Monday, June 28, 2010

Gillard has little room for compromise on tax

Ending the fight over the resource super profits tax may be at the top of Julia Gillard's to-do list, but she has no scope to drop the tax and little scope to reduce it.

Surprisingly to some, the reason the new Prime Minister can't drop the tax is not because it would leave a hole in the budget. Arithmetically, the tax could be dropped without affecting the government's commitment (repeated by Gillard) to have the budget back in surplus in 2012-13.

Why? Because, as Wayne Swan repeated on Friday, the resource tax is part of a package of tax changes. That package is essentially revenue-neutral and thus detachable from the budget.

Virtually all the proceeds of the tax would be used to pay for the other alleged reforms in the package: the cut in the rate of company tax, the instant asset write-off for small business, the various superannuation concessions, the resource exploration rebate, the standard tax deduction, the discount on tax on interest income and contributions to the planned state infrastructure fund.

Since the resource tax isn't due to start until July 2012, all the measures it pays for will be phased in from that date, a further indication it's part of a package.

Thus dropping the tax wouldn't leave a hole in the budget, but it would mean dropping all the political goodies it would have paid for.

So that's the first reason Gillard can't just drop the resource tax. It would rob the government of all its election promises and much of its second-term agenda; its rationale for seeking re-election.

But there's a deeper reason. Kevin Rudd, and now Gillard, have repeatedly insisted the miners pay the owners of the resources they mine a "fairer share" of the proceeds. Simply walking away from the tax because it had proved unpopular with the miners would be seen as a repeat of Rudd's decision to walk away from the emissions trading scheme (something he now says Gillard and Swan urged him to do).

And just as even people who were relieved to see the back of the trading scheme still concluded Rudd lacked convictions and the courage of them, so people with doubts about the wisdom of the resource tax would nonetheless conclude Gillard was equally lacking in convictions - an impression that would be reinforced by the motivation behind her brutal installation as leader.

If anything's crystal clear from Rudd's remarkable decline in public esteem following his cowardly abandonment of the emissions trading scheme, it's that voters expect their leaders to stand for something. Show them your sole motive is clinging to office and you're dead meat.

Combine the voters' desire for strength of character with the budgetary arithmetic and you see why Gillard has little scope to reduce the revenue raised by the resource tax. Cut too much from expected collections and you look weak in the face of powerful vested interests and you have to cut back your promised tax goodies to fit.

Considering the way business people have either stood silent or actively sympathised with the miners' resistance to paying more tax, it would serve them right if the net cost of reducing the tax was covered by reducing the planned 2 percentage point cut in the company tax rate.

Gillard will need to distinguish between changing those features of the resource tax the miners find most objectionable and simply reducing the burden of the tax. The former is a lot easier to concede than the latter.

Resource rent taxes come in different models. Ken Henry's version is theoretically superior to the present petroleum resource rent tax, with the latter's less generous treatment of losses but its threshold for the tax set at the long-term government bond rate plus 5 percentage points.

But it seems the miners were expecting the extension of the petroleum tax. They've been hugely critical of the Henry tax's guaranteed 40 per cent rebate on losses in place of the extra 5 percentage points on the threshold.

Gillard could accommodate them on this, and probably also exclude various lower value resources from the tax regime, at no great net cost to revenue - particularly if the planned move to a rebate (rather than a deduction) for exploration expenses was also abandoned.

This would probably make a lot of the smaller miners less unhappy and it would also yield modest savings to the big miners. Would it be sufficient to satisfy the big boys? I doubt it.

Here's where the "negotiations" (why an elected government should negotiate with unelected vested interests I don't know) get hard. The big boys' demand that the tax not apply to existing projects is simply impossible to accede to.

Why? Because, leaving aside the weakness of the argument that they should be excluded, it's clear existing projects would account for all the revenue. Indeed, it's a safe bet the reason BHP Billiton, Rio Tinto and Xstrata are carrying on so much is they'll be paying the lion's share of the $9 billion a year in revenue.

That leaves the possibility of cutting the 40 per cent rate of the resource tax. But this would be hugely expensive. Independent modelling I have commissioned (using a pocket calculator and the back of an envelope) suggests cutting the rate just to 35 per cent would cost about $1.1 billion a year.

It's therefore possible no compromise Gillard could come up with would satisfy the big miners now they've had the taste of blood.

But whether they go quietly or keep fighting turns on Gillard's skills as a conciliator and whether she can use a combination of offered concessions and argument to convince most voters that the miners' objection to giving the community a greater share of their windfall gains is unreasonable.