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[Please see ‘How to Save a Life’ post below for explanation]

I’m in two minds (and always have been) about the RSPT. On the one hand, the tax is distortionary and problematically structured. On the other, it has great benefits – namely capturing the (temporary) profits from the resources in the ground and (theoretically) reinvesting them into productive infrastructure or the rest of the economy. And it also acts as a nice way to close the gap in the two track economy.

I think what mostly pisses me off is the socialist way that the Rudd government and Greens have been marketing the tax. They call it a tax on the rich, as though that is the only justification required. They justify it by means of a ‘super-profit’ mechanism defined as the minimum profit that you would expect of a completely riskless project (as opposed to one of the riskiest real investments there is).

Topic 2: Resources Super-Profit Tax (hereinafter ‘RSPT’)

It’s hard to get good information on the RSPT. The standard of journalism in Australia is very low when it comes to deeper analysis.

Here is a basic summary of all the RSPT’s feature’s by the CBA’s Commsec:

http://petermartin.blogspot.com/2010/05/this-resource-super-profits-tax-how.html

Here is a non-basic summary of all the RSPT’s features. Your taxpayer money paid for this: http://www.futuretax.gov.au/documents/attachments/Announcement_document.pdf

An even shorter summary of the RSPT (SMH, I didn’t read it because I assumed it was crap): http://www.smh.com.au/business/the-resource-super-profits-tax–what-is-it-20100511-usnu.html

The rationale for the RSPT, as Ken Henry designed it, is not to tax “super-profits” (that is a political argument, invented by the ALP government). It is designed to do two things 1) replace the inefficient State royalties system 2) capture a “fairer” share of the profits from those minerals

The calculation of the RSPT is as follows

RSP Tax = 40% x [Profit – ordinary expenses – all expenses involved in prospecting and buildign the mine – risk free rate]

2) Fairer share

As you may know from property, all minerals in the land are owned by the States. Mining companies pay fixed royalties to extract those resources. Those royalties do not increase if the price of metals increases. Therefore, because the price of metals has vastly increased, the royalties are a pittance in comparison. We are not capturing a fair share of those profits. The idea is to replace those royalties with this tax but in exchange, the government will guarantee all the costs of building and investing in the mine.

If you think of this in finance terms, its all a matter of risk-shifting. Currently, the government gets a fixed (risk-free) royalty. The mining companies take all the risk. The RSPT is switching that around (the government takes a bigger share of the risks, as well as a bigger share of the profits). It takes those risks by paying for the prospecting costs etc via the very generous tax deduction for all prospecting costs etc (see the calculation).

Effectively, the government is taking 40% of the profits, but paying 40% of the expenses. It is like a JV where one partner uses the full might of the Law and the police forces to barge into the investment and enforce the rights it gave itself.

1) Inefficient State royalties

I left this till second, cause it makes more logical sense this way. Having said that – we’re assuming the prices of all resources skyrocketed. Not true. There are more minor minerals which aren’t affected and which are severely disadvantaged by this current state royalties system. This fixes that. I’m not too aware of the details.

It’s also inefficient because of Vertical Fiscal Imbalance (you did Fed Con!) States have no money, so essentially they’re grabbing what they can. Their rate of tax is higher than the (theoretical) economically optimal point because they’re so desperate. And that’s economcally inefficient.

Questions to think about:

Is it appropriate to shift all that risk to the Government? Isn’t the argument for privatisation to shift that risk off government balance sheets and to the private sector who can most stomach risk and distribute it most efficiently?

Isn’t this just like buying at the peak of a stock market, just before a crash? The government is taking on all this risk because its confident there is no risk of a crash – it just sees all these profit (just like stupid investors see huge dividends, without realising there’s a risk that next year there won’t be huge dividends).

What are the implications on public policy if trenchant lobbying by powerful industry groups like the miners can actually influence governments into backing down from policies? How safe is fiscal policy then? (See the Club Troppo article in Deficits email).

Most critically, what effect will this sudden tax have on marginal projects?

Why should miners bother getting out of bed for a 6% risk free rate of return? (The answer is that they wouldn’t. But this RSPT is giving them more than a 6% rate of return – it all depends on a lot of very complicated factors. The effective tax rate on the projects could actually be as low as 13% on some projects.

But isn’t tha a problem? If the rate of return is heavily dependent on the tax rate, which is dependent on a whole lot of arbitrary factors, doesn’t that rerank the priority of projects? Under classical finance theory, you have $X to spend. You rank all the projects in terms of NPV then spend $X until you run out of money. But this RSPT has a heavily distortionar effect by changing the rate of return based on a whole bunch of arbitrary factors arising from a tax calculation.

As you can see, I’m personally quite critical of the RSPT. I don’t disagree with the proposition that we should tax the mining companies more. But the structure is distortionary. And at the end of the day, if it reduces investment in future projects then the Australian people (who own those resources) lose out.

It was sort of hard to find a good economic analysis online that supports the RSPT. (Don’t get me wrong, there are economists supporting this, and Ken Henry is a very eminent economist. He’s actually a Howard appointee who Labor criticised for being too much of a Liberal supporter, but I can’t find any right now and I don’t care enough to bother searching more).

I guess the main thing to focus on is this: Perhaps this tax is distortionary but all taxes are distortionary. Is it better to increase taxation on mining a little in order to decrease taxes for everyone else? Is it better to have that money go into an infrastructure fund that will boost productivity in future more than the distortionary effects slow productivity now?

The infrastructure argument is a very strong one, in my mind. Many countries which are heavily resource dependent fail to adequately capture the profits from their brief time in the sun. And then the resources dry up and their countries go kaput. The exceptions are those countries which intelligently invested those resources (eg. Norway had a successful infrastructure fund from memory). Dubai attempted the same by turning itself into a tourist and financial hotspot for the Middle East. Perhaps, if you are going to defend the RSPT in your interview tomorrow, you should run that line.

Another good argument is that it is a discretionary fiscal tool to manage the two track economy. If WA’s economy is overheating but NSW and Victoria’s economies are still too cool, what better thing to do than douse it with a bit of icy cold tax? In practice, I think that’s unrealistic. Tax rates aren’t like yo-yos or interest rates. You can’t just yank them up and down when you feel like it. But as a blunt instrument, it can slow down the mining economies right now, giving monetary policy more room to manevour.

Here’s a post I made on these last two topics a few months back. Please note the time stamp on that post and the title. It may not be the most coherent post ever. https://thejackalscodex.wordpress.com/2010/05/13/insomnia/

Articles:

Here is a persuasive argument against the RSPT: http://petermartin.blogspot.com/2010/05/swan-on-resource-super-profits-tax.html

Here is a good article, but I don’t think it adds much to what I had to say already: http://www.theage.com.au/business/coinvestment-idea-sets-stage-for-cgrade-mining-boom-20100514-v4ni.html

Here’s an article (sort of) defending the RSPT. http://www.stubbornmule.net/2010/05/resource-super-profit-tax-everything-correctly-explained-r-s-p-t-e-c-e/

Here’s an article in the New Matilda – more about the politics of things than the economics, but it has good data on effective tax rates. http://newmatilda.com/2010/05/26/digging-figures-mining-profits

And various articles from Club Troppo, which as I mentioned is a good economics blog in Australia. http://clubtroppo.com.au/2010/06/09/is-the-kpmg-report-on-the-resource-super-profit-tax-reasonable/

http://clubtroppo.com.au/2010/05/28/winners-and-losers-of-the-resource-profit-tax/

http://clubtroppo.com.au/2010/05/27/the-long-and-the-short-of-the-new-resource-rent-tax/

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