Winners and losers of the Resource Profit Tax

Paul Frijters analyses the topical economic issue facing Australia’s resource industry and the public: the Federal Government’s proposed Resource Super Profits Tax. He identifies all the key stakeholders and how the proposed legislation change will affect them.

The recently announced Resource Profit Tax is in principle a profit grab, taking from those who owns large mines, and handing this out to those that dont. Obviously this makes mining executives angry and the noise they are creating at the moment is deafening, with all sorts of nonsense bandied about in the media about how this tax will mean the end of the world as we know it. Leaving the noise from a few super-rich to one side, it is useful to think of who belongs to the winners and the losers of the proposed tax.

A difficulty in making that assessment is that no-one yet knows how this tax will be carried out. Part of the difficulty is that the tax is meant to replace the existing royalty system in individual states, but these individual states are unlikely to simply agree to such changes in their tax raising activities. Also, definitions of ‘costs’, ‘rents’, and just exactly what constitutes a ‘mining project’ are yet to be worked out, so we can at the moment do no more than give a best guess. Let’s presume that the tax gets implemented in the way it designed, meaning that the profits of all current and future mining projects will be taxed at 40%, whereby the initial costs and losses count as a kind of tax-offset.

At the moment, the government’s plan includes the possibility that mining firms that made a loss on a project get part of that loss reimbursed, but exactly how that will work out is not clear (what happens in the case of bankruptcy?), so let’s presume that costs and initial losses will be treated as tax off-sets, which is what they will be for most of the big mining companies.

Since a profitable project now remains a profitable project in the future, the long-run effect of this tax is that at least as many projects will go ahead as without this tax. Indeed, more will go ahead because the tax replaces existing royalty taxes which tax all mining activity and do discourage all mining activity. Hence, in the long-run more mining will take place under this new tax, implying higher levels of investments. The beauty of the tax is that the underlying assets (minerals in the ground) cannot run away and hence the tax cannot be avoided by mining somewhere else. It is just not credible for any company to pretend they will refuse to make money and not dig up and sell the minerals that are there. All talk of capital flight, sovereign risk, and other forms of saber rattling are just not credible.

Another clear effect of this tax is that it will give mining companies (like Xstrata and BHP Billiton) an incentive to increase the costs, just like any tax-offset increases people’s incentive to use those offsets. This means that one should see increased job security, higher wages, and increases in other cost factors like transport. Indeed, the tax office will have a tricky time in deciding whether all the costs mining companies will start putting on their books are really costs associated with mining activities. Mining companies can for instance try to hide profits by paying excessive amounts to transport companies for transporting the minerals if these transport companies are owned by the same parent companies. All kinds of tax-avoidance games can be played. However, let’s presume the tax office will do a reasonable job and manage to keep the increase in ‘fake costs’ to acceptable levels. Even then, anything that is essentially a cost to mining (like employment, wages, and inputs) should get an easier time in negotiations with mining bosses because the government now effectively pays some of those costs.

Who, then, are the winners of this tax? They include:

  • Mine workers and mining communities. The long-run level of activity should go up, and the pressure on their wages and employment relations should go down.
  • The general business community. Non-mining activities are taxed less because mining profits are taxed more, meaning that in general, businesses win out.
  • The general public, simply because they can expect to benefit from reduced taxation and receive parts of the services bought by this tax.
  • The economic system, because this kind of tax is very dependable (minerals can’t run away to foreign countries and hence the tax can’t be avoided), making the public finances sounder and more reliable.

Who are the expected losers of this tax? They include:

  • Shareholders in mining activities in Australia. When they bought their mining shares, the shareholders expected to receive a certain flow of profits, and that profit stream is now taxed more, making shares in mining less valuable. These losers include domestic shareholders and foreign shareholders, such as major Chinese interests in Australian firms and foreign shareholders in mining companies operating in Australia. To a certain extent, the RPT means Australia is grabbing in the coffers of foreigners to the benefit of its own population.
  • Shareholders in mining activities outside Australia. Many countries are facing the problem of how to tax economic activities without reducing the level of economic activity, and Rent taxes are recognised as being pretty close to the economic textbook ideal as to how to do it. Hence other countries will no doubt follow suit if Australia pulls it off. This makes international mining companies understandably nervous.
  • Other holders of fixed assets within Australia. This tax of course establishes the principle that assets that cannot run away might witness an increase in the taxation of the income generated by those assets. There are quite a few other sources of rent that could in principle be treated similarly, making owners of fixed assets justifiably nervous. Land, in particular, would be a prime long-term target for tax increases.

The specter that land-owners might be taxed on the basis of the value of that land (as an imputation of its profitability) will undoubtedly make owners of prime real estate nervous, and no amount of protestations on the part of the current government that it will not introduce such a tax will entirely allay the fears of those who see an analogy between taxing what is beneath the surface (minerals) and taxing the surface itself. And it would be quite possible that the Liberals introduce such a land-tax in their next government. Hence all those super-rich that make their money off fixed assets rather than their skills can all justifiably feel they have something to lose from the introduction of this tax.

In short, many of the expected losers of this tax are foreign or super-rich, whilst the expected beneficiaries include the vast majority of the Australian population and the business community. If the tax indeed goes ahead as hypothesised above, the political question will be whether the few losers will manage to fool the many winners into believing that it is in the interest of the many (including workers in the mining industry!) to protect the few.

I consider Rudd exceptionally lucky with the current avalanche of misinformation and self-interested commentary coming from the rich mining companies. It is not often in economics that a proposed new tax is so obviously a fight between the interests of the few and the interests of the whole, making it easy for economists to be fairly united on where they stand. The more fuss is made about it, the more it can become a defining issue for current politicians and the more satisfaction they can take from the experience.

I fervently hope this debate drags on for a long time and becomes a debate about what kind of society Australia wishes to be: one that is run in the interest of the whole, where small groups of super-rich cannot sway public opinion, or one where any change that has a couple of well-funded losers can be stopped by disinformation and fear mongering.

Author: paulfrijters

Professor of Wellbeing and Economics at the London School of Economics, Centre for Economic Performance

14 thoughts on “Winners and losers of the Resource Profit Tax”

  1. Hi Paul

    This is a really good post. One question though. In Ross Garnaut’s recent speech he differentiated between rents and quasi-rents and made the quite reasonable claim that taxing the former would have no impact on future mining investment, while taxing the latter could. He then went on to say that in practice it can be difficult to differentiate between what is a pure rent, and what is a quasi-rent and seemed to imply that there was some danger that the RSPT could tax quasi-rents and thus inhibit some investment. You don’t discuss this possibility above, but perhaps you could offer some comment?

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  2. “making the public finances sounder and more reliable”

    Perhaps some more comment on this as well would be good. I would have thought that revenues from this tax could prove quite volatile and more pro-cyclical as the profitability of mining projects varies considerably with the global business and commodity price cycles.

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  3. Great post on the subject. The miners have been preaching of the apocalypse – as you would expect them to when defending their interests. However, I am not clear about  how the Federal government intends to use the super-profits. Is it being placed into a sovereign wealth fund, or is it going into general taxation revenues? I would think this choice will determine just how beneficial to Australia this tax revenue will prove to be. Some commentary on this would be informative.

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  4. Theological arguments differentiated gifts of nature from the work of man. The general idea was that ‘whatsoever a man soweth that therefore shall he also reap’. Similar arguments applied to ancient usury laws. British laws permitted collection of tithes until their repeal in the 1930s. The revenues were generally applied to social welfare in education, hospitals and poor relief administered through the secular parish. The secular parish replaced the ecclesiastical parish after Henry 8’s excommunication by the Roman Church.
    Land tax in Australia had origins in ideas about rent that were well established by the late 1600s as indicated in writings writings by Petty – Cromwell’s surveyor general in Ireland. This connected the idea of supernormal profit to rent on land and through the notion of ‘years purchase’ (a reciprocal of ROI) to land valuation. There is no difference in principal in carrying these ideas over into valuation of other resources tied to land.
    In the 1700s, French Physiocrats promoted ideas about a single tax on land. A single tax movement grew out of ideas promoted by Henry George. Land as a tax base applies to local government rating that adopts the idea of unimproved value to separate work by the owner from work done by nature and infrastructure funded externally.
    Land taxes based on unimproved values were once considered as flat rate taxes; but the states usually use regimes that are strongly progressive. Arguably, this progression was to avoid undue monopolisation of land and force it into subdivision as part of closer settlement policies. A problem with taxation is that its rationale is usually buried deep in history. It is easily lost in political negotiations. The public seldom sees cogent argument about why taxing proposals are fair and reasonable. Political rhetoric is a veil thrown over crass political opportunism and wealth redistribution.
    Business risks are already accommodated to some extent through conveniently overlooked limited liability laws governing insolvency. Rents deserve to be differentiated from exploration costs where the product is information. A case can be made for subsidisation or cost sharing to coordinate with other mapping activities provided that the cost of publicly-funded information is freely available and does not become a source of monopoly power.
    One interesting aspect of the debate that might happen is that mining interests may advertise using resources that probably ought to be paid in a resource rent to the public. The government plans to counter this campaign using public resources raised through taxation. Seemingly, the public will pay for both sides of the argument. It will cost people more in time it will take to become informed on the issues, assuming their are minds still open. It would be nice to think that they could get their money’s worth.

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  5. Labor outsider,

    the reply above by John Cook nicely spells out the implication of the fact that minerals have to be found, which is that it makes sense to fiscally separate the exploration-and-extracting activity from the pure selling of minerals. By subsidising the former via the off-set system and, as John mentions, the limited liability provisions in the bankrupcy laws, the remainder is almost purely a rent and no longer a quasi-rent.
    The stability argument on this tax is a long-run stability argument. Because minerals cant run away, one has a reliable tax base as long as the minerals are not yet exhausted which, in the case of several commodities like coal and uranium seems to be a very long time. Also, because mining activities are often long-run projects, the volume of activity would seem quite predictable. But you are right about the prices: like other taxes on profits, the uncertainty of price fluctuation would of course affect the revenue.

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  6. Just a small point, Paul – the replacement of royalties by the RSPT is de facto, not de jure, so the States’ agreement is not needed.  Royalty payments are just to be dollar-for-dollar deductible from the RSPT.

    As I’ve said elsewhere this is a great tax-shifting tool for the States and probably accounts for the quiescence of some State premiers who might otherwise have taken the opportunity to bash the Feds.  They can jack up the royalty rates without economic or political consequences because the miners pay no more tax overall.  Its just that the Feds then get less.

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  7. Derrida,
    (the same point came up in the cross-post at Club Troppo so I will give an extended version of the same reply here).
    thanks for adding the nuance that was not in the post, but it doesnt take away the point that there must now be some new agreement between the commonwealth and the states about these ‘as-if’ royalties: would the states be allowed to increase the royalties to more than the total tax? What about simple increases in the royalties, can these still be decided upon unilaterally? I dont think the tax is workable if the states remain free to set their royalties to whatever level they want, so one way or another a new understanding has to be reached with the states. The ‘normal’ political solution to this would be to have a grandfathering of the original levels of the royalties and set those in stone. Even then, that would be a de facto reduction in the tax raising powers of the states.
    In the documentation provided by the government fact sheet (just follow the link given above), it is phrased like this ”
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    The Government will discuss with the States on what royalty rates to credit”
    I can see understand why the state governments are being quiet: they are probably waiting till they see the offer the Commonwealth is going to make to them on this issue, hoping it will be a higher level of royalty than they have at present…

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  8. Derrida,

    (the same point came up in the cross-post at Club Troppo so I will give an extended version of the same reply here).

    thanks for adding the nuance that was not in the post, but it doesnt take away the point that there must now be some new agreement between the commonwealth and the states about these ‘as-if’ royalties: would the states be allowed to increase the royalties to more than the total tax? What about simple increases in the royalties, can these still be decided upon unilaterally? I dont think the tax is workable if the states remain free to set their royalties to whatever level they want, so one way or another a new understanding has to be reached with the states. The ‘normal’ political solution to this would be to have a grandfathering of the original levels of the royalties and set those in stone. Even then, that would be a de facto reduction in the tax raising powers of the states.
    In the documentation provided by the government fact sheet (just follow the link given above), it is phrased like this
    ” The Government will discuss with the States on what royalty rates to credit”

    I can see understand why the state governments are being quiet: they are probably waiting till they see the offer the Commonwealth is going to make to them on this issue, hoping it will be a higher level of royalty than they have at present…

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  9. The trouble with the textbook theory is that it assumes a closed economy: the resources might be immobile, but the capital to develop those resources sure is not.  Therefore as long as there are resources in other countries – and there are, plenty of them – reducing the after tax return to mining projects in Australia will REDUCE investment in mining.

    It is not sufficient to say that investment will continue because it is profitable; it will be less profitable in Australia and more profitable elsewhere.

    So mining investment in other countries will increase.  And just like Copenhagen, there will be no international agreement on raising mining taxes to match Australian levels, even if there is some temptation to raise them a little.

    For all large resource houses, there is effectively a global competition for capital and it is allocated to projects that secure the largest post-tax net returns across the world (they already own the acreage in most cases).

    This puts an entirely different spin on who the winners and losers will be.

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  10. Judith,

    not at all. Yes, capital is mobile, but it also goes to its highest return. This is what the centering level of profit is about, i.e. the ‘super’ in super-profits. The structure of the tax is to tax profits only above a baseline level, such as the government bond rate. As long as that baseline is chosen to be close to the international market rate for the return of capital (it can be a bit lower and doesnt have to coincide with it: all one needs to ensure is that the expected return are no lower than the market rate), then capital will continue to be attracted to the mining industry at the maximum rate it can be absorbed by that sector. That maximum rate depends on other bottlenecks, such the availability of skilled labour, the business of mining permissions, etc.

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  11. Wow,
    First time I’ve ever seen an economist argue decreased productivity is good thing as it increases jobs and wages.

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