3 thoughts on “Fallacies in the reasons given for the extra tax on mining in Australia”

1. Technology is revolutionizing underground mining. The recently opened underground Argyle diamond mine, has no underground workers at all.

   And as for the mining tax. When you tax profitable businesses and subsidize unprofitable or less profitable businesses. The result is less of the former and more of the latter.

2. don’t miss Henry Ergas in the Oz today

   My column today discusses a paper Jonathan Pincus and I are presenting at the Australian Conference of Economists being held in Melbourne next month. The paper deconstructs the estimates of the average excess burden of royalties used in the Henry Report on Australia’s Future Tax System (AFTS).

   The paper focuses on the measurement of the average excess burden (AEB). That would broadly be the relevant measure for a major tax switch – for instance, replacing royalties by say, the MRRT. The claim made for such a switch is that the MRRT raises revenues at lower economic cost than do royalties.
   Those claims are highly questionable. In practice, the MRRT only offsets royalties on what are effectively infra-marginal projects, i.e. projects that have sufficient net income and associated MRRT liabilities to offset royalty payments. At the same time, the MRRT is itself highly distorting, as shown in Ergas, Harrison and Pincus 2011, because it taxes normal profits on high risk projects. Moreover, it creates incentives for states to increase royalties, as on infra-marginal projects, these are effectively paid by the Commonwealth. As royalties rise, the result is to increase whatever distortion they create on marginal projects, and especially on those approaching the end of their life. As a result, the Commonwealth’s MRRT has likely significantly increased, rather than reduced, the distortion to mining induced by taxation.
   Of course, the government’s goal was not to reduce the social costs of taxation but to effect a revenue grab. But it sought to cloak that revenue grab in the legitimacy of the Henry Report’s estimates of the excess burden of royalties.
   By the by, the Henry Report never explained why states would set royalties at levels that left miners earning large rents, or if there was a better system of taxation, would not adopt it. After all, if there are large rents, the states would not be vulnerable to inter-jurisdictional tax competition, and hence (all else equal) should have incentives to tax resources efficiently.
   But all else is not equal, because horizontal fiscal equalization (HFE) distorts state’s revenue-raising incentives. A more sensible approach would have been to discuss that and propose reform of HFE, rather than superimpose a new, highly distorting, tax. But that would not have gotten the government the revenues it wanted. So instead the focus was on how economically costly royalties are, with the associated claim that first the RSPT and then the MRRT could reduce those economic costs.
   For reasons we explain, AFTS’ estimates of royalties’ AEB are questionable. But it is additionally worth noting that AFTS’ estimates of the marginal excess burden (MEB) of royalties also seem difficult to credit. AFTS estimates the MEB of royalties (which it considers together with the crude oil excise) as 70 percent. Now, assuming linearity, which is appropriate for marginal changes, and assuming royalties are a tax on revenues in the order of 6% to 10%, an MEB of 70% implies an elasticity of supply of between 4 and 7. It strains credulity to believe the supply elasticity is anywhere near that high, all the more so in the light of recent experience with mining output.
   More generally, it is not easy to understand exactly how the technical study deals with the fact that mining involves a fixed factor. It seems to use a CES production function with a common supply elasticity of 1.5. But that implies (at least in the Cobb-Douglas formulation) that the marginal cost curve is concave, whereas for mining it should be convex. And concavity is obviously likely to overstate the excess burden of royalties. As a result, one would have expected considerable sensitivity testing of the supply specification – but there isn’t any.
   Note this is not to claim there is no excess burden associated with royalties. Clearly, the supply curve is not entirely vertical, so yes, there will be distortion. But again, the question is to measure that correctly – and not only for royalties but also for proposed alternatives. The KPMG study mentions some of the ways a resource rent tax can be distorting but then appears to simply assume that the full incidence of the PRRT is on “the GOS for the oil and gas industry which represents the return to a fixed factor”. This, it rightly notes, “will imply a zero excess burden for the PRRT, since it will simply be a transfer of surplus from the oil and gas industry to the government sector”. The result, reported in Table A, is that the AEB and MEB are zero – which is completely implausible. Again, the Table notes this is by assumption, with footnote 3 explaining that “the zero excess
   burden for the PRRT rests on the assumption that it is designed so that it only taxes the excess profits of petroleum extractors, which they derive from access to a natural resource which is in limited supply.”
   In other words, the report estimates the MEB/AEB for royalties on assumptions which seem assured to generate a high excess burden, but assumes a zero MEB/AEB for the PRRT – which is then presented as a result in the AFTS report.
   To make matters worse, as explained in the paper, it is not possible to derive the reported MEB/AEB for royalties from the data presented in the technical report.
   In short, a crucial estimate – the ‘magic number’ of the welfare cost of royalties the government has relied on heavily – seems deeply flawed in its substance and in any event, entirely lacking in transparency. As for comparisons of that welfare cost with proposed alternatives, these are nothing more than hot air, derived not by analysis but by assumption.
   A final point. As every economics student learns, the concept of rent was first properly explained by David Ricardo, who in Chapter X of the Principles also showed (in discussing Smith’s claim about taxes on land) that taxes on pure rents are non-distorting, in the process laying the basis for the economics of taxation. But contrary to popular belief, Ricardo was no supporter of taxes on rents.
   In fact, as the late Carl Shoup (the intellectual father of value added taxes) showed in his classic study, Ricardo On Taxation, the opposite is the case. This is because Ricardo believed such taxes would mutate into expropriation, as in reality “rent often belongs to those who, after many years of toil, have realized their gains.. and it certainly would be an infringement of that principle which should ever be held sacred, the security of property, to subject it to unequal taxation”. Rather, any country which relied on taxation of rents would “find it desirable to adopt the Asiatic mode”, i.e. to nationalize land and deprive landowners of their rights. Discriminatory taxation would, in other words, make private ownership unsustainable, as resources that provided rents would “be so uncertain a property that no safe provision could by means of the possession of it be made for children.” He should have met Julia Gillard and Wayne Swan!
   References:
   Treasury, 2010, ‘Australia’s Future Tax System’, Commonwealth of Australia, Canberra. At taxreview.treasury.gov.au/content/Content.aspx?doc=html/pubs_reports.htm
   Ergas, H., Pincus, J. and Harrison, M. 2011, ‘Some Economic Aspects of Mining Taxation’, Economic Papers of the Economic Society of Australia, 29(4) 369-389. At onlinelibrary.wiley.com/doi/10.1111/j.1759-3441.2010.00090.x/abstract
   KPMG Econtech, 2010, ‘CGE Analysis of the Current Australian Tax System’, Final Report, 26 March. At taxreview.treasury.gov.au/content/html/commissioned_work/downloads/KPMG_Econtech_Efficiency%20of%20Taxes_Final_Report.pdf
   Shoup, Carl. S., 1960, ‘Ricardo on Taxation’, Columbia University Press, New York.

   everything this Government says you’ve got to check three times

   I made the comment on Catallaxy maybe the Fink report should have enquired into politician behaviour and not newspapers

3. I repeat – the State Govts own the minerals, with the exception of the Territories and seabed between the low tide mark and international marine boundaries. Until this point is understood, economists & politicians are just wanking … good luck with that referendum

   State Govts impose a rent, called a Royalty, for the right to mine and sell the minerals. The Feds make a big bone about how inefficient Royalties are (this is never evidenced), but …

   The States (eg. NSW) have tried basing Royalties on profits rather than production – Broken Hill at the height of the silver boom was levied on profits (as was the then Broken Hill International Stock Market and the then Broken Hill Opera House). This worked fine until the boom price of silver went south and State Govt revenue plummeted … so levying Royalties on production rather than profits was instituted. A much more even flow of State Govt revenue was experienced, and continues to this day

   The initial Henry Report wanted to expropriate State Royalties and subsume them in a profits-based tax. In return (for the miners, not the States), a tax credit was to be allowed for projects that went sour. At least Henry recognised what risk actually meant, but this was politically unacceptable to the Federal ALP. For example, BHP had racked up close to $1bn in losses on its’ nickel laterite project in WA since the best geological, geotechnical and metallurgical skills that money could find worldwide were unable to devise an economic method for treating the ore. Under the Henry proposal, this meant that BHP had $1bn in tax credits to off-set against its’ profitable Pilbara and Bowen Basin mines. One can imagine the Daily Telegraph headline here on “Tax Breaks for the Rich” 🙂

   No-one believed it for a moment, not even himself

   Last point, not addressed by lefty economists. The headline profit “BHP has record $550m profit” is deliberately misleading. It is meant to excite populist envy. The true measure of profitability here is “Rate of Return on invested capital”. Henry wanted this set at a few % above the bond rate – with an abysmal limit like that, who would bother risking $6bn+ of capital ?