Saturday, August 14, 2010

Miners moan, but we need our fair share

It's easy to forget that the future of the minerals resource rent tax - the most significant tax reform since the goods and services tax was introduced a decade ago - hangs on the outcome of this election.

Should Tony Abbott win, he won't proceed with introducing the mining tax in July 2012, meaning he won't proceed with most of the tax concessions the new tax would pay for.

Labor has justified the tax as necessary to give Australians a fairer share of the profits from mining the now hugely more valuable coal and iron ore deposits the community owns. Exploitation of these resources is subject to royalty charges levied by state governments, but these payments have failed to keep up with the resources' higher market value.

Against this, the Liberals have claimed this "great big new tax" would do great damage to the mining industry and hence the economy. The big three mining companies - BHP Billiton, Rio Tinto and Xstrata - initially agreed with this claim, but dropped their objections after the incoming Julia Gillard did a deal with them that significantly watered down the original "resource super profits tax".

However, the smaller coal and iron ore mining companies - which weren't part of the deal - now believe (correctly) they were dudded by the big boys and have continued their opposition, claiming the tax means "families will be hurt with job losses in every community across Australia".

It's not hard to see why miners would object to paying more tax, but the tax was recommended by the Henry tax review and it is hard to see why these eminent economists would advocate a tax that could damage the economy.

The very reason for levying a tax on the "economic rent" derived from mining (that is, on the "super-normal profit" earned in excess of the "normal profit" needed to keep the mining companies' resources employed in the mining business) is to ensure the tax does not discourage mining activity.

Indeed, the review argued that, as well as raising revenue that could be used to reduce other, less efficient taxes, the resource rent tax would tax the resources sector more efficiently. That is, over time it would lead to a bigger mining industry, not a smaller one.

As originally proposed, the tax had three main advantages in terms of encouraging the efficient allocation of resources. First, using an increase in the tax on immobile resources (such as minerals) to finance a reduction in the tax on internationally mobile resources (such as financial capital, via company tax) would improve Australia's ability to compete against other countries in attracting foreign investment.

Second, using the tax to effectively replace state royalties would do much less to discourage mining activity. Royalty payments are inefficient because they're levied either on the volume of minerals mined or on their market price. This means royalties take no account of the cost of mining the minerals, which varies with the quality of the mineral being mined and how hard it is to get at.

The effect is to discourage the mining of low-grade deposits and discourage miners from continuing to mine the more costly, deeper-down minerals once the less costly stuff near the top has been won.

Third, the royalty system does nothing to recognise the high risks involved in setting up a mine. You can spend a lot of money, then discover it isn't profitable after all. The royalty system ignores all your costs, but starts charging you from the first tonne you manage to produce.

The great (but much misunderstood) beauty of the original resource super profits tax was it went as close as it practically could to the symmetrical treatment of profits and losses. You'd pay 40 per cent tax on your net profits, but if you incurred a net loss the government would cover 40 per cent of it. If you couldn't immediately deduct the 40 per cent from other mining tax payable, you could carry it forward, with its real value preserved by indexation to the long-term bond rate. If you abandoned the mine as unprofitable, the taxman would refund 40 per cent of your indexed accumulated loss.

Many critics of the tax got terribly muddled over this unfamiliar arrangement, accusing the government of using the (risk-free) long-term bond rate to measure the economic rent, when everyone knew you should use the risk-adjusted rate of return.

They failed to see it was the government guarantee of 40 per cent of losses that took account of risk. This recognition of risk meant fewer firms would be discouraged from undertaking risky investments by the tax system's failure to make adequate allowance for those risks.

So, as originally designed, the mining tax was highly efficient in its effect on the allocation of resources. Trouble was, it would have raised more than double the revenue Treasury originally estimated. That was the real thing bugging the big three companies.

Gillard should have responded merely by halving the rate of the tax from 40 per cent to 20 per cent. Instead, she cut it to an effective 22.5 per cent and butchered its design for good measure. In the process, she greatly reduced - but didn't eliminate - its efficiency benefits.

Originally, the tax involved a complete, up-front rebate of state royalties; now all you'd get is a deduction against any mining tax you owe. Originally, the tax applied to all minerals; now it applies only to coal and iron ore, with an exemption for those firms owing less than $50 million in mining tax. Originally, 40 per cent of losses were guaranteed by the government; now 7 percentage points have been added to the bond-rate "uplift factor" (which arbitrarily leaves some projects better off and some worse off).

It was always the case that virtually all the new tax was to have been paid by the big three companies; in some years, more than all. In other words, excluding the other minerals and the coal and iron-ore tiddlers may actually have saved the government revenue. If so, those other firms are worse off under the changes. They'd remain subject to all the drawbacks of the state royalty system. And fewer mining projects are likely to be started because their potential promoters will find the prospect of early losses more daunting.

Even so, a butchered mining tax would be better than no mining tax.