TAX NEWS - June 2010

RSPT: Kevin Rudd's RSPT tax model is flawed

There has been a lot of talk about the likely negative effect of the resource super-profits tax (RSPT) on the mining industry. But what about the risk it could pose to taxpayers?

So long as the mining industry continues to prosper, the RSPT will boost Treasury coffers. But should the mining industry slump and participants leave the industry, then suddenly the equation changes.

Taxpayers will have to stump up 40 per cent of the losses made by those participants.

A major slump in the industry could expose the government to a sudden and very large outlay of mining expenditure incurred over many preceding years.

This is the problem with effectively becoming a silent partner in an enterprise, which is what the RSPT makes the government.

It is wonderful when times are good, but can be costly when times are bad. For a government that is a silent partner in every mining project, a mining slump could have disastrous results. And the design of the RSPT exacerbates the risk.

The RSPT is based on the concept of the cashflow tax proposed by E. Cary Brown in 1938.

Brown's model was much simpler than the RSPT. His tax had two distinguishing features: it allowed a 100 per cent deduction for all outlays, and the government would pay immediate refunds (or "negative tax") for losses.

Yet, rather than pay its contribution upfront as per Brown's model, the federal government is allowing its liability for contributions to accumulate (with interest at an "allowance rate" and either be offset against future profits, or become payable when the participant exits the industry. This is fine, so long as there are future profits. Otherwise, the government (or, more correctly, the taxpayers) can be liable for a significant outlay in a short time.

This is probably not a major concern to the government at the moment, because the outlook for the mining industry is looking good. But a tax reform of this level requires the government to look at the longer term (and the further we look the more likely it is that there will be a slump) to ensure that the taxpayers of Australia in the decades to come won't have to pay, and pay substantially, for decisions taken today.

The government points to its obligation to cover losses as justification for controversially setting its allowance rate at the low government borrowing rate (being the 10-year government bond rate). The Henry review cites an article by G. Fane and B. Smith to support this. However, Fane and Smith found this only applies if the taxpayer holds government bonds that it can sell to finance the project. They recognise that the allowance rate should be higher if the cost of funds to the taxpayer is higher.

If the government did not guarantee payment, then the longer-term risk for taxpayers would be removed. However, there would then be no question that the allowance rate should be higher, to reflect the fact that the government is not bearing the risk of the project. This would create a situation where the government would be paying interest to the miners at a higher rate than its own borrowing rate, a clear case of bad financial management.

Instead of accumulating the liability, paying upfront would have two benefits.

Firstly, the government contribution would be disclosed and transparent; it would remove the risk of a sleeping and growing exposure.

Secondly, as there would be no delay in the government's contribution, there would be no need for an allowance rate at all.

So why doesn't the government pay its contribution upfront?

The Henry review says that upfront contribution could result in the short term in public concern that the resource sector is not paying an adequate charge.

This may be true where there is not also an income tax, but is not so convincing in the case of Australia where the RSPT is to be levied in addition to the income tax. Any concern is further mitigated by the requirement that miners continue to pay royalties (albeit with adjustments through the RSPT). Logically, the government should be indifferent as to whether it makes its contribution today or later with interest. The real explanation seems to be that given a choice between borrowing from the miners or borrowing through normal channels, the government chooses to effectively borrow from the miners because these borrowings are not disclosed in the budget.

The government needs money and it needs it quickly to restore the budget to surplus, particularly after its expensive response to the global financial crisis. Over the forward estimates period (that is, until 2014), the RSPT is expected to raise $12 billion. The government proudly states that the budget will return to surplus in 2012-13. But it would not do so without the RSPT in its current form. It is no surprise that the government is loath to change that form, regardless of its deficiencies.

To borrow the words of Fane and Smith, the current form of the RSPT has "a more impressive cosmetic effect on the government budget deficit in the politically important short run".

Dr Julianne Jaques is a Melbourne barrister. She has completed a doctoral thesis on the cashflow tax and was a senior tax adviser in the Howard government.