The long and the short of the new Resource Rent ‘Tax’

I discover, that while I’m on the other side of the world, the Age and SMH have published a column they asked me to write on the new resource rent tax. They’ve published it, but edited and garbled various bits of it.  Anyway, for better or worse, here’s the original.

It’s strange. The Opposition’s most successful attempts to paint the government as economically irresponsible have arisen when the Government has most closely followed the advice of its premier economic advisor – the Treasury and its Secretary, Ken Henry who are hardly paragons of economic irresponsibility.

Tossing over 50 billion dollars into our pockets and rushed infrastructure spending seemed somehow to offend commonsense. In such dire straights shouldn’t we be suffering to make things better? Not if you understand economics.

Likewise, won’t the so-called super profits tax on surging mining profits kill the goose that laid the golden egg, the industry that saved us from the downturn? Not if you understand economics.

The real question on tax is not ‘are there problems with this tax?’ – there always are – but ‘can this tax, with its problems, help us reduce other taxes with more problems?’

Taxing rents on fixed factors of production – like mineral wealth that can be mined for supernormal profits – minimises disincentives to invest because the remaining profits are sufficient to underpin investment incentives.

You might have heard the line about how ‘super profits’ can’t be defined as anything earned above the interest governments pay on their borrowing – currently around 5½ percent. Quite so. But that’s a complete misunderstanding of the new policy.

In fact the policy seeks to put the miner in the same position it would be in if it had agreed to all Australians (though their national government) becoming 40 percent joint venturers in the project – taking 40 percent of any subsequent net profits and bearing 40 percent of the net costs throughout.

In principle this kind of taxation would allow firms to reclaim 40 percent of its costs from government as it built a mine. That’s quite unlike company or personal income taxation where the taxman only assists in funding costs by allowing them to be deducted from eventual profits that eventually emerge in a project.

So ironically you’ve understood the new policy when you realise it’s not really a tax at all. It’s rent on the minerals (that’s why it’s tax deductible). But the terms on the government offers our minerals to mining companies is cleverly calibrated to the fact that not even the company knows just how much the minerals will be worth over the course of a project. So the rent on the minerals is the Government’s 40 percent ‘silent partnership’ in the project.

At least in theory the new arrangements it need never stop a single mine going ahead. If a project is viable, 60 percent of the same project is viable. In reality where multinationals are timing a global portfolio of projects around the world the new arrangements could lead them to queue a few offshore projects ahead of Australian onesours. Still they’ll only be delayed not stopped. Against that, the new arrangements plus lower company tax will also encourage more marginal mines to go ahead. A pretty good outcome given the torrent of new tax revenue these changes bring on.

The public remains oblivious to most of this. The Opposition can take some credit for this – the government its share of the blame. Spinning it as a ‘super profits’ tax seemed like a good idea at the time, but it helped frame the alarmists claim that we were killing the goose.

Had the Government been less frenetic it could have been more strategic. Earlier decisions and earlier release of the Henry Report could have paved the way for better explanation and consultation – for the announced arrangements require substantial tweaks.

Not only will transitional issues need to be carefully considered, but the tax has been formulated to defer the government’s contribution to 40% of the costs until a project is profitable. The threshold of profits above the long term bond rate is there not as a definition of super profits – which would be risible – but to reimburse the project for the funding costs of carrying the government’s contribution as debt onto its balance sheet.

Henry has recently argued that because the promise to bear 40% of the costs comes from the government, it’s as good as a government bond and so the financial markets should fund it at the bond rate. Fiddlesticks. The government should stump up the cash rather than persevering with an artificial – and costly – scheme to push debt off its balance sheet.

For the rest, however self-serving, the miners’ arguments contain vital information we ignore at our peril. If we use their feedback to make the right changes, the new ‘tax’ can join the Pantheon of Australia’s leading edge policy innovations – along with HECS, the Child Support Agency, compulsory super, Centrelink and our family payments system (the best targeted in the world) – the very mechanism that enabled Australia’s cash splash to be got out the door faster and more effectively than in any other country in the world.

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19 Responses to The long and the short of the new Resource Rent ‘Tax’

  1. Ken Parish says:

    Many thanks Nicholas. Finally an article that not only explains the resources rent tax (or whatever it should be called) in terms I can understand, but also succinctly explains how it could/should be improved.

    I wonder why Kevin Rudd is seemingly incapable of this advocacy feat? It largely duplicates his dreadful advocacy efforts on the emissions trading scheme, which was equally readily explainable and equally non-scary when properly understood. As you say, why call it a “super profits tax” when it’s nothing of the kind? And why launch it with the class warfare rhetoric (greedy overseas mining companies etc) Rudd and Swan employed before realising belatedly that it was going down like a lead balloon?

    I’m not at all sure I agree that it would have been better in a political management sense to have released the Henry report earlier and leave the promise/threat of a RRT hanging without filling in the details of how the RRT would work. That would have grounded the mother of all scare campaigns, making Abbott and the miners’ current efforts look tame by comparison. I think what they really should have done was launch it with the sort of clear, calm explanation you’ve just given as well as foreseeing and including the major tweak you discuss at the end of your post: the government anteing up its 40% contribution to costs “up front”. If they’d done it that way then people would have readily understood that this was a compulsory joint venture arrangement rather than a tax.

  2. Graham Young says:

    I think the government might have a problem if the “tax” were seen to be a joint venture Nicholas. That would mean that they would have to stump up 40% of the current value of the existing mining industry, because to share in the profit as though you had equity when you hadn’t contributed any would offend against the constitution – you can’t acquire property except on just terms.

  3. Ken Parish says:

    Thinking about it as a compulsory JV immediately raises some questions too.

    First, do we as taxpayers really want to be jumping into JV bed with every miner who comes along, however reckless or ill-considered their project might be? Mightn’t that distort some of the market signals without which capitalism doesn’t work well?

    On the other side of the ledger, will mining companies wish to go into a joint venture with a partner which can (by definition) completely rewrite the terms of the JV agreement, or tear it up completely, if it happens to suit it? Of course this is the point that the miners have been labelling “sovereign risk” and so it is. But conceptualising it as a JV makes the point so much more dramatically.

    Lastly is the point Graham makes. If it really IS a compulsory joint venture arrangement in essence, then its effect on existing mining ventures is to effect a Commonwealth acquisition of 40% of all existing mining ventures and is doing so without any compensation. Prima facie that breaches Constitution s51(xxxi). That may well be why Rudd and Swan haven’t been selling it in that way. Presumably Nicholas would argue that his joint venture point is merely an explanatory simile or analogy. That may or may not be so. If it really IS an acquisition of property then it will certainly be challenged in the High Court irrespective of how Rudd and Swan try to characterise it.

  4. derrida derider says:

    I reckon as a matter of political strategy they should have done a design more like the petroleum RRT – ie a high hurdle rate, but no reimbursement for falling below the rate.

    I realise that this would be an economically inferior design that is actually a bit more likely to deter risky projects. The current design doesn’t deter such projects – indeed, compared to the royalties it’s replacing it actually encourages them. But the reason this is so is far too hard to explain in a soundbite, which lets the miners convince people otherwise. And the reason the “super profits tax” really is only on super profts is also too hard to explain in a soundbite, but wouldn’t be if the hurdle rate was 10% rather than the Treasury bond rate.

  5. Ken Parish says:

    Thinking through the acquisition of property issue a bit further, the High Court usefully mused about the nature of property rights in Yanner v Eaton in 1999. The joint judgment observed:

    The word “property” is often used to refer to something that belongs to another. But in the Fauna Act, as elsewhere in the law, “property” does not refer to a thing; it is a description of a legal relationship with a thing. It refers to a degree of power that is recognised in law as power permissibly exercised over the thing. The concept of “property” may be elusive. Usually it is treated as a “bundle of rights”. But even this may have its limits as an analytical tool or accurate description, and it may be, as Professor Gray has said, that “the ultimate fact about property is that it does not really exist: it is mere illusion”. Considering whether, or to what extent, there can be property in knowledge or information or property in human tissue may illustrate some of the difficulties in deciding what is meant by “property” in a subject matter. So too, identifying the apparent circularity of reasoning from the availability of specific performance in protection of property rights in a chattel to the conclusion that the rights protected are proprietary may illustrate some of the limits to the use of “property” as an analytical tool. No doubt the examples could be multiplied.

    Nevertheless, as Professor Gray also says, “An extensive frame of reference is created by the notion that ‘property’ consists primarily in control over access. Much of our false thinking about property stems from the residual perception that ‘property’ is itself a thing or resource rather than a legally endorsed concentration of power over things and resources.”

    “Property” also includes duties and liabilities as well as rights.

    What is the content of the “bundle of rights” (and duties and liabilities) comprising a mining lease? Arguably it includes the following:

    (1) the exclusive right to extract named minerals from the lease area for the duration of the lease;
    (2) the exclusive right to process and sell them;
    (3) the liability to pay the costs of development, mining and processing;
    (4) the duty to reinstate/rehabilitate the land when mining is finished;
    (5) the right to retain the profits of mining (subject to tax etc).

    It appears that the RRT involves the Commonwealth in compulsorily acquiring 40% of (3) and (5), and presumably 40% of the financial liability flowing from duty (4). Is that enough to constitute an acquisition of property? Or is it just a weird form of tax? One of the arguments in Pape’s case last year was that the $900 stimulus package payment by the Rudd government couldn’t be properly characterised as a tax measure (i.e. a rebate of tax paid) because people were entitled to the payment even though they hadn’t necessarily paid that amount of tax. The majority sidestepped that dilemma by holding that the law could be supported (in effect) under the implied nationhood power even if it wasn’t a law with respect to taxation. Like the stimulus package, the statutory liability the Commonwealth would impose on itself to pay to miners 40% of the cost of development of a resource would be independent of any tax liability the miner accrued i.e. the Commonwealth would have to pay 40% of development costs irrespective of whether the miner ever made any profit and thereby accrued a tax liability. That doesn’t look like the sort of law that could be supported by the taxation power.

    My initial reaction is that the argument that it’s an acquisition of property (at least for existing projects) is at least a respectable one. The mining companies will probably challenge any legislation on that basis.

  6. pablo says:

    Agree the new RSPT has an elegancy about it including the potential for it to be described as rent on minerals yet to be dug. As I understand it the Feds will reimburse the royalties now claimed by the states with eventually these royalties to be abolished? That would save a bit of churning but have the states agreed to this? If it is anything like the GST there were lots of promises but there are still a lot of regressive taxes like stamp duty, payroll in NSW at least.

  7. David says:

    I am not sure they followed Henry closely at all. But that aside, the Government really needs to work out whether its slugging the rich or getting into bed with them. If it’s the latter one would think they could at least engage in some foreplay first.

  8. Corin says:

    Nick, I don’t think they’ve sold the whole package (which includes other reform like lower company tax) to the punters, here’s my attempt at a Keating like metaphor:

    In formula one racing, one car in front punches a ‘hole in the air’ creating wash behind, this is currently a metaphor for the current ‘two-speed economy’, however if the car behind can get close enough it can sit in a slip stream and get dragged along without suffering to quite the same extent, improving the lap times enormously.

    The car in front is mining and the car behind is the other economic sectors.

    The mining tax may create a bigger ‘hole in the air’ but it will also do so more efficiently. The car behind is given a super-charge in the form of the lower company tax rate and can therefore stay closer to the car in front. The effect is that the economy over all (as measured by the two cars) performs better and in greater balance. This would be the team getting a one and two podium place as opposed Schumacher continuously lapping the field (ala 2002).

    I think they’ve become trapped by a debate about part of a package and really even if the above view is totally inadequate to explain what is happening (which it is) it needs to be simple to get people to engage with the issue rather than the scare.

  9. Megan says:

    Your explanation shows to all how difficult it will be to explain this tax to the general public, especially when the basic tenet in our tax laws is that the intent is “to make a profit”.

    What we need to look at is the potential for losses and the australian government virtually subsiding foolish mining projects, and or cowboy companies who will take advantage of these new laws. Where is the incentive to make a profit?

    I’m interested in your thoughts on tax losses.

  10. Nicholas Gruen says:

    Ken,

    I took myself to be suggesting what you’re suggesting in terms of PR.

    Corin, Don’t give up your day job ;) (ie. I’m not a fan of the metaphor!)

  11. Corin says:

    I accept that it is a metaphor but currently the Govt is caught in a debate about mining and projects failing – they need a bigger vision – a bigger sales pitch. What’s you sales pitch that is going to engaged people? You can’t win a reform without engaging the public in a conversation they understand.

    How about the cycling peleton ….?? Very funny I hear you say.

  12. Nicholas Gruen says:

    Yes, I think you do need a larger narrative. I’m not sure that each item needs its own little story. I’d be telling a story about rebalancing tax away from the bottom onto those who can afford it – which means broadening the tax base and taxing rents – environmental (an ETS), amenity (congestion) and mineral (RRT).

    I’d be saying that we’re keeping the personal tax system progressive, but decoupling it from the business tax system which is about efficiency.

    Anyway, I accept that it’s easy to shoot this down – congestion taxes open another front that a government wouldn’t want to do, but I think one can construct a general narrative. Another way of making the point would have been to have a straight switch with RRT funding lower company tax – ie lower than the fairly pitiful 2% reduction – that would then at least set the business community some genuine dilemmas!

    Of course if I were running this I’d add that to my dividend imputation proposal – abolish that and recycle it as lower company tax. Then I’d introduce an undistributed profits tax and you might find you could get the company tax rate down to around 15% and the undistributed profits tax protects you from using the new lower rate for tax avoidance! That would be quite economically transformative I think and I think it could be explained.

  13. Corin says:

    Look I agree with many of your points. I think they should have nailed their colours to the mast and gone for a 25 % company rate even if that meant either a bigger defacit or selling more permits under the ETS. I would prefer the latter but then they ran scared of the ETS as it was.

    I think the GST needs to go up over time, so 12.5 % by 2020 would be entirely in keeping with the need to reduce the defacit, spend more on health and lower tax rates on income as far as this is affordable. By going to 15 % vertical fiscal imbalance would reduce and taxes like payroll tax and reform of land taxes could occur. You could also have lower income taxes across the board.

    The first part is doable, the GST uplift will happen in our life times just not yet. The health system will ensure this and people won’t accept income tax going up.

  14. Richard says:

    The trouble is that the government isn’t coming up with the dosh. It is effectively forcing companies to invest in an illiquid government bond of uncertain term. Meanwhile the company still needs to finance the development expenditure and it will have to pay more (probably a lot more) for the money in the meantime. Also, if BHP develops Olympic Dam for $20bn and it has to close because metal prices collapse, do we really see the government writing a cheque for $8bn plus interest at a time it’s owm revenues have probably collapsed?

    If investors want to put 40% of their portfolios into government bonds then they can do that today. When evaluating investment opportunities will Canada where they can put all of their equity to work be more attractive than Australia? You bet it will.

    The retrospective nature of the tax is particularly odious. It is taking 40% of all the successful projects without refunding past unsuccessful projects.

    Fundamentally if the goverment really expects to get $9bn per annum from this tax then at a modest PE of 12 that will reduce share values by $108bn. This either comes from Australian investors (directly or indirectly Australian workers) or foreign shareholders who will remember this exprpriation of wealth in making future investment decisions.

  15. Bill Cushing says:

    Um … these minerals to be taxed by Canberra are the ‘property’ of the States. This is well explained by Richard Court in ‘The Oz’, 28 May.

    Could be another constitutional issue for Rudd & Co once States wake up (Victoria facing tax on power stations’ brown coal, Stawell gold, etc).

    Nice mess.

  16. Tel says:

    Nick, if they had sold this using your explanation AND they had phased it in gradually as new projects come online with government buying into its 40% silent stake in new infrastructure… then I doubt those BHP shares would have crashed so bad and maybe the Rudd government would have a point or two more popularity now.

    The problem being that this government desperately want to get their hands on money right now, without anything resembling a genuine partnership. Any sincere partnership must be based on trust, which is sadly non-existent between the Rudd government and the mining industry. Quite frankly, I find it difficult to trust the guy… he was proud to be a fiscal conservative before the election, then he was a Keynesian the moment an opportunity came along to splash around some money around the building industry (complete coincidence that the building unions happen to be Labor Party backers). Then he was a dyed in the wool Greenie when there was a sniff of revenue coming from carbon trading, but that became unpopular so out to lighten the pockets of those wealthy miners and transfer a bit of wealth, maybe bolster up a vote or two.

    Seriously now, anyone who would voluntarily go into partnership with that, please put up your hand.

    Interesting to compare the innovation of compulsory partnerships with the innovation of compulsory superannuation. It’s a good comparison. Compulsory super is the investment that’s so attractive you need to ram it down people’s throats and force them to swallow. I heard this little bit of parliament on the radio recently (Hon Antony Windsor, member for New England):

    It is becoming a bit like the superannuation debate, where originally it was a good idea for people to save for their retirement, then someone said, ‘There’s a lot of money in there; we could get some tax,’ and then the government said ‘Okay, let’s tax it.’ So we taxed it twice and then we taxed it three times. I think it is back to twice now. But the message the consumers took was: ‘Why are we saving for our retirement if we are only saving to have the money taken away before we retire?’ Anybody that has been looking at the various superannuation funds in recent years, particularly through the financial collapse, would have to ask the question: ‘What have we been doing? What is the policy message in all of this?’

    … and a bit later on the subject of fuel and renewables …

    People want to be involved in doing things better. They want to be encouraged, but they want policy that does not penalise them when they get there. The Leader of the National Party made a very significant point the other day on the issue of natural gas, I think it was. The issue is similar to the ethanol issue that I just raised. Why did we encourage people to go into LPG cars et cetera and then penalise them when they did? Why do we do this? What was the point of doing it in the first place if not to trap them? I am not suggesting that liquid petroleum gas is a renewable fuel, but it is a better fuel in terms of emissions et cetera than some of the other fossil fuels that we have been using.

    No need to wonder why sovereign risk is such a powerful devaluing force.

  17. Chris Lloyd says:

    @16: “Seriously now, anyone who would voluntarily go into partnership with that, please put up your hand.”

    Hand up. There’s ore in the ground. All you have to do is dig it up. Some liberal party shadow ministers are even investing in bhp.

    When did “sovereign risk” become a euphemism for overseas companies saying they don’t like our tax rates? Tax rates will change occasionally. This one has not been articulated very well but to the extent that it has, investment in the non-resource sector should not expect any changes. The only risk is that bhp deliberately try to trash our reputation so that no-one will do business here. But the market is hopefully efficient enough that the business world will realise what self serving crap this is. More likely that otehr governments around the world will realise what a smart tax this is.

    Question. Why do miners get to “negotiate” about this tax? Why does anyone in Canberra even answer their calls? I honestly hope these meetings are just a PR exerecise from the government. They would be crazy to give an inch after all this publicity that the miners have purchased. Might as well at least get the full 100c for it.

  18. Tel says:

    The only risk is that bhp deliberately try to trash our reputation so that no-one will do business here.

    How about the risk that China waits until state mineral royalties are abolished then buys Rio Tinto at substantially above the market share price? The government would no doubt approve this deal (they approved it last time) and the shareholders are unlikely to block it either.

    With that inefficient volume-based state royalty gone, the new Rio Tinto owners could get down to negotiating a contract price for selling all their output back into China. They could demand a very high price, and pay lots of efficient tax on their high profits, or they could sell off the minerals for an astounding bargain price, and make hardly any profit at all. Which would they choose?

  19. James A says:

    Chris Lloyd: The actual sovereign risk is what the banks refuse to accept: Henry doesn’t have tax answers: Forrest

    The billionaire says Dr Henry told him during “an animated discussion” at the post-budget National Press Club function in Canberra on May 12 that the logic of the tax collapsed if financiers put no value on a 40 per cent tax credit guarantee on losses.

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