Biting the golden goose that feeds you

“I’ve just felt I was living and breathing a George Orwell novel…”

Update: JQ lists the pros (several) and cons (none).

The reporting of the resource rent tax plan has been poor, and last night’s ABC television coverage was a good example. In his ‘Finance’ segment of the News, Alan Kohler revealed that share prices for mining companies have fallen, as if this wasn’t exactly what one would expect; and as if, by ‘wiping out wealth’, the policy has already had a negative affect on the economy. The strangest bit was at the end, when Kohler noted — with that meaningful twinkle of his eye that he affects when he’s reporting some fact whose significance speaks for itself, at least to the cognoscenti (so thank goodness he doesn’t have to explain it) — that the reduction in shareholder value was about equal to all the revenue the tax will raise ‘in the first few years’.

What was his point? That the fall in stock value cancels out the gain in revenue? In any case, the loss to shareholders is actually less than the capitalised value of all the additional tax the government will appropriate over the foreseeable future, so it could have been worse for them. (To be fair, Kohler gives generous praise to the Review in ‘The Drum’ today; but he’s more interested in the 136.25 recommendations the Government is ignoring than he is in the resource tax.)

After the News The 7.30 Report got stuck into it too, following the standard approach, which is to line up a couple of the tax’s critics from the mining industry, the Opposition or the Murdoch press, against a couple of its defenders from the government or the review committee. The critics of the tax tell us how it will decimate the industry and thereby impoverish the rest of us; the advocates declare that it’s time the industry paid its way. At the end of the day it’s all reduced to a matter of opinion, a divisive policy, a bit of politics, and off we go, talking about ‘how it will play with the electorate’, which is about all the ABC current affairs team really like to talk about. This profound analysis by The Australian’s George Megalogenis sums it up:

Everything involves a very, very clear political message, which is: I’m going to take a bit of money off these people who don’t vote, in this case miners, and I’m going to give this money to, and I’m gonna take the money and give it to some other people who do vote.

You’d never guess that there actually exists a set of widely agreed criteria for comparing competing tax rules and regimes, and that facts and figures can be obtained to assist in applying these criteria. I wonder if the ABC employs even one senior reporter who has an economics degree with a standard public finance unit in it. Have any of them have actually read the relevant chapter of the Henry Review? If they had, they’d at least be able to explain the basics:

Source: The Henry Review

1. Rent taxes can be presumed more efficient, because they appropriate surplus income that arises from ownership of a resource that’s unique or fixed in supply. Since the income doesn’t correspond to a cost of production, taxing it doesn’t affect economic decisions and distort the allocation of resources. This is standard economic reasoning, notwithstanding the odd nincompoop who thinks the idea came from Marx.

2. Under ideal conditions, the rights to the resource would be auctioned to the highest bidder. But because of economic risks, and ucertainties about future government policies, the government is likely to raise more money from a rent tax. In fact tax is a misnomer, as the Review notes, because it’s really the sale of a publically owned asset. Royalties should not strictly be counted as tax revenue at all.

3. Apart from the Petroleum Resource Rent Tax, current mining royalties are collected mostly by the states. They are calculated on volumes rather than profits, which is universally recognised as inefficient because it takes no account of the costs or market prices of the commodities. Such charges may indeed discourage extraction at the margin — which is exactly what the mining industry is illogically complaining that the proposed rent tax would do. In fact the Henry proposal is to apply a 40% tax to profits over and above a prescribed rate of return, equal to the ‘long-term Australian government bond rate’.

4. The proposed 40% tax rate, together with the 25% company tax rate that currently applies to mining profits, would imply a 55% overall tax on rental income (the income tax is applied after the rent tax is deducted). This would leave a significant portion to the mining companies, providing incentive to optimise their extraction. A 100% tax rate would obviously take away firms’ incentive to improve their efficiency.

5. Tax collected from mining profits has more than tripled in absolute terms in the course of the minerals boom of the last decade, as the diagram shows. But as a proportion of profits it has fallen by about three quarters. Had the proportion been maintained, royalties would be earning the states — according to my eyeball calculation — about twenty billion more than at present, although the revenue projection for the current proposal is apparently only $9 billion. In any case, the Federal Government would be in a much better position to impose a resource tax on multinational mining companies than individual states. And, regardless of who collects it, that amount would reduce the stress on budgets at all levels of government.

6. An alternative is to save the revenue. This would have the effect of reducing net capital inflows whether or not the government establishes an explicit ‘sovereign wealth fund’, as discussed in the Review. In principle, if the flow is large enough, it should reduce pressure on the Australian dollar and in turn the urgency experienced in some quarters to expel Western Australia from the Union. In practice $9 billion dollars is about equal to the statistical noise in the current account balance, so I can’t see it making that much difference.

All this amounts to a pretty good prima facie case for the resource rent tax. If our economic reporters did a bit more homework, they’d place the burden squarely on the critics to prove otherwise, rather than just invite them to fulminate and threaten.

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16 Responses to Biting the golden goose that feeds you

  1. John Passant says:

    Thanks James. Sinclair Davidson thinks an RRT is based on the labour theory of value. My admittedly limited understanding is that economic rent squares the circle of use value and exchange value in a capitalist friendly way (ie solves the issue of something having value without seemingly extra labour involved).

    One question: Why does Government fund 40% of the project through the tax system? (And is it?)

    The hysteria is par for the course when some slight impost on profits occurs. The same thing happened when the Petroleum Resource Tent Tax was introduced 25 years ago. I think it is all b/s, as I wrote on my bog.

  2. Tel says:

    Since mining shares like BHP are the sort of thing that super funds buy (and self-funded retirees too), the government has just dipped their hand into people’s retirement funds and decided to use that to cover their deficit. Then forcing workers to put even more money into Super. That’s what you get when you apply Central Planning to personal investment.

    It might also be a bit of a Green vote grab, making those rich miners pay for CO2 yadda yadda. I guess we will see how the campaign slogans shape up.

    On the theoretical side, correct attribution to this methodology goes to Willie Sutton, rather than Marx. A quick summary of Keynesian Economics ==> saving yesterday, saving tomorrow, but always spending today.

    There is socialist theory discussing the issue (very easily found on google):

    Marx’s theory of land and mineral rent can be easily extended into a general theory of rent, applicable to all fields of production where formidable difficulties of entry limit mobility of capital for extended periods of time. It thereby becomes the basis of a marxist theory of monopoly and monopoly surplus profits, i.e. in the form of cartel rents (Hilferding, 1910) or of technological rent (Mandel, 1972). Lenin’s and Bukharin’s theories of surplus profit are based upon analogous but not identical reasoning (Bukharin, 1914, 1926; Lenin, 1917).

    Doesn’t seem entirely incompatible with the concept of a tax on mineral rent. Certainly the oil industry have demonstrated that limiting “mobility of capital for extended periods of time” is entirely achievable. I believe that Hugo Chavez is running a similar system: grab money from minerals and use it for social programs. It seems to be working OK for Hugo.

    The concept of taxing rent ignores the effort that went into prospecting to discover the minerals in the first place, which probably doesn’t matter much for Chavez and OPEC, might be more important in Australia.

    Federal Labor does seem to be determined to repeat Whitlam’s ham-fist efforts and piss off the widest selection of people in the shortest time. They should learn a lesson from John Howard’s cunning that it is safer for a government to annoy a small number of people by a large amount, than it is to annoy a large number of people by a small amount. Thus the price we all pay for Howard not having the decency to retire when he rightly should have.

  3. James Farrell says:


    It’s based on neoclassical principles loosely with a lineage classical economics, in which the labour theory of value was an ingredient. Since Sinclair is forever proclaiming the superior wisdom of what he calls classical econonmics, he should be pleased.


    Your summary of Keynesian economics is as intriguing as it is subtle, but I fail to see the relevance. As for ‘taxing rent ignores the effort that went into prospecting’, the Review discusses this issue at length. Check it out.

  4. Mr Denmore says:

    Lex, the London Financial Times columnist, and normally a defender of the mining industry had this to say today about the resource rent tax and the resource sector’s loud objections:

    “At bottom, the idea is not a bad one. The “competitiveness” argument is a non-starter: non-renewable resources do not move. So is the supposedly ruinous effect on the net present value of multi-year, multi-billion dollar projects: tax is just one of many inputs that are altered all the time. More fundamentally, this is a global age of austerity. All governments need to capitalise on their distinct advantages: Australia’s happen to be geological. Enshrined in the country’s constitution (Chapter IV, article 91) is parliament’s right to tax metals as it sees fit. What could be more appropriate, that citizens who have spent their working lives on Australia’s soil should have their retirements funded by it?”

  5. Nicholas Gruen says:

    Thanks for the post James – I bang on about this all the time. I wonder what can be done about it?

  6. Tel says:

    What could be more appropriate, that citizens who have spent their working lives on Australia’s soil should have their retirements funded by it?

    That would actually make sense… if the government still paid people’s retirements out of tax inputs. But under the superannuation system, this new tax has merely shifted the wealth that was sitting in retirement funds over to government spending projects.

  7. James Farrell says:

    You do indeed, Nicholas. The only reason I didn’t mention the fact is that I didn’t want to implicated you in this paticular example. For all I know you have most of your millions in resources, and were screasming ‘Go, Mitch!’ in that interview.

  8. Nicholas Gruen says:

    Mitch has a very compelling bass baritone voice. A loss to singing – though perhaps he is not – perhaps he sings, not just in the shower, but in one of the many choirs in Canberra – where I used to sing a bit. (I had a worse voice).

  9. Patrick says:

    Or otherwise put, Tel, from private sector retirements to public sector retirements…

    Actually I don’t think it is such a bad idea. But I think that the general company tax rate should have been cut to 25% outright and all the ‘nuisance’ recommendations (abolish nuisance taxes, luxury car rules, etc) should have been put through. I don’t understand the political calculation of inflicting pain and minimal gain.

  10. Nicholas Gruen says:

    What’s such a ‘nuisance’ about the luxury car tax? It’s a good, pragmatic sumptuary tax. Adam Smith may well have approved (after you’d explained to him as best you could what a car was.)

  11. Tel says:

    On further study and reflection, I like this less and less. The state-based tax on extraction volumes is regarded as inefficient “because it takes no account of the costs or market prices of the commodities” but it would be vastly simpler to allow volume royalties to float in price, than it would be to use the suggested Henry system.

    For instance, suppose before a mining lease is granted, the terms (including a negotiated volume royalty price) are published and some months of waiting period allows better offers to come along — the state government then offers that lease to the best payer. Simple to administer, and only a very small deviation from current practice. They could even time-limit the contract to make it long enough to encourage exploration and risk taking but short enough to allow a change in price as commodity prices will inevitably rise.

    Ken Henry’s system of whacking a tax on profits was probably designed to facilitate Federal takeover of state turf — economic efficiency theory used as justification for whatever it needs to justify on this day, which is standard practice really. Taxing profits is efficient because my employer can get his hands on them without breaking the Constitution.

    Implementing the Henry system requires that some companies be designated “resource renters” and their profits taxed at a different rate to other companies. However, money goes back and forth between private companies all the time with equipment hire, services to remote areas, consulting fees, and so forth. The inevitable conclusion that the Feds will come to is they need to inspect the books of all companies even tangentially related to minerals and declare this hire company to be a 30% “resource renter” and that company to be only a 15% “resource renter”. Then they will need standard rate cards for all equipment hire and services to compare against (no doubt updated by a newly invented Federal department, with a newly invented budget).

    Bah! An accountant’s wet dream and a businessman’s nightmare. One more intrusion of federal inspectors into every conceivable detail of our lives. All in the name of theoretical economic efficiency… :-( We already have a tax system that is complex beyond belief, no one wants it more complex. Smack fingers. No!

    It gets worse when you consider the implication that a government lowering the long term bond rate will instantly increase their tax revenue base. Thus putting additional pressure on the RBA to lower interest rates and we end up following in Bernanke’s footsteps. Let’s wait and see where the US economy goes before deciding to do that to ourselves.

  12. Patrick says:

    Sorry, NG, I meant the ‘luxury car tax rules’ which apply to owners and lessors/lessees of luxury cars. They are complicated to administer and deliver minimal revenue benefits.

    From a policy perspective I agree, I couldn’t really complain about LCT.

    Tel, yes and no. I don’t think there will be any new departments and budgets, the ATO is already rather big. But there are absolutely issues as to the scope and reach – what is a ‘non-renewable non-minimal value natural resource’ after all? What is the profits attributable to that resource? These questions are likely to be resolved, if the tax goes ahead, but frankly given Rudd’s apparent political ineptitude (not something I thought I would be saying 12 months ago!!) I think you can all calm down and look for the next storm.

    This looks unlikely to happen now. In a way that is a shame, the underlying idea is not an unreasonable approach to taxation.

  13. Patrick says:

    Actually, one more point – I think it would make more sense, economically, commercially and practically, to impose a given % tax on price per unit, not on ‘profits’, ie a % royalty.

  14. Edward Mariyani-Squire says:

    Patrick said:

    Actually, one more point – I think it would make more sense, economically, commercially and practically, to impose a given % tax on price per unit, not on ‘profits’, ie a % royalty.

    How so?

  15. James Farrell says:

    Yes, Patrick, assertion doesn’t take the place of argument here.

    With a tax of, say, 40% of the price of a unit, there would be no guarantee of any profit at all. A mine would have to close for sure if the price fell by enough. A rent tax by definition avoids this outcome, because the tax cuts out exactly when the shut-down price is reached.

    Time for third thoughts.

  16. Nicholas Gruen says:

    Intriguingly, the structure of the tax seeks to maximise output, which will minimise any market power we have. Just a thought, I have no idea how important it is. Joshua Gans had a post on this, but focused more on the market power of infrastructure providers.

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