess-profits tax, exclaiming that “a literal application of this law will not only curtail, but will be disastrous to the oil and gas business in general; that it will stop the exploration for oil and gas in new fields; that it will dry up the source from which the Government would obtain large revenues, and will make the supply of petroleum products necessary for the nation’s use a difficult if not impossible task.” The Mid-Continent operators went so far as to suggest that taxation without a more generous depletion allowance and other concessions would so cripple oil companies that the industry would fail to produce the oil so desperately needed for commerce and warfare.Footnote ⁴⁰ Adopting an alternative argument, others argued that the discovery of a profitable well usually occurred only after months or years of investing in many more unsuccessful wells. If a successful well represented a return of capital investment of not only that well but the failed wells that preceded it, the income earned from the successful well seemed less an “excess profit” than a reasonable one.Footnote ⁴¹

Declaring the fundamental constraint on oil production a geological one, the Mid-Continent lobby advanced a novel proposal for calculating depletion allowances based on that very geology. If the depletion allowance served solely to return capital, it would be based on cost: divide the cost of the investment by the total number of barrels the well was projected to contain. The result was the unit cost, or the amount of capital depleted with each barrel sold.Footnote ⁴² Yet since oil producers claimed their actual costs were too low to generate a meaningful depletion unit to affect their taxes under the excess-profits regime, the Mid-Continent operators argued that oil producers should be allowed to do something ordinary firms could not: revalue their investment to consider not only what the land originally cost—the actual capital invested—but what the discovery of oil there was worth—a far greater numerator for calculating the unit cost and hence a far greater allowance for depletion. Put another way, the lobby argued that instead of basing income and excess-profits taxes on profits as ordinarily understood (income minus expenses and depreciation), oil taxes should be computed based on comparing income to the value of the newly revalued property. The principle would become known as discovery depletion, as it granted the privilege of depletion based on revaluation to new discoveries. Unlike any other increase in value, the wealth of nature gained from an oil discovery under discovery depletion would be tax free. Critically, in order to restrict the more generous discovery depletion provisions to those wildcatters most needing relief and presumed to shoulder the greatest risk in discovering new oil for the war effort, the Mid-Continent lobby sought to vest geologists with the authority to select which discoveries deserved higher depletion allowances. Their plan would use the tools of geology to determine how exactly to revalue oil properties by measuring how much oil they contained. By framing this economic problem geologically, the operators sought to account for depletion scientifically.Footnote ⁴³

When the 1918 Revenue Act passed in February 1919 and incorporated the principle of discovery depletion, the oil lobby had such a hand in these provisions that it became known to Washington insiders as the “Oil Tax Law.” Above all, Congress sought a tax system that acknowledged the peculiar market and geological uncertainties of oil exploration, encouraged oil exploration to fuel the war effort, and still returned meaningful revenues to the government. The administrative simplicity of the original five percent deduction thus gave way in 1919 to the technocratic wish of relying on objective science to navigate the minefield of tax equity among large and small oil producers, the oil industry as a whole and other natural resources industries, and these industries of wasting assets and all taxpayers.Footnote ⁴⁴

Judging the appropriate values of oil lands in tax returns required expert geological knowledge unfamiliar to the lawyers and economists of the BIR. Even as the Oil Tax Law wound its way through Congress, the commissioner of Internal Revenue, Daniel C. Roper, had begun bringing geologists to Washington to deal with the tax problems faced by natural resources industries. Early in 1918, Roper invited Michigan’s state geologist R. C. Allen and California’s leading petroleum geologist, Ralph Arnold, to join the War Excess Profits Tax Reviewers, an ad-hoc advisory committee that audited complicated tax returns and adjudicated certain appeals. The economist T. S. Adams, Yale’s preeminent authority on taxation, chaired the board and its other members included representatives of several large industries. By including Allen and Arnold, Roper anticipated allaying tension between the government and extractive industries by welcoming to the bureau technical experts familiar with the oil, gas, and mining industries.Footnote ⁴⁵ Members of the Mid-Continent Oil and Gas Association delighted in “the splendid results” of their lobbying efforts, assuring members that “the peculiar nature of the oil business made special treatment necessary.”Footnote ⁴⁶ From the perspective of the BIR, the simultaneous demand for revenue, oil, and cooperation with industry made expediency, not political favoritism, the dominant factor in the adoption of the new system.

The authority and influence of tax geologists grew as the war progressed. When the complexities of oil, gas, and mine taxation proved too cumbersome for the Tax Reviewers board in the summer of 1918, Roper invited Arnold to establish his own office within the bureau to handle the problems of taxing oil and gas. The oddity of dusty geologists more accustomed to field surveys than government bureaus becoming Washington administrators was not lost on Arnold. “It seems a far cry from the paleontological laboratory or geologic expedition to the problems of the Treasury Department,” he explained in 1918, “but such is not the case under the exigencies of war.”Footnote ⁴⁷ Arnold’s Oil and Gas Section, the new unit of the bureau’s Division of Natural Resources, seized upon the Mid-Continent operators’ plea for taxation based on the objective criteria of valuation even before Congress passed the 1918 Revenue Act codifying the principle. According to an Oil and Gas Section deputy in Oklahoma, taxation based on valuation brought “a more equitable and scientific method” to the figuring of taxes. Arnold and his agents recommended that oil companies hire geologists and engineers, if they had not done so already, to assemble as much information on the geology, production history, and economics of their operations as possible to aid the BIR in assessing oil industry taxation.Footnote ⁴⁸ Thus the technocratic wish began to reshape the taxation of natural resources. The fact that science itself also involved subjective judgment became clear only much later.

A GEOLOGISTS’ WAR: TAX POLICY AS NATURAL RESOURCES POLICY, 1918–1919

Ralph Arnold had arrived in Washington in 1918 with a distinguished professional career. As student at both the Throop Polytechnic Institute (reorganized in 1920 as Caltech) and the fledgling Stanford University, Arnold evinced a keen technical world view, cherished the obligation to public service, and developed the social network to tie the two together. While an undergraduate at Stanford, Arnold began associating with two other students fascinated by the earth, the aspiring mining engineer Herbert Hoover and Hoover’s older brother Theodore. While earning his master’s and doctoral degrees there, Arnold began an almost decade-long affiliation with the U.S. Geological Survey as a paleontologist and geologist, engaging in fieldwork and also protecting federal oil land from fraudulent entry as homestead claims. Between 1911 and 1916, through a Hoover connection, Arnold led the first team of professionally trained petroleum geologists to Trinidad and Venezuela, catalyzing commercial oil drilling for the first time in both regions. Three weeks before President Wilson asked Congress to declare war, Arnold cabled the director of the U.S. Bureau of Mines, Van Manning, to offer his geological services in case of an emergency.Footnote ⁴⁹ When the BIR needed an expert with mastery of geology and mine valuation who understood the oil industry from both its economic and scientific perspectives, Arnold was an obvious choice.

Once sworn in for Treasury work, Arnold’s war service began with the recruitment of geologists for taxation research. Through his network of personal and professional associations, he sought advice from oil executives, leading professional and academic geologists, and government bureaucrats in the Bureau of Mines and U.S. Geological Survey. Geologists who could not participate referred others who could. Government service paid modestly, about $9 per day, but affiliation with the Treasury offered other rewards. Most significantly, the BIR provided a rare opportunity for young geologists to develop expertise on the geography and geology of U.S. oil fields. Petroleum geology in the 1910s was a young profession, still trying to demonstrate its utility to the larger industry.Footnote ⁵⁰ Since many oil fields were privately owned, geologists in universities or government typically had little access to them except as consultants to individual companies, and then only when companies would hire geologists at all. Many geologists jumped at the opportunity to join the BIR’s field staff during the war. Arnold assembled teams ranging in size from eight geologists in the Rocky Mountains to twenty-one in Illinois and Lima-Indiana; others investigated oil deposits in California, the Gulf of Mexico, Appalachia, and the newly discovered Mid-Continent field. As Arnold boasted to one target of his recruitment efforts in the clipped prose of the telegraph, “best geologists country serving for this.”Footnote ⁵¹

In the closing months of 1918, Arnold and these “best geologists”—nearly ninety of them—attempted to use the tools of taxation to do more than simply provide equity in taxation. Arnold’s Oil and Gas Section seized the rare opportunity to use science to regulate and reform the oil business. The focus was establishing an objective, reliable, and geologically informed accounting system for the industry and translating scientific observations into economic facts by bridging two conflicting concepts of value. “Market value” represented the value of a property as agreed upon by a willing buyer purchasing from a willing seller. Market values were unpredictable, often no more than what Arnold termed “the psychological value of the property,” a value grounded not on science and engineering but intuition and expectations of profit or loss. The Treasury used market values in taxation. In contrast, the “theoretical value” represented the value of a property as measured by a geologist or engineer. Theoretical values included an estimation of the amount of oil under a given property, the methods of production, and current and likely future oil prices.Footnote ⁵² For the technocrat, theoretical values were grounded in science.

Arnold sought to bring market values in line with theoretical values by making geological calculations the foundation of the economics of oil production. Since all producers now faced income and excess-profits taxation, Arnold hoped that by becoming “the missing link between the market value and the theoretical value,” geologists could become an institutionalized presence in the oil industry.Footnote ⁵³ The project was radical. No longer, hoped Arnold, would sellers and buyers—or the forces of supply and demand—alone determine value in the marketplace. And no longer would taxation be subject to the whims of politicians and the brawn of corporate political influence. Instead, geology would play an intermediary role, using science to advise buyers, sellers, and the taxing government what oil land values should be.Footnote ⁵⁴

Grounding natural resources taxation on valuation actually brought a kind of regulation to the extractive industries that had already been introduced to other major sectors of the economy. In 1913, Congress had instructed the Interstate Commerce Commission to value all the property of the industries it regulated—the vast American infrastructure of railroads, telegraphs, and telephones—in order to ground rate-making on a supposedly objective foundation of economic fact. The “facts” of value, of course, rested on the judgment of subjective evaluators, a weakness that would tail the ICC for decades. For this reason, the valuation project, conducted through the ICC’s Bureau of Valuation, became what Morton Keller has called “an emblematic Progressive attempt to find fixed grounds for regulating an enterprise whose prime reality was flux.”Footnote ⁵⁵ But the elusive challenge of objectivity should not distract from the structural consequences of this legislation. Frank Dixon, a Princeton economist, explained in 1922 that ICC valuation “transformed from the dream of a few idealists into the corner-stone of our regulation policy,” noting the ways it shaped its regulated industries.Footnote ⁵⁶ Mining, though, was a different matter altogether. As difficult as it was, railroad valuation, according to the chairman of the federal government’s Tax Simplification Board (set up in 1921 to resolve many of the problems created by wartime finance) was “easy compared with the valuation of property which cannot be seen.”Footnote ⁵⁷

To value this property that could not be seen, estimating the size of oil reserves became the core labor of the geologists and the principal way they mediated between the industry and the government. Estimating reserves required detailed knowledge of individual oil fields, bringing the federal government closer to the routine production of oil than ever before. The BIR’s Oil and Gas Section accepted a variety of techniques for estimating the size of these reserves, but preferred the analysis of historical production curves. These graphs plotted the life history of an oil well, from its initial period of “flush” production through the gradual tapering of its later years. Each well exhibited a unique production curve, but wells in the same field closely resembled one another. The resemblance was so close in fact that according to the BIR’s Manual for the Oil and Gas Industry, which compiled these data, “the best indication of the future production of any well is to be found in the history of similar wells in the same or similar districts.” By plotting the production curves for older wells in each of the nation’s six principal oil regions, it became only a matter of matching younger wells to geologically similar older ones and extrapolating the younger wells’ future production.Footnote ⁵⁸ As the tax geologists learned about the structure of the nation’s oil fields, the companies whose records they studied expected to use this information to reduce their tax liability through the depletion allowance.

This, anyway, was the theory. In the field, the technocratic approach to taxation began to break down. First, the kind of production information the BIR sought was frequently unavailable. Before detailed accounts became necessary for taxation, many oil companies simply did not keep careful production records. The Ohio Oil Company, for instance, controlled upward of 80 percent of oil-producing land in the Lima-Indiana and Illinois fields. The company held few records prior to 1909 or 1910, however, which hampered the bureau’s ability to trace the histories of the field’s older wells. Worse, the company pumped oil from new wells into the same tanks that held oil from older ones, making a measurement of the production of individual wells impossible. Without this individual well data, the BIR could not construct average production curves for this field.Footnote ⁵⁹ Furthermore, valuation itself, the focus of BIR work in natural resources industries, proved a particularly difficult problem. One future president of the American Petroleum Institute confessed that “in view of modern taxation problems I have made some terrible mistakes in handling my personal investments and in the organizing of small companies.” He explained his carelessness as “overlooking entirely any necessity or desire to establish book values.”Footnote ⁶⁰ Arnold insisted that this corporate disorganization cease. If an oil producer sought the advantages of the depletion allowance, Arnold quipped, he must no longer keep “his account book in one hip pocket and his check book in the other.”Footnote ⁶¹ “Definite and true records must be kept of each well’s production,” insisted a proposed set of BIR instructions.Footnote ⁶²

Few oil companies kept production records because in the early twentieth century, the cost was rarely worth the trouble. Operators had previously “not found it necessary to work on as narrow a margin of profit as is common in other kinds of business,” according to Bureau of Mines engineer Carl Beal. But with profit margins declining, the industry was already shifting to what Beal called “a more conservative basis” and which would require a better accounting of costs and a better basis for valuing particular investments. This shift, however, was gradual. Even in 1919, Beal observed that many oil producers remained unaware of the size of their oil deposits and even their rates of production, together what he considered “the most valuable and useful knowledge an oil operator can possess.”Footnote ⁶³ Beal had envisioned the federal government—particularly the Bureau of Mines—as the logical agent for aggregating this information, and he began assiduously collecting it in early 1916. But the Bureau of Mines could only offer information, not demand compliance like the BIR, and when Beal’s research was incorporated into Arnold’s Manual for the Oil and Gas Industry Under the Revenue Act of 1918, it was to aid taxpayers in their newly required accounting for tax purposes.Footnote ⁶⁴

Geological uncertainty compounded the absence of records. Scientifically determining land values depended on learning how much oil remained underground. Before the development of geophysical prospecting methods in the 1920s, judging the size of underground reserves depended on extrapolating from the production of several nearby wells. How much underground oil each well “proved” to exist remained unclear, however.Footnote ⁶⁵ Arnold insisted that the answer depended entirely on local geological conditions. Some oil fields spanned large, uniform areas in which territory hundreds of feet from existing wells was reasonably expected to contain oil. In Oklahoma’s Mid-Continent field, for instance, nearly 90 percent of new wells struck oil. In contrast, in regions like California’s McKittrick field or the oil territories of Tabasco and Tampico in Mexico, oil occurred in narrow, geologically complex structures. In these fields, new wells drilled even a few yards from producing wells might not encounter any oil whatsoever. Precise, generalized definitions of proven acreage thus remained elusive.Footnote ⁶⁶

This difficulty became clear in the field. One BIR questionnaire asked for the proven acreage of producing land, or what portion of land likely contained oil. “What is proven acreage?” wrote one frustrated revenue agent to Washington, “Does one well on 10 acres, or on 40 acres, or on 80 acres constitute proven acreage? … If no well is on the property, but producing wells are on one or two sides, would that constitute proven acreage?”Footnote ⁶⁷ The answers to these questions were not obvious, but neither could they be ignored. Geologists with experience in the oil industry generally assumed that these questions could be addressed only on a case-by-case basis, if at all, making the work of the BIR hideously complex and susceptible to dispute. According to geologist Samuel Caudill, estimates of future production “must be done with great care and judgment if satisfactory results are to be obtained.” Yet removing subjective judgment was precisely the goal of relying on geology.Footnote ⁶⁸ These case-by-case judgments gradually began undermining the touted objectivity of geology-based taxation. Objectivity—and the technocratic wish—implied that different experts would draw the same conclusions from the same information, and this was manifestly not the case.

In an attempt to overcome these obstacles, Treasury regulations shaped not only the accounting required of natural resources producers but also the kinds of technical data they were now required to collect and supply to the government. Beginning in 1919, natural resources taxpayers attached extensive addenda to their federal tax returns detailing the physical and financial aspects of their production, which included a geographical and geological account of the land under production; the total quantity of ore, mineral, oil, or gas in every mine or well; the estimated value of the property and its improvements, plus how that figure was calculated and by whom; the amount of capital represented by a single unit of production (barrel of oil, ton of coal); and precisely how many units were produced over the course of the year. In the case of new oil wells, the bureau sought production logs by month or even day—what it called “highly desirable information.” To determine when a mine or well had exhausted its total allotment of depletion, the bureau requested a retrospective account of past production and depletion charges, along with other evidence to support the taxpayer’s requests for depletion.Footnote ⁶⁹

Oil and gas producers returned additional information, mostly involving geological and engineering details. They provided maps of oil bearing land along with the location of various wells. To establish a complete geological picture, they estimated the subsurface thickness of oil deposits, measured the specific gravity of all oil produced, and accounted for any geological phenomena (like flooding) or engineering activity (like pressurizing wells) that increased or decreased production. Since the bureau also defined the very meaning of discovery, oil producers claiming the privileges of discovery depletion had to submit additional evidence, including maps and production logs of the new well and wells nearby, detailed production records of the discovery well and its subsurface geology, and proof that the new well contained commercial quantities of oil.Footnote ⁷⁰ To complete their tax returns, oil companies had to begin consistently collecting this vast array of information.

The demand for these data mandated that companies collect and preserve it in the form required by the Treasury. While accountants and executives had initially assumed that idiosyncratic accounting practices, specific to every industry, would be accepted by the Treasury, they found that the government sought a more uniform standardization instead. The process was slow, but as T. O. McGrath, a professional mine auditor, noted in 1922, “It now appears that the Treasury Department’s Regulations are gradually crystallizing into a fixed system that must be met by all business enterprises regardless of trade practices and customs.” After 1919, regardless of state, whether drilling on public or private land, a large integrated firm or a shoestring wildcatting operation—all oil companies in the United States had their operations shaped by federal regulation. Well before the spread of prorationing and the unitization of oil fields, the tax system was forcing accounting and technical uniformity in the private oil business.Footnote ⁷¹

Perhaps surprisingly, Arnold encountered support from much of the industry. Critically, national oil associations embraced geological valuations and helped spread the bureau’s message. When representatives of the National Petroleum War Service Committee joined more than 350 other service committees in December 1918, they passed a unanimous resolution approving of the BIR’s techniques for assessing depletion and urged oil companies to turn over to the Treasury all statistics that might aid it in its taxation work.Footnote ⁷² Even if imperfect, the depletion system had the desired effects of lessening industry taxes and facilitating additional exploration. Months later, the fledgling American Association of Petroleum Geologists (AAPG) devoted an entire morning of its annual meeting in 1919 to a symposium on taxation and valuation issues. Arnold delivered the keynote address, and he and his staff explained the challenges they faced valuing oil and gas lands, the criteria they used to assign value, and the technical methods the BIR developed to estimate future production for individual wells.Footnote ⁷³ They acknowledged the hardship and expense their investigations caused, but using examples familiar to industry geologists, they insisted that taxation based on valuation, and valuation based on the objective study of geology, actually protected industry interests and ensured fairness throughout U.S. oil fields. As Arnold insisted, “We are really doing it in order to help you.”Footnote ⁷⁴

Still, some companies remained leery as Arnold and his geologists tried to mediate between the government and the oil industry. Since oil companies jealously guarded their geological reports and production statistics from other producers, some moved cautiously before releasing this material to the government. One company wrote the BIR to confirm whether a geologist inquiring about company records actually represented the Treasury Department.Footnote ⁷⁵ Citing “private confidential information,” another company refused to turn over oil-field maps.Footnote ⁷⁶ Still other companies balked at the time and cost required to collect this evidence. Nevertheless, most companies eventually complied, especially when BIR agents persuaded them that cooperating with the new tax system might save them as much as ten times the cost of complying.Footnote ⁷⁷

By the end of the war, the Treasury had expended more resources—in time and money—dealing with the taxation of the oil and gas industry than it did for any other single industry under taxation.Footnote ⁷⁸ But the investment paid off. According to Arnold’s office, spending just over $130,000, the Oil and Gas Section secured an additional $10.5 million in revenue for the government. In terms of technical data, Arnold and his staff had collected the production records of between ten and fifteen thousand tracts, roughly five thousand individual wells, and at least one map for “every oil field or pool in the United States.” Some of these maps, like one drawn for Wyoming, synthesized geologists’ understanding of whole regions like never before.Footnote ⁷⁹ From the perspective of political economy, the group created a structure and a system for taxation where none had previously existed.

Yet despite these evident successes, geologists found it difficult to maintain the technocratic role of mediator between government and industry after the wartime politics of crisis had passed. The war had convinced many geologists and engineers to leave lucrative positions in industry for relatively meager-paying jobs in the government. Millionaires earning upward of $200 per day in the nation’s oil fields went to Washington for a fraction of that.Footnote ⁸⁰ After combat ended in November 1918, the government could no longer induce geologists to remain in national service. Moreover, in ostensibly cost-saving actions, Congress slashed the Treasury’s budget while eliminating wartime positions. Some geologists returned to prewar employers; others found new opportunities in industrial consulting. Several parlayed their Treasury experience into the industry, accepting posts principally to perform valuation calculations for taxation purposes.Footnote ⁸¹ By January 1919, the days of scores of geologists engaged in valuation work for the Treasury were manifestly over.Footnote ⁸² Arnold began worrying that the bureaucracy needed to maintain geologically based taxation was beginning to crumble.Footnote ⁸³

GEOLOGY AND ITS DISCONTENTS, 1920–1926

As the Treasury geologists left Washington for lucrative careers in private industry in 1919, the armistice seemed to conclude a tumultuous era and mark the reemergence of a peacetime economy. Treasury officials knew better. Like all belligerents, the United States had financed the war through a combination of direct taxation and borrowing. Borrowing displaced the war’s cost onto future taxation and future taxpayers. Treasury secretary William McAdoo had originally hoped to divide the war’s cost equally between taxation and borrowing. This plan proved impracticable, but the United States still settled more of the war’s cost through taxation (23.3 percent of war expenses) than any other nation involved. Although the conflict had ended, fully $25 billion (76.7 percent) remained unpaid by the U.S. Treasury.Footnote ⁸⁴ R. C. Allen, Ralph Arnold’s counterpart in the BIR for mine taxation, observed that “though the War is over, it has not been paid for and the peacetime work of the Bureau will continue as in wartime for many years to come.”Footnote ⁸⁵

Before their own departures from Washington, Arnold and Allen designed the structure for a permanent bureaucracy for taxing the industries of wasting assets. A reflection of its affinity with other resource-focused agencies in the government, the bureau’s now-permanent Natural Resources Division was housed within the Interior building, in close proximity to the both the Geological Survey and the Bureau of Mines, where the division’s new head, Albert H. Fay, had previously served as a mining engineer. The division oversaw five industries: oil and gas, timber, coal, metals, and nonmetals like rock quarries and clay. Collectively, the division received the returns of nearly forty thousand taxpayers. When the process ran smoothly, tax returns were submitted to Internal Revenue Collectors scattered throughout the country, then shuttled to Washington, culled for basic statistical information, and passed through a series of valuation engineers (by 1922 the division employed 90) and specially trained auditors (150) to judge the appropriateness of every claim for depletion, estimation of value, and projection of the size of recoverable reserves. A series of reviews and opportunities for appeal completed the process.Footnote ⁸⁶

Yet the process often did not run smoothly and the vision of a technocratic solution to natural resources taxation grew increasingly elusive. While tremendous revenue collection indeed remained, the end of the war brought calls to reduce tax rates dramatically and scale back wartime bureaucracies, and the BIR was no exception. Congressional budget cuts meant to disassemble the war-mobilized government left the bureau starved for funding and personnel, and without adequate staff, evaluating tax returns was hopelessly slow.Footnote ⁸⁷ Overall, the BIR bureaucracy in Washington totaled about 5,500 people, with an additional 2,800 scattered throughout the rest of the nation—large numbers but still only half of what the bureau’s Deputy Commissioner estimated in 1922 was necessary to complete the backlog of returns since 1917 and process new ones constantly coming in. By then, fully 28 percent of the returns from between 1917 and 1920 remained to be audited, with “a large percentage” of those left coming from the complicated natural resources industries, often because of the challenges of retrospective valuation. By one account, the bureau’s Natural Resources Division was “staggering under an apparently ever-increasing burden.” The backlog was so severe that Treasury Secretary Andrew Mellon issued a request (what Albert Fay called an “almost command”) to speed up work.Footnote ⁸⁸

The Natural Resources Division also found itself increasingly besieged by tax returns manifestly legal but at odds with congressional intent. The most strident offenders included some railroad and gas companies, who employed the depletion allowance beyond its ostensible wartime purpose of compensating risk-taking wildcatters and separating capital from income. These companies diversified into oil production, claimed depletion allowances many times the income from the well, and after avoiding taxes altogether for the oil, used the “excess” allowance as a deduction for income from their nonextractive operations. Both Congress and the Treasury objected to this practice, and Congress began limiting depletion claims. The 1921 Revenue Act restricted depletion to 100 percent of net income from a given well, thereby limiting the depletions claimed to the wells that produced the oil. When a handful of irregularities persisted, Congress reduced restriction to 50 percent of net income in 1924.Footnote ⁸⁹

A more pervasive practice subverting the principles of the depletion allowance also became widespread in the early 1920s and subverted the technocratic principles of scientific taxation. Under Ralph Arnold’s original plan of 1919, Treasury geologists alone determined whether new oil wells represented genuine discoveries (and thus qualified for the depletion allowance), as well as how much land a new well “proved” to contain oil. According to Arnold, the geologists’ authority both grounded taxation in science and protected “the ones who were taking the big hazard in the business,” rather than producers who merely profited from the risks shouldered by others. Predictably, BIR geologists frequently found themselves at odds with oil producers, who sought the maximum number of properties to qualify for the depletion provisions. Invoking a metaphysics of expediency, the Mid-Continent Oil and Gas Association argued that since the presence of oil can never be known with absolute certainty until brought to the surface, all new wells represent genuine discoveries. According to this view, all oil wells ought to be eligible for discovery depletion, instead of only those approved by the government’s tax geologists and engineers. The BIR’s Oil and Gas Section protested that this view clearly perverted congressional intent and deliberately ignored the vernacular use of “discovery” within the industry. In response, Commissioner Roper offered a compromise. Not all wells would count as discoveries, but those successfully drilled in prospective—that is, unproven—territory would thereafter prove for the purposes of taxation an arbitrary forty-acre patch forming a square with the well as its center. Outside this square, new wells became eligible for revaluation as new discoveries. Arnold and his staff, having largely left government service, watched with dismay. The changes “practically annul all our ideas on proved land,” Oil and Gas Section deputy Carl Beal informed Arnold.Footnote ⁹⁰ For Arnold and his colleagues, Roper’s compromise undercut their exclusive authority over oil taxation. If geologists were not needed to evaluate every depletion case, their whole system lost the very scientific foundation they had tried to achieve during the war.

It took a bitter, and at times petty, public battle to expose the consequences of these decisions. In November 1923, Treasury secretary Andrew Mellon announced a “scientific tax plan” of his own, asserting that it would meet government needs while simultaneously stimulating private industry.Footnote ⁹¹ Skeptics questioned how Mellon’s own financial empire, amassed before entering public service, might benefit from the changes, and the leading skeptic to emerge was Michigan’s senator James Couzens. Couzens, a cofounder with Henry Ford of the Ford Motor Company and the architect of the Five Dollar a Day wage plan there was, like Mellon, a Republican and one of the wealthiest figures in government. When Couzens asked Mellon for more information on his proposed tax reform, evidently expecting economic data from the Treasury to justify it, he received instead a gruff suggestion to keep out of business he knew nothing about. Couzens responded in 1924 by instigating a broad-ranging investigation into the Bureau of Internal Revenue in an attempt to embarrass Mellon, both for his management of the Treasury and for the treatment of his companies by the tax bureau that reported to him.Footnote ⁹²

No issue attracted the scrutiny of Couzens’s Select Committee on Investigation of the Bureau of Internal Revenue more than depletion, according to the committee’s report “one of the most important as well as one of the most troublesome questions involved in administering the income tax law.”Footnote ⁹³ The Couzens Committee found that revaluation led to situations that threatened to unravel the foundations of economic logic. Geology, it seemed, was a less certain activity than its advocates had claimed. Oil-land lessors and lessees could legitimately claim different valuations for the same piece of land, for instance, when the land was assessed for them by different geologists or engineers. In one example, known as the Connolly and Larkin case, five investors in a single property claimed four different values for the same piece of land; moreover, these valuations were made on the same date and based on the same value of oil but from valuations performed by different petroleum engineers. Although the BIR recalculated a uniform valuation for these properties as soon as it realized the discrepancies, what of similar cases that remained undiscovered?Footnote ⁹⁴ The technocratic ideal of scientific taxation promised objective fairness and reliability regardless of the geologist or engineer judging value. As the Couzens investigation discovered, this reliability was patently absent.

Yet if the appraisals of BIR experts rankled the committee, the senators expressed an even greater exasperation that BIR administrators disregarded the “sound determinations of values to be depleted” estimated by their own geologists and engineers and instead bestowed favorable valuations by administrative fiat. Couzens found more than thirty cases in which the BIR permitted depletion deductions beyond both law and economic principle, including examples involving Mellon’s Gulf Oil, which artfully used depletion deductions to reduce its taxes from $2,579,127 in 1919 to a mere $307,011. Couzens accused the bureau of abandoning fairness and instead permitting illegal deductions, awards of discovery to previously known deposits, and “bargaining with taxpayers.”Footnote ⁹⁵ As for valuation, the committee concluded that within the BIR “there appears to be no system, no adherence to principle, and a total absence of competent supervision.”Footnote ⁹⁶

As for discovery depletion itself, the committee called it “clearly an exemption from taxation on net income and as such is a discrimination against every other taxpayer and every other industry.” While it accepted depletion as a principle for separating income from capital, discovery depletion and revaluation represented instead what has come to be called a tax expenditure, a privileged tax provision encouraging particular activities (like oil drilling) by reducing the tax burden upon them.Footnote ⁹⁷ Noting that the end of the war had obviated the explicit policy objective of encouraging production for national defense, the committee demanded that tax policy catch up with the realities of oil production in the mid-1920s. “The production of oil now exceeds the demand,” the committee concluded. “The present problem is how to conserve this natural resource.”Footnote ⁹⁸ The hearings further revealed that despite congressional intentions, industry experience with manipulating the provisions of discovery depletion—especially the geometry of where to drill—allowed nearly every new oil well to claim its benefits anyway, irrespective of the judgment of technical experts. And despite the original desire to provide relief for the wildcatter, roughly two-thirds of all discovery depletion claims went to larger firms. Not only did taxation based in geology thus appear unreliable, but the function it was designed to play of rewarding exploration was routinely flaunted by oil drillers. According to L. C. Manson, counsel to the committee, “If there is anybody that is not getting depletion now, it is because he has overlooked his opportunity, and I doubt it.”Footnote ⁹⁹

It was not illegal applications of the depletion allowance that proved most politically troubling, however, but the perfectly legal ones. Following the Couzens committee report, both the House and Senate took up the depletion question while debating the Revenue Act of 1926. At no point did either chamber seriously consider abandoning the principle of depletion. It was by then too entrenched in industry activities. Legislators debated only how best to calculate a fair depletion allowance, how much territory new wells should prove, and who should be entitled to the deduction. House members acknowledged the legal confusion and practical disarray caused by the depletion question, but they believed the limits they instituted in 1921 and 1924 were working, and that only additional restrictions to existing methods were necessary. Yale’s T. S. Adams, still an authority on taxation, confessed to the House Ways and Means Committee that the original wartime depletion provisions were “bad in theory and bad in practice,” but changing the law would be difficult for both political and economic reasons because “industry has become habituated to it.” He added that “it is something like accustoming a child to some debilitating or harmful luxury and not being able to take it away from him all at once.”Footnote ¹⁰⁰ Put another way, in just a few short years, Congress and the BIR had used taxation to construct a political economy for oil and other natural resources that shaped not only corporate profits and taxes but production levels and market prices as well. Critics also called geology itself into question. The solicitor of Internal Revenue, A. W. Gregg, worried that in a hypothetical legal challenge to the BIR’s fixed area proved by a well, the courts might force them to use geological conditions instead—as intended by statute. But, he added, “It seems that nothing is more doubtful than the extent of a given pool as indicated by geological conditions. It is a matter of speculation and would impose a tremendous burden on the Treasury,” especially for determining geological conditions a decade earlier, as cases took years to work their way through the legal system while companies continued to pump oil from their land.Footnote ¹⁰¹

The Senate, in contrast, considered a comprehensive overhaul of the depletion system. Couzens, after investigating the BIR, supported scrapping discovery depletion and revaluation entirely, replacing it with a simple depletion based on cost like depreciation for any other industry. He insisted that “capital” once again mean a company’s actual investment in property and exploration and not a speculative revaluation. The Mid-Continent Oil and Gas Association balked. Depletion on cost would return natural resources taxation to its pre–World War I tax disadvantages and practically eliminate the utility of the depletion allowance. Now joined by half a dozen other regional oil lobbies, the Mid-Continent lobby began pursuing sympathetic senators. It argued for either the retention of the 1924 limitations or a return to percentage depletion, that is, an administratively simple fixed (and preferably high) percentage deduction from gross income. Since the operators insisted that all oil producers should benefit from depletion, not only wildcatters, all should be eligible. After reviewing the findings of the Couzens Committee, the Senate Finance Committee agreed with eliminating the burden of valuations and discovery depletion and replacing them with a fixed percentage deduction for all producers. Kansas senator and future vice president Charles Curtis submitted the operators’ proposal for a 35 percent deduction to the committee, which reduced it to 25 percent but enthusiastically agreed with the principle.Footnote ¹⁰²

Science, even when performed with integrity, introduced uncertainty into taxation—a result precisely contradicting the reasons the Treasury hired geologists in the first place. Oklahoma’s John Harreld believed that geological work was simply too much of a burden, requiring a substantial “force of oil engineers” to calculate depletion figures.Footnote ¹⁰³ Pennsylvania’s senator David Reed, another ally of Mellon from the secretary’s home state, caricatured oil valuation by questioning the authority of geological expertise: “The expert engineer of the bureau goes to the area where the oil is being produced,” he explained, “he finds out what the size of the tract is, and, by a combination of guesswork and imagination, he estimates the quantity of oil in that area, the quantity of oil that is likely to be produced by that well during its entire life.” If that process was not shaky enough, he continued, “by another process of guesswork, he estimates what each barrel of that oil will bring in during each of the future years during which the oil will be produced, and having arrived at one uncertainty, he multiplies it by the other uncertainty,” a sure recipe for inconsistency.Footnote ¹⁰⁴ In the conference committee, the House receded to the Senate’s plan, adjusting the percentage depletion to 27½ percent of a well’s gross income.Footnote ¹⁰⁵ For his part, Couzens was resigned. “Having already given them half the earth,” Couzens shrugged, “we have now decided they shall pay taxes on only a fourth of it.”Footnote ¹⁰⁶