The statement by economists supporting the RSPT resource rent tax is curious in its intent. It supports taxing profits rather than the existing production-based royalties as most economists would. But its other contentions that the mining industry will not ‘contract’ conflict with this view.
The claim that depletable resources are ‘different’ to other industries suggests there is a market failure associated with their production. Perhaps the implied notion is that they are costless to explore for, prove up produce and exploit – it’s hard to say for sure what they think because they don’t say. Hotelling in 1931 taught that in the absence of distortions competitive extractive industries drive a competitive equilibrium. It would be good to know what the distortion is here that warrants special treatment but for goodness sake don’t tell us it stems from the fact that the firms extract depletable resources. Is it that rights to explore are not auctioned? Be clear economists!
From the correct claim that a profits tax is better than production based royalties our economists jump to the view that there is no reason to expect that the mining sector will contract when a profits-based tax “replaces” a royalty-based tax. The word replaces here is ambiguous since it suggests revenue neutrality but the current government proposal is anything but that. My understanding is that the current government tax is designed to yield huge revenues for government net. In no sense is it a “replacement”.
In the final part of their statement the economist recognise that the resource tax will reduce “the profitability of mining companies and the value of the exploration and mining rights “ they hold. It is hard to tally this obvious recognition with their earlier claim that there “is no reason to expect a net contraction in mining over the longer term”. In fact you cannot reconcile these statements – they are simply inconsistent.
Update: I pursue these views over at John Quiggin’s blog.
hc: I could not find your comment at JQ’s. Here is my own, as I doubt he has the guts to “unmoderate” it. The footnotes & table did not get across, so I will email the full text. I am glad to see we are on the same wavelength.
The letter signed by some 21 Australian self-styled economists endorsing the so-called Resource Surplus Profits Tax is full of deception and gross distortions not only of basic economic theory but also of Australia’s existing taxation of mining.
1…`the current public criticism of the proposed tax has been dominated by misinformation’. The main source of “misinformation” has been the Government (Rudd, Swan, Henry), with (1) their wilful relating of tax paid to revenue instead of profits, and (2) their reliance on a grotesquely erroneous paper by a pair of American economists. With company tax charged at 30 percent of mining profits, BHP and Rio would be in breach of the Law if they were indeed paying tax at only 13-17% of profits as claimed by our leaders. That is also the inherent fallacy of the Markle & Shackelford paper (NBER, 2009), which was repeatedly cited by Australia’s Commonwealth Government’s Treasury Secretary Ken Henry and its Treasurer Swan for its “proof” that the “effective rate of tax” (ERT) on mining companies’ net before tax profits is only 17% for “domestic” companies (their Table 4) .
Anybody other than the 21 who has ever glanced at the daily share listings of Australian mining companies would know that the majority pay no taxes because they earn no profits (and never pay any dividends). But then neither Markle & Shackleford nor Ken Henry and the 21 would know that averaging taxes paid by mining companies that do earn profits across all mining companies including those that do not produces only manure like their absurd 17% figure.
2. Consider for example, one of Australia’s leading coal miners. Macarthur Coal’s actual taxes payable in 2008-09 on sales revenue of A$697.4 million (hereafter simply $) were royalties of $59.7 million (at 7% on sales at $100 per tonne and 10% on sales fetching above $100 per tonne (the average price was $157.7 per tonne in 2008-09), and company tax on net profits before tax of $242.2 million that produced a tax liability of $73.6 million. By an astounding coincidence the latter amount was 30% of its net profit before tax, exactly equal to the tax on profits faced by all companies. For anybody with slightly more than Year 9 arithmetic, and that does not include any of the 21 economists, still less Mr Rudd and Mr Swan when they singled out one of the 21, John Quiggin, in parliament (26th May), those two payments, one to Anna Bligh’s Queensland government, the other via the ATO to the also arithmetically challenged Ken Henry and Wayne Swan, sum to A$133.32 million, which is indeed “only” 19% of total sales revenue, but that does not take into account all the costs of mining and of finance. The total taxes paid by Macarthur Coal to Bligh and Rudd-Swan of A$133.32 million were already in 2008-09 no less than 55% of Net Profit Before Tax, despite the royalty payment being a taxable deduction from net profits. Clearly the 21 economists have no more idea than Rudd-Swan-Henry that a royalty of 7-10% of sales revenue amounts to a much higher tax of profits, since profits are of course always much less than revenues (profits before tax were only 35% of sales for Macarthur in 2008-09), so the royalty paid was actually 24.6% of net profit before tax. That is a sum too far for the 21 and Australia’s government.
3. But clearly the total of 55% of its net profit payable by Macarthur in tax and royalties in 2008-09 was grossly “inefficient and inequitable”, according to the 21 and their inspiring leaders, so we now need to have a Resource Super Profits Tax. That will in principle be charged at 40% on profits that yield a return of more than the government’s bond rate, about 6%. Return on what? Macarthur Coal was capitalised by the ASX at A$1,678.38 million on 30th June 2009 (A$6.6 per share of 254.3 million shares on issue). The RSPT threshold for “super profits” is therefore 6% of A$1678.33 million, which is A$100.7 million. Macarthur’s actual net profits before normal tax in 2008-09 were A$242.2 million, so its “super” profits were A$141.5 million, on which RSPT at 40% would have been payable, namely A$56.6 million. Ironically, Macarthur would have been able to claim a credit for its royalty payment to Queensland that year of A$59.7 million, so it would have escaped the RSPT altogether. Truly, it needs really brilliant economists, not just those from Queensland, to dream up such a stupid tax that yields NIL even in Macarthur’s most profitable year in its history. But to be fair, let’s instead assume the tax base for the RSPT is not a company’s market capitalisation, but its non-current liabilities, which comprise its total debt. For Macarthur Coal in 2008-09 these amounted to only A$238.4 million, because it has for many years financed its investments and other capital requirements from its internal net after-tax revenues, rather than new debt, a concept unknown to Australia’s Treasury. That amount is actually less than Macarthur’s net profit before tax of A$242.2 million in 2008-09. So the geniuses of the Treasury are now in lal-la land, whereby Macarthur has net profits that are more than 100% of its non-current liabilities. Hallelujah! – for now the RSPT really does kick in: at a 6% long term “risk free bond rate”, the allowable return on A$238.4 million is just A$14.3 million, so Macarthur’s “super profits” magically soar to A$227.9 million, on which the tax due in 2008-09 would have been A$91.1, albeit less the royalty rebate for Macarthur of A$59.7 million. The 21 authors of The Letter seem to think that allowing the mining company to claim their royalty payments as a deduction from the RSPT does not affect the Commonwealth’s total receipts from company tax and the RSPT. But of course it does. The actual company tax payable by Macarthur in 2008-09 was A$73.6 million. Rebating the royalty Macarthur actually paid (despite its tax deductibility against its company tax) means the net company tax payable by Macarthur becomes A$8.116 million (28% of A$242.2 minus A$59.6 million), to which the implied RSPT can be added. ONLY if just Macarthur’s outstanding loans are allowable as the base for the allowable 6% “risk free return” will the RSPT and net company tax produce the revenue bonanza the Treasury anticipates as shown in Table 1. However that “favourable” outcome for the Treasury is dependent on the fact that Macarthur has financed its re-investment for many years from retained earnings. That is yet another alien concept to Mr Henry and The 21, neither of whom ever mention it. If those reinvestments were brought to account as the base on which the allowed ‘normal’ profits of c6% (the Commonwealth government’s long term bond rate) would be imputed, as they should be, then the allowability of royalties could well result in the Commonwealth obtaining no net revenue gain from its RSPT.
4. The 21 go on: “Mining is different to [sic] other industries in that it uses and depletes natural resources. Some return on those resources should flow to the Australian public. The existing royalty system reflects the fact that it is desirable to levy a charge for access to publicly owned mineral resources, in addition to normal corporate income tax.” So, since a royalty system enacted by the State governments and enshrined in the Constitution already exists, why does it need to be reinvented? The 21 economists’ letter fails to address that issue. Originally royalties were like land rents charged at specific rates (e.g. so much per acre or per ton), but with inflation , ad valorem rates (x% per $ of sales revenue) came to be charged. The basis for a flat rate royalty is precisely that it is not normally (except in Queensland) progressive with respect to revenue per tonne, and that would also be the case with the flat-rate company tax, were it not that it is adjusted progressively with the incomes of the owners (aka shareholders) of mining companies when they receive their dividends. Many Australians have paid income tax at 46% (now 45%) on their dividend income (i.e. basic 30% credited as paid, plus an extra 15-16% after submitting their tax returns. The 2010 Budget’s changing of the standard company tax rate to 28% makes not the slightest difference to those with incomes above the applicable thresholds paying income tax at more than that rate, as their dividends will still be charged at their top rate if their basic earned income only reaches the 28% rate. Mr Henry’s Treasury and The 21 seem to have forgotten if they ever knew that companies are not people, whereas their owners are. The effective all-in income tax rate for top-rate payers on mining dividends under the existing State royalties is already well over 60 percent, and for dividends if any from companies incurring RSPT above effective royalty payments, will raise the top marginal tax rates for such persons to well over 70%, as they will receive no imputation credits on the RSPT (which are also excluded from the existing State royalties).
5. The 21 go on to claim ‘There is no reason to expect a net contraction in mining over the longer term as a result of replacing royalties with the proposed resource rent tax. This is because a tax on economic rent of non-renewable resources is a more efficient way of raising revenue than taxing mining production (royalties)’. There are two confusions here. One is that the States’ royalties do NOT charge “production” (in the form of a dollar rate per tonne) as they all charge their royalties as a percentage of the sales revenues of mining companies . Secondly, much depends on the actual royalty rates charged by the States now and in the future. The RSPT creates an enormous incentive for the States to lift their royalty rates to perhaps as much as 40%, knowing that the mining companies will not incur any extra burden, as their royalty payments will be rebated against their RSPT liabilities. So much depends on the States’ future royalty rates. Mr Swan is confident despite the Macarthur Coal data above that the RSPT will produce net additional revenue (even after allowing for rebating the States’ royalties). Why would that not impact on the projected net cash flow to miners’ shareholders and thence on the companies’ incentives to continue mining and seek out new projects? Truly, we live in a strange world where reducing the profit expectation in sector A relative to that in RSPT-exempt sector B has NO impact on future investment in mining sector A. The 21 should be asked to rewrite their microeconomics textbooks accordingly.
6. The 21: ‘Royalties tax production [sic, actually they tax gross sales revenue] no matter how profitable. A resource rent tax only taxes production when it is profitable and only after all costs have been deducted’ (Mr Rudd, parliament, 26th May 2010). But that is exactly the same as the existing company tax on mining profits. Neither Mr Rudd nor his chief source, The 21, has any idea of what they are talking about.
7. The 21: ‘If the project does not make a profit, some of its costs are potentially refundable or otherwise claimable. This means the Government shares the risk associated with exploitation of our minerals resources’. That is already exactly the case with the Company Tax, which only applies to Net Profits if any – no profits no tax. The only difference is the as yet unsubstantiated claim that the Commonwealth Government would live up to this commitment to refund “some” (which? by how much? On what basis?) of losses arising from unprofitable mining projects. Again a glance at mining shares listed on the ASX shows that very few ever have any net earnings or taxable profits – most are truly penny dreadfuls, but will be licking their lips in anticipation of Mr Swan’s future largesse.
8. ‘So, the proposed design for the RSPT effectively only taxes those profits over and above the hurdle rate of return for a mine (that is, its risk-adjusted cost of capital), after allowance is made for the proposed 40% rebate of the cost of developing each mine’. This is gross disinformation, as it is not now nor ever will be the case that miners can raise their capital at the government bond rate – and most rely heavily on speculative equity contributions from their shareholders that will no doubt be disallowed for computation of the “hurdle rate of return”. Moreover, as Lonergan & Associates note in their report to Macarthur Coal on its proposed takeover of Gloucester Coal earlier this year, the real cost of equity funding to Macarthur is 14.5% (2010:p.63), far above the “hurdle rate of return” allowable under the RSPT.
9. ‘Given the Government’s commitment to bearing some of the risk by refunding
[some] losses, uplifting undeducted capital and losses by anything above a risk free rate would create potential distortions. Any increase in the uplift rate would require a corresponding modification of the risk shared with government’. The government shares no risks unless it provides upfront finding, as Messrs Forrest, Kloppers and de Villiers have repeatedly pointed out. The existing “super” tax on new petroleum and gas projects allows for an “uplift” (allowable profits) rate of the government’s long term bond rate plus five percent. The 21 do not explain why that system has not given rise to the “distortions” they claim would result from applying the same “uplift” to mining in general.
10. ‘Any modifications in the design of the RSPT should be underpinned with evidence about the relative shares of returns for natural resources as well as returns on other factors of capital’. This is pure metaphyics. There are no “returns for natural resources” or for “other factors [sic] of capital”. There is capital (funds employed); there are no other “factors of capital”, and minerals in the ground are not a “factor of capital” until real capital has been deployed to raise them from the ground.
11. ‘Moving from taxing mobile capital towards less mobile tax bases in this way is
consistent with economic theory and recent work of the OECD and IMF on the
application of economic principles to guide taxation policy’. Such as? – this is anyway an empty appeal to non-existent authorities, certainly they are no better than the North Carolina economists so beloved by Wayne Swan and Ken Henry.
12. ‘Australia has a long history of resource taxation and resource economics. The Petroleum Resource Rent Tax that started almost 24 years ago only applies to some sites offshore [not true, it mostly applies only to new onshore projects] and represented a significant practical and conceptual advance in our thinking and tax
practice. Applying this principle more broadly to other minerals represents the next
measured but difficult step’. Why are the signatories to this letter so blatantly underwriting an obviously unmeasured highly politicised new tax proposal if they are not signalling their availability for yet more ARC grants and Fellowships?
13. ‘The RSPT will reduce the profitability of mining companies and the value of the
exploration and mining rights allocated to them by Australian governments on behalf
of the public’. This is the first and only true statement in the whole letter.
14. ‘The current high profitability of these companies means that this is an
appropriate time for them to adjust to a more efficient and equitable system of
sharing the value of those rights’. The RSPT is basically a greedy windfall tax grab, and would never have been introduced when mineral and metal prices were at their levels from 1990 to 2001. Real economists know that the RSPT is like any other progressive tax, including income tax, because of its negative impact on incentives at the margin. Real economists know that where efficiency is the criterion, flat rate taxes are best. As for equity, all Australians have benefited from both the taxes and the dividends paid by mining companies, since up to 80% of the shares in companies like BHP are held by Australian pension funds.
15. ‘The RSPT has been criticised on the basis that revenues are dependent on cyclical fluctuations in mining sector profitability. In reality, this is a substantial advantage of this aspect of the tax’. Company taxes paid by the miners have also always been cyclical in nature; the 21 dishonestly yet again fail to mention that this supposed advantage of the RSPT applies to Company tax.
16. ‘The counter-cyclical nature of tax revenues will help to stabilise both the macro-economy and the level of activity of the mining sector’. It is more likely to promote Zimbabwe-style stagnation and decline. Has anybody suffered from the booming mining sector and macro economy since 2001?