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Should miners believe governments really are risk-taking investment ‘partners’?

By Geoff Carmody - posted Thursday, 10 June 2010


Opponents of the Resources Super Profits Tax (RSPT) claim financiers put zero value on government promises to repay mining costs, plus a government bond rate “uplift factor”, in future. This undermines miners’ ability to finance new mining projects.

The view is governments will likely renege on the deal when faced with large future refunds.

This might be understandable, for three reasons.

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First, governments hate tax revenue risk. They usually demand a larger share of successes (tax on profits) than losses from failure (tax refunds to losers).

Look at income tax systems around the world: governments demand income tax revenue up-front, but deny, defer, and/or allow the destruction of, tax losses.

Deductible income tax losses are often subject to “quarantining” (not claimable against all sources of taxable income). If carried forward, they generally don’t benefit from an uplift factor. They can be lost completely even if eligible for tax deductibility (e.g., if the affected entity goes belly-up) because refunds aren’t allowed.

At face value, this government’s RSPT IOU offer is more generous than for most other income taxes. Is this part of the reason why RSPT opponents think it’s just too good to be true?

Second, refunds under the RSPT would be triggered by global recession, rising unemployment, and a budget sliding fast into deficit. The last event will be accelerated by the operation of the RSPT itself (including large and fast-growing RSPT contingent liabilities).

This is politically toxic. Will governments facing such budget pressures concentrate on delivering RSPT IOUs to the mining industry? They’ll likely support hard-hit individuals first, try to minimise the slide in the budget bottom line, and possibly apply some budget belt-tightening to businesses.

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Third, when “sovereign risk” in Australia appears on the rise, should those affected believe the Government’s RSPT IOU will be honoured?

The market “discount rate” on policy credibility and stability in Australia has probably risen a fair bit. RSPT IOUs might not be called in for many, many years. They might have no discounted net present value.

Can we escape this RSPT morass? Yes. There are two avenues. The first requires governments to be full and equal partners in project risk.

To tax “pure” resource rents, auctioning exploration/minerals rights is one way of valuing such rents up-front, rather than retrospectively. (These rents can’t be measured in practice: this is a market approximation.)

After that, a proper cash flow tax on mining (and other industries?) should be applied. That way, governments take the bad (tax refunds) with the good (revenue).

How does this tax work? In any accounting period (e.g., a year), all cash income received is taxable, and all expenses incurred to generate income are deductible. If cash inflows exceed expenses, tax is payable on the excess. If expenses exceed inflows, a tax refund is payable.

This offers huge benefits.

It’s simple - a feature to which key policy makers are attracted.

Fair up-front treatment of losses and gains is delivered. Haggling about depreciation tax allowances, concerns about inflation effects, “uplift factors” under the RSPT, etc., disappear.

Retrospective tax concerns disappear. “Sovereign risk” recedes. No need to worry about governments honouring refund IOUs years down the track.

What’s holding us back? Governments are risk averse and they want their tax revenue now.

Paying refunds immediately is anathema to governments. “Protecting the integrity of the revenue system” is the high-sounding jargon used to justify this risk aversion.

Government risk-aversion renders income and profits tax design even more inefficient than it needs to be, to protect short-term tax revenue. But this undermines revenue collections over time.

The second avenue out of the RSPT morass recognises, up-front, that governments are risk averse.

Volatile tax bases mean volatile cash flow tax revenue. Stable tax bases mean the opposite.

Future mining downturns make mining cash flow taxes risky. Investment booms might generate similar concerns, especially with a tax focused on mining. This might encourage broadening the RSPT base to cover other industries to diversify the tax base and reduce revenue risk.

Even so, it seems obvious that the revenue downsides under the RSPT are magnified compared with a cash flow tax, because RSPT IOUs generally accumulate rather than being refunded as they occur. And they fall due as refunds just when they’re least welcome.

Government risk minimisation suggests greater reliance on more stable, broad tax bases. Consumption expenditure is a good example. A stable tax base with cash flow treatment can share risks and returns, too.

In fact, a cash flow tax, on a relatively stable tax base, already operates fairly well around the world.

In Europe, it’s called Value Added Tax. In Australasia, it’s the GST. New Zealand has the best on offer.

The Henry Review favours cash flow taxes for some purposes (see pages 51-2, and page 91, of the Henry Review, Part I, Overview).

The Henry Review (page 51, Part I, Overview) also states that:

Consumption is potentially one of the most efficient and sustainable tax bases available to governments. Empirical evidence indicates that a broad-based tax on consumption is one of the least damaging taxes to economic growth.

It’s a pity the GST was excluded from Henry Review consideration. Was this an evidence-based decision?

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First published in the Australian Financial Review on June 2, 2010.



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About the Author

Geoff Carmody is Director, Geoff Carmody & Associates, a former co-founder of Access Economics, and before that was a senior officer in the Commonwealth Treasury. He favours a national consumption-based climate policy, preferably using a carbon tax to put a price on carbon. He has prepared papers entitled Effective climate change policy: the seven Cs. Paper #1: Some design principles for evaluating greenhouse gas abatement policies. Paper #2: Implementing design principles for effective climate change policy. Paper #3: ETS or carbon tax?

Other articles by this Author

All articles by Geoff Carmody

Creative Commons LicenseThis work is licensed under a Creative Commons License.

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