Saturday, July 3, 2010

Battle over tax leaves Labor with bloody nose

The deal Julia Gillard has done on the mining tax is bad for her government's reputation, bad for democracy and bad for the future of economic reform, but not too bad for the economy.

The immediate reaction of most parties will be relief. What was seen as a great threat has gone away.

The big miners will be quietly congratulating themselves on the extent of their victory, but leaving it to their friendly business commentators to do the crowing for them.

Concessions extracted from the government because the big mining companies were holding a gun to its head will be interpreted as proof that all the miners' dubious arguments against the resources super profits tax were valid.

But the initial emotional reaction to the deal is one thing, the longer-term consequences are another.

Although Gillard, being a new prime minister, will be given a lot of slack by the electorate, the Labor government's backdown on the mining tax, coming on top of its retreat on the emissions trading scheme, will entrench its reputation for weakness and lack of conviction, and further embolden vested interests to actively resist legislation they don't like.

Labor will be looking for people to blame, but it should consider its own part in this political disaster. Its decision to adopt such a controversial reform so close to an election was a basic political miscalculation.

Its belief that, simply by naming the tax a "super profits" tax, it could harness all the public's envious resentment of the rich mining companies, which would be sufficient to outweigh all the propaganda the miners would put up, was another bad call.

This government has shown an inability to set priorities for itself, tried to do too much, and grossly underestimated the degree of ground-preparing, consulting and explaining needed to ensure a controversial reform makes it from announcement to reality.

Professor Ross Garnaut said early in this war that it would be a test of whether difficult economic reform remained possible in Australia, or whether powerful interest groups now had too much sway over the political process.

By that test we haven't done well, even if a significant element of reform remains in the compromise forced on the government. It's now clear to all that governments daring to take on the mighty mining industry can expect to lose.

The big miners have won their fight against the emissions trading scheme, and now they'll be seen as achieving major concessions in the attempt to make them share with the owners of the resources a larger proportion of the windfall gains from the resources boom.

These guys are giant killers. They saved themselves $1.5 billion over the first two years - and probably a lot more in later years - for the price of an advertising campaign estimated to have cost just $7 million.

They prove that if you're big enough, rich enough and aggressive enough you can push around the elected government of Australia.

This Labor government has always been afraid of big business and now its drubbing at the hands of three big companies will deepen that fear. What do you reckon are the chances of a re-elected Labor government returning to the Henry report for further ideas on tax reform?

I fear this is the end for controversial micro-economic reform from Labor. And it's hard to see the cause being taken up by a future Liberal government. Don't forget the major part the Abbott opposition's unprincipled opportunism played in this affair and in the abandonment of the emissions trading scheme before it.

The deal involves changing the (dumb) name of the resources super profits tax to the minerals resource rent tax, turning it into a more generous version of the existing petroleum resource rent tax and extending the coverage of the petroleum tax.

That's not the end of the world. The miners had been expecting something similar to petroleum tax and, had that been what the government decided to introduce, it would have been greeted by economists as a big improvement in the efficiency of resource taxation.

In theory, the originally proposed tax was more economically efficient than the petroleum tax - that is, it would have done less to distort miners' choices about what projects to undertake. But some of the miners' criticisms of it - namely, that bankers would discount for purposes of collateral the value of the government's guarantee to cover 40 per cent of project losses - were genuine.

The main difference in changing the original tax to be more like the petroleum tax is to drop the guarantee to pick up 40 per cent of losses, in return for the cut-in point for the application of the rent tax being raised from the long-term bond rate to the long-term bond rate plus 7 percentage points.

This is just a change in the way the tax allows for "risk" in the universally accepted proposition that economic rent is what projects earn in excess of their risk-adjusted rate of return (the long-term bond rate being taken as the risk-free rate of return). Don't forget that those minerals that remain covered by the new tax - iron ore and coal - will still have the new tax effectively take the place of the states' volume- or price-based (but not profit-based) royalty charges. This feature does much to improve efficiency.

What's hard to understand about the deal is that so many changes could be made at such a small net loss of revenue from the new tax: $1.5 billion over the first two years. Three possible explanations come to mind. First, the original costings had a lot of leeway built into them in anticipation of some concessions having to be granted.

Second, the ultimate cost of the concessions won't be felt until after the first two years of the tax (the estimates for which we've never been shown).

Third, the exclusion of many other minerals from the tax may involve a net saving to revenue because those firms would have gained from not having to pay state royalties while paying little or no resource rent tax. If so, the small miners have only themselves to blame for throwing in their lot with the big boys and then being dudded.

And the same goes for all those businesses now facing a cut in company tax of only 1 percentage point rather than 2 points because they stood back while their big mining mates did over the government at their expense.