TAX NEWS - June 2010

Super profit tax needs superpolitics

Even if your cause is just, you had better mobilise your forces before going to war. When Kevin Rudd, Australia's prime minister, triggered mining companies' ire with a new "resource super profit tax", he seemed unprepared for the industry's fierce counterattack. What should have been an easy populist sell has turned into a political liability: Mr Rudd's popularity in the polls is plummeting.

The purpose of resource taxation is to capture for the nation the "economic rent" of its natural resources – profits in excess of normal rates of return, caused by physical scarcity and selling prices far above the cost of extraction.

In economic terms, the new Australian tax is a good attempt at achieving this goal. But politically, the government has badly bungled the process. With Chinese demand keeping commodity prices and mining profits high, it should have been easy to sell the reform from the high ground of fairness as well as the low ground of populism. But springing the plan as a fait accompli on an unsuspecting country has given critics free rein to vilify it. Mining groups are threatening that jobs will disappear. The opposition accuses the government of economic vandalism. Little wonder that voters, while they like the extra revenue the tax will bring, worry about killing their golden goose.

But that worry is overdone. The tax is structured to be neutral with respect to future investment decisions. By taking 40 per cent of profits and bearing the same share of costs, the government will in effect act as an equity partner with carried interest – an exceedingly common arrangement in the oil industry worldwide (but without an equity partner's voting rights). That Canberra raises its capital stake in Australia's mining wealth will not dent investors' appetite for whatever share is left for them.

The plan does have wrinkles that should be ironed out. A higher interest rate should apply to cost deductions carried forward – in reality forced lending to the government. Private miners will not be able to raise finance at the government bond rate (the current plan) on the financial markets.

And applying the tax to mines already in production must be done with great care, ensuring the government's contribution to costs incurred in the past is as generous as for projects not yet started.

Such consistency is necessary – and for a wise government, attractive – to calm investors' fear of a raid on profits after they have borne the whole risk and capital. But it is hardly a moral principle. No country, except those too poor or weak to have a choice, accepts that the government has a duty to compensate those it taxes for the inconvenience of higher rates.

So the miners protest too much when they demand "negotiations" over the tax. What the government should have done, and must still do, is consult, with citizens as well as the industry. It took Mr Rudd's predecessors two years to finalise the equivalent tax for oil and gas. If he wants to survive elections expected in the autumn, he had better win his people over soon.