Sunday, June 06, 2010

A note on the mining super profits tax

I have continued watching the debate on the proposed Australian mining tax with interest. There has been, I think, more heat than light on both sides.

One of my problems with the tax in the first place lay in the fact that I did not properly understand it. I am not sure that I do now. However, if we cut through the fog I think that a few things are clear.

The first is a fundamental conflict in interest between the states who formally own the resources and who depend upon mining royalties for revenue and the Commonwealth. The tax is meant to replace the present system of royalties with a profit based tax. The effect on the states is cushioned to some degree by proposed deductibility of current royalty payments, but what about the future? By hypothecating the projected revenue in the way that it did, the Commonwealth gave itself very little room to move.

The second thing is that the net effect of the tax on project profitability depends upon the combination of higher payments through the super profit tax on one side with gains from lower company tax plus the 40% offset on the other side. I don't think that we need to worry too much about the detail of the 40% offset because there is a more basic problem: nobody believes it!

In simple terms, if a company is to factor a benefit into its calculations on project benefits, it has to assume that that benefit will not be altered in future. Here, and Treasury has itself to blame, people are reluctant to accept this because experience shows that taxation regimes are inherently unstable.

Consider the early history of the R&D tax concession. This provided a windfall gain, a greater deduction, to people already doing R&D. The projected benefits from the concession came from increased R&D as a consequence of the tax concession. The net result depended upon the increase in R&D minus the additional gain to companies already doing R&D.

For a company to expand R&D, the taxation benefit had to be stable. The life cycle of an R&D project varies, but can extend over many years. If you are sure that the tax benefit is stable, you will build this into your calculations, increasing returns and expanding R&D spend. However, if you don't believe that the benefit will be stable, then you count the benefit as either zero or very short term.

Sadly, the Commonwealth Departments of Treasury and Finance who had opposed the tax were quickly able to bring about changes to it designed to reduce the benefits offered. This reduced the immediate cost to the taxpayer, but also ensured that business would not factor the increased R&D concession into planning. The extra subsidy on existing R&D remained the same, but the additional R&D expected to flow was reduced.

If you look at this example, you can see why people are cautious about placing value on the second leg of the proposals. The problem is that if you count this as zero or low in cash flow terms, the investment neutrality arguments fall to the ground.

I don't think that we should be too worried about some of the mining industry arguments. Anybody losing $A9 billion in projected net profits over a short period is going to react strongly! However, we should pay attention to specific analysis and argument. However, here we have a real problem.

Bluntly, we don't have any objective source of analysis that will explain the issues in a way that the ordinary Australian will understand. We have to rely on the winnowing effect that partisan debate has over time. I think that that's a problem.   

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