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Super profits tax

Ken Henry argues that introducing a super-profits tax and cutting royalty charges will increase investment in Australian mining because while firms are developing their mines and earning profits they will be less penalised in terms of reduced royalties and given additional exploration incentives – and they will only lose a fraction of their super-profits if they strike it rich. As a straight piece of economic analysis this seems incorrect.  Firms explore for and seek to develop high-risk mining projects in the hope of gaining super profits.  The hordes of penny-dreadful stocks on the mining lists and their substantial price volatility are testimony to this approach.  Reducing the possible profits firms can earn if they are very successful will reduce incentives to explore and develop even if exploration and development decisions are fostered.  As an empirical issue it is a priori unclear that the enhanced short-term incentives to explore and develop exceed the long-term lower rewards.

Cruder versions of the Henry argument are appearing on leftwing blogs.  They are reminiscent of the Henry George fallacy of promoting land taxes as a deadweight-loss-free way of extracting rents from land owners.  The unsophisticated version of this story is that land is fixed in supply so tax it until it only earns 1 cent per hectare for its owner and you won’t alter its supply. You will leave demanders happy and augment the government coffers.  This argument is wrong once you see that it is not “land” but “land with investment improvements” that is sold in markets and the case for making these improvements depends on the probability of turning a profit when you rent out or sell the land.

Henry George also took the view that land should be owned as common property – a view shared by the resource super tax supporters who see mineral resources in the same light. A great excuse for conficating property – we will sold it to you we forget to tell you that it really always remains ours.  

Australia’s mineral wealth does not consist of numerous deposits each with exactly known commercial potential which is each given away gratis to firms – in the view of the Rudd government primarily foreign multinationals.   Mineral deposits have to be proven up and be brought into development or purchased from firms who have done this work on terms acceptable to their vendors. Most exploration ventures in fact fail.  Treating the few which are successful to a super-profits tax reduces the incentives to punt on what are incredibly risky ventures.   It secures rents from those which are established winners but reduces incentives to repeat the process of bringing new projects to fruition.

A good question asked by the leftists is, if my argument is correct, why have any taxes at all? My answer to this question is pragmatic – we are doing extremely well out of the current mineral boom with well-paid workers securing their future, State and Federal governments taking huge slabs of profiit, income tax and royalty revenues.   Why risk this?

If eliminating inefficient royalty regimes is the objective then do so but make the change revenue neutral. Don’t risk damaging the most productive and profitable segment of Australian business.

6 comments to Super profits tax

  • observa

    “If eliminating inefficient royalty regimes is the objective then do so but make the change revenue neutral.”
    Of course it is an interesting exercise to consider the revenue neutrality of complete reliance on resource taxing whereby all other taxes for the miners are abolished. ie no payroll tax, stamp duties or company tax, nor the admin costs of GST and income tax accounting. Of course in contemplating almost total reliance on resource (and topically CO2E taxing), it’s impossible not to consider the use of land (and rivers and seas) as a resource too. That invites a lot of dead economists and philosophers to light the path, not least Henry George. Your point about taxing land til the pips squeak is an obvious one but a subtler one for the times is not to tax natural environment whatsoever, for the converse, that to do so would encourage it’s use for economic return rather than its intrinsic value. John Walmesly via Earth Sanctuaries(http://www.abc.net.au/news/stories/2010/05/17/2900962.htm) tried to market that intrinsic value, but alas was doomed to failure, competing as he was with the massive incentive scheme to turn it to our wants.

    Henry was naturally a philosophical prisoner of his times and whilst new lands and horizons were seemingly in abundant supply that is not the case now. Whist in Henry’s day they could understand the tragedy of the common, the tragedy of many privates was a long way from such common consciousness. Not so today where we need to envisage not only nhow to protect natural environment, but also like Walmesley, how to create or recreate it. That is the fundamental question now, particularly as a great moral imperative has faded from view.

  • derrida derider

    Harry, you’re missing two critical points:

    – a large slab of this tax is effectively replacing royalties (as royalty payments are deductible dollar-for-dollar from the RSPT liability). Of course any tax on mining, just like a tax on any other activity, is always going to have some reducing effect – but some tax structures do so far more than others. Royalties, payable regardless of the actual return you’re getting, are one of the ones that do it most. So replacing royalties with the RSPT improves incentives for risky projects.

    – the tax on the upside risk is matched by a subsidy on the downside risk. Projects earning less than the bond rate get 40% of the difference made up. This is not a trivial thing. In effect, the RSPT transfers some of the risk of a project from the miners to the government – given normal risk aversion by investors this should make MORE, not less, projects viable.

    As usual when a tax change is proposed those affected resort to bullshit – and we’ve seen plenty of that already.

  • hc

    DD, You can hardly say I missed these points as they are the central part of the post. Offering short-term incentives but longer-term punishments will have at best an ambiguous effect on mineral project development. You cannot assert it will encourage activity.

  • derrida derider

    “You cannot assert it will encourage activity.”
    You can if it s explicitly replacing something that has a discouraging effect with something that has, even on your assumption, only an ambiguous effect. Which is my point about royalties.

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