TAX NEWS - JUNE 2010

Australia Tax: Nobody's perfect

by CHRIS RICHARDSON, 03 June 2010 -- The controversial tax is an impost on effort and entrepreneurial expertise as well as on mineral resource rents.

No real-world tax is perfect. But the resource super-profits tax (RSPT) has been modelled and marketed as if it were perfect. Taxes cause most harm when they fall on mobile factors. That is, they change behaviour most when families and businesses can readily react to the tax by switching to less-taxed activities.

In contrast, immobile tax bases are best. So "resource rents" - the return to the minerals themselves - are a logical tax base, as the minerals cannot move in response to higher tax rates. Vitally, however, implicit in the Econtech modelling and much Henry review commentary is there is no difference between resource rents and "super profits".

Yet you can't observe resource rents, and the "super profits" are just a mechanical proxy formula to estimate them. The RSPT simply assumes that all profits above a threshold - the government bond yield - are no longer "normal profits" but "super profits".

So if you believe that this resource super-profits tax (RSPT) proxy is perfect at identifying resource rents, then you'd also have to believe Australia's banks and breweries have been doing a lot of mining.

If not, you'd have to admit this proxy picks up more than pure resource rents. Most importantly, the RSPT's formula will show more super profits are created when miners work harder or smarter. That makes the resource super-profits tax (RSPT) a tax on effort and entrepreneurial expertise as well as a tax on mineral resource rents. The upshot is that miners are being taxed on some of their normal profit as well as any super profit. And that's a problem. The KPMG Econtech modelling assumes that the resource super-profits tax (RSPT) is the perfect tax, causing no harm.

Its result - that the abolition of royalties and introduction of the resource super-profits tax will increase investment and output in mining in Australia - will therefore presumably hold regardless of the RSPT rate: that is, at 99 per cent just as much as at 40 per cent. That should start you wondering.

As the resource super-profits tax (RSPT) more than doubles the tax take in royalties, that will add to the cost of mining in Australia, which will push Australian development options up the global cost curve. And although the minerals aren't mobile, new investment in them is.

All impacts are at the margin for new projects, so the cost impact of the new tax will send some greenfield developments towards Canada, Indonesia, Brazil and others. These nations are substitutes for what is now to be a very highly taxed activity in Australia.

That points to three phases of RSPT effects on mining output:

First, it will squeeze extra production from existing mines - where the decision to locate here was made years ago. That will happen because a profit-based tax bites less deeply than a production-or revenue-based royalty.

Second, it will slow greenfield investment here by cutting the return to Australian development options.

Finally, it will raise output once more in the long run - but only once Australian mines have returned to their initial relative position on the global cost curve, which may well take decades.

Proponents of the new tax claim that it will increase the size of Australia's mining sector. Yet they also claim it will preserve more of the benefits from mining for later generations and act to reduce the "curse of Australia's strength in minerals, taking pressure off manufacturing and tourism.

As this analysis makes clear, both these things are possible - they just refer to very different periods of time. And they won't both be true at the same time.

The argument is that this policy will make sense as mining margins will rise over time. Many people expect they will. I expect they won't.

And the world's miners seem to agree. If they expected future margins to keep rising strongly enough, then they would simply leave minerals in the ground - as developers put together land banks on the outskirts of cities in the hope of future capital gains.

In fact, the consensus among minerals forecasters is also for big falls - almost a halving in iron ore prices in real terms in the long run.

If so, then the resource super-profits tax (RSPT) may slow mining activity when mineral margins are highest (thereby reducing the Australian community's return from their extraction), leaving the sector recovering only once the benefit to margins from the industrialisation of China and India passes.

This policy shift may run the risk of a perverse outcome, with the delay in Australian mining development meaning we end up with only moderate net tax returns to the public despite notably increased taxes on miners' profits.