For some reason, I have decided to ponder the resources rent tax today. The sensible debate is not focused necessarily on the principle of the tax as its implementation. The principle is very sound: it is more efficient to tax rents than other forms of income. Ross Garnaut said as much. The issue is in terms of risk.
Let me dismiss one issue right away: sovereign risk. You know, this risk exists and doesn’t necessarily change with the type of taxation or government activity. Unless you do something like they did with the GST and distribute a whole heap of veto rights, taxes can change and political short-termism can come to play. I don’t see the risk as any higher for this tax than others. That said, if we are all about thinking of this as ‘rent sharing’ then it certainly can’t hurt to make sure that this risk is minimised. The issue is how to do it.
The other risk is the risk to incentives. Again, Garnaut:
Whenever a case arises in which it appears appropriate to tax a rent, one has to be careful that the apparent rent is not what economists since Alfred Marshall have called “quasi-rents”. Quasi-rents are payments that in the longer term provide some incentive to an established and economically valuable allocation of resources. The return that a company expects from investment in mining includes a part that represents a return on exploration, that might have been undertaken a long time ago. That return is a quasi-rent of exploration. A current mine will not be closed down because a tax does not allow the generation of a satisfactory return on exploration; but new exploration will be affected. Similarly, after a mine is in operation, part of its expected income represents a return on the original development of the mine—if you like, is a quasi-rent on that mine development expenditure. While a tax could transfer part or all of that quasi-rent from a mining company to the Government without affecting production at established mines, it would remove the incentive for new mine development.
The issue is how to deal with this. At the moment, royalties do not worry about costs at all so it can hardly be said that is an ideal incentive scheme. An upfront auction might do a better job and the Henry Review said just that. But a resource rent tax will tax profits when they occur and when they occur will be for successful exploration to development projects with good draws on the international demand for the resource. So any upfront investment activity is going to worry about the distribution of returns and if you skim the upside there can be problems. This, by the way, is the VERY SAME ARGUMENT that occurs for all government intervention. Again, careful upfront design can alleviate these things without necessarily compromising revenue. The argument for the principle that we should tax rents remains undiminished by this possibility.
Of course, that analysis suggests that restricting the RSPT to new projects is exactly the wrong thing to do. This is what BHP advocates but it makes no sense whatsoever.
So what do we know about this risk in the mining sector? One argument going around is that mining companies will invest elsewhere. OK, but there is still ore in them thar’ hills and so someone will be interested in developing them if the net present value of the project is positive — which by the way, it has to be in order for there to be a rent to tax.
But there is an issue over the elasticity of supply for mining development. Is there more exploration to do and is there more development of existing projects to occur? I think there is likely to be more of those (and I have said so in competition policy matters in advice commissioned by FMG). But others do not appear to agree. Here is BHP from its submission to the NCC on the ongoing rail access matter:
No deposits of sufficient size in the Pilbara
3.9 It is unknown and uncertain whether junior suppliers of iron ore tenements hold iron ore deposits of a sufficient size. Indeed, the Council recognises that the deposits owned by such suppliers “fall at the smaller end of the spectrum”.15 The Council also states: “If the inferred resources [of potential entrants to the iron ore market] are confirmed, most of these deposits will apparently be large enough to support their own mining infrastructure . . ..”16
3.10 There is, however, no certainty that inferred resources will be confirmed. That is, even on proving an iron ore deposit, it may be the case that the size (and/or quality) of the deposits will not support the construction of mining infrastructure. In such circumstances, the Council’s assumption that inferred resources will be confirmed is highly speculative.
3.11 A report provided to the Western Australian Government by Evans & Peck in August 2004 indicated that there may be few, if any, economically viable deposits in the Pilbara that have not already been identified. BHPBIO notes that currently there are no proven17 iron ore deposits in the Pilbara apart from those held by BHPBIO and RTIO/HD.18
3.12 The 2004 Evans & Peck report also indicated that 85% of the identified iron ore resources in the Pilbara were controlled by BHPBIO or RTIO, with HD and FMG holding 10%, and other suppliers holding the remaining 5%.19 Most other identified deposits which have not met JORC reporting requirements are largely held by BHPBIO and RTIO.20 According to the Evans & Peck report, the holdings of junior explorers are too small to have a measurable competitive impact on iron ore sales21.
3.13 The Council has given insufficient weight to the possibility that there may not be (or there may be very few) other economically viable deposits in the Pilbara. Similarly, the Council has not properly taken into account the uncertainty as to whether there could be any potential vendors of proven iron ore deposits apart from BHPBIO and RTIO/HD. Even if such deposits exist, as junior explorers have apparently suggested to the Council, it is possible that these deposits would be uneconomic to exploit even if the Mt Newman Service is declared.
Now this was a statement from 2005 and I would be interested to hear public clarifications of it. What it says to me is that BHPBIO believe that themselves and RIO have it covered and that the supply at least of iron ore is inelastic. That is, they argued the NCC was wrong in thinking that smaller players have any viable projects out there. The implication of this is that a tax on rents will be purely distributive and move money from BHPBIO and RIO shareholders to the government. In other words, it will operate as a pure resource rent tax rather than something else. I should stress that I don’t agree with this assessment and it is likely that neither do smaller miners but surely it would be useful for our mining giants to clarify their position on these matters publicly.