Mining rents and ‘super profits’

A resources rent tax is good policy. Many years ago, while serving on the Minerals and Energy Policy Committee of the Tasmanian branch of the ALP, I argued for precisely such a measure as being inherently preferable to quantity-based, or even ad valorem royalties. I continue to hold that view. But I think the Commonwealth Government has erred seriously with its Resources Super Profits Tax (RSPT), and unless it modifies the proposal as we know it, it will do serious harm to the Australian economy.

Unfortunately, the government has convinced itself that any opposition from the mining industry is just the usual bleating. They will continue to convince themselves their policy is not the mistake I think it is by dismissing the industry complaints with the Mandy Rice-Davies defence of “they would say that, wouldn’t they”.

But the indicator is not what they say, but what they do. “Follow the money” is probably a better principle, and money has gone out of the mining sector and out of Australia over this past week, something a turbulent week on international markets should not obscure. Mining equity prices, and the Australian market, went down while Wall Street went up. More significant will be where the money goes in future.

The policy is also being defended by reference to the introduction of the Petroleum Resources Rent Tax (PRRT), but this comparison is, for reasons I explain, invalid. So what is wrong with the RSPT?

First, retrospectivity. The RRT on petroleum at introduction did not apply retrospectively to existing projects. The retrospective nature of this tax at introduction has inevitably raised the sovereign risk for mining investment in Australia compared with competitive investment destinations.

The second problem is with definitions and thresholds. The RSPT treats anything above the long-term government bond rate as “super profit”. No investor in equities in any sector would accept this trigger level, and we expect our superannuation investments to return 10 per cent or so as a minimum. If you can earn a government guaranteed 6 per cent, why would you invest in a sector where the lead time from exploration to commissioning might be ten years, and where the returns are highly uncertain? The nature of mining investment is precisely why there is a distinction between “Industrials” and “Mining and Oil” on the Australian stock exchange.

The Petroleum Resources Rent Tax allows a margin for risk above the bond rate before the tax kicks in. The comparison between PRRT and RSPT is invalid for this reason. Early chambers of mines in Australia were established (with active encouragement by colonial governments) to assure investors that the risks of doing so were less than they appeared. Governments wanted to signal certainty and return on investment. This decision has the reverse effect.

Finally, the tax reflects an out-dated view of the sector - one that dates back to the 1970s of Rex Connor and Nugget Coombs, when the architects of this tax were in their formative years. That “Quarry Australia” view (to cite the title of a popular book then) underestimates the skill required now to discover and develop most mineral deposits.

That thinking used to bemoan the fact that all we did was “dig holes in the ground”. Modern mining is much more difficult than that, and Australia has developed excellent skills - from geologists and mining engineers through to mine workers - in this area.

But the world has also changed. A decade ago, the industry globally was actually returning to its investors less than the long-term bond rate. What has changed is not just the story of China (and India), but the opening up of opportunities and the ending of factors that once deepened the troughs and clipped the peaks of the inevitable commodity cycles. The current resource “supercycle” is not just about Chinese demands. What other factors are at play?

First, the end of Communism has reduced the extent of nationalised mining that occurs. There is less mining at below cost for reasons of national income (taxation or foreign exchange), that used to deepen the bottom of the cycle.

Second, this has opened up opportunities for investment in the sector in Developing Countries, which have addressed concerns over sovereign risk for highly prospective regions. Capital has flowed to these opportunities (and will do so in greater volumes in future if the risks are higher in Australia).

Finally, rising expectations with respect to environmental and social performance by the industry have increased the costs and lengthened the lead times for bringing new capacity into production. These measures have largely been supported by the large players in the sector, not just because it is the right thing to do, but because it makes good business sense. Making it harder for juniors and artisanal miners to bring capacity into production has kept the supercyle going for longer because it has inhibited the factors that have traditionally clipped the peaks off cycles.

There have been defences of the policy, some coming from the union officials who should be questioning the policy in the interests of their members, that have reflected the outmoded assumption that because the resources are not mobile and are located in Australia, the miners will have no option but to get on and pay the tax.

It is true that natural resources are not mobile, but capital is, and in a world where there are plenty of opportunities for investment, decreasing the likely returns in Australia will inevitably shift investment.

Australia is unique among the markets of the developed world. Mining has recently usually accounted for around 20 per cent of the value of the ASX. The closest comparator is Canada, where the percentage is around only a quarter of that.

A shift in those relativities has begun. The use of the language of “super profit” for domestic political consumption has not helped.

Unless the government addresses these issues, the increase in the Superannuation Guarantee - itself a good idea - will do nothing to offset the losses in all our superannuation investments resulting from the misapplication of an inherently good policy.

The government can save the situation by changing the trigger, dropping retrospectivity and perhaps graduating the rate to make it progressive. But that will require that it acknowledge its error.

This measure might not even be smart politics. Superannuation guarantee has made us all at least petit capitalists, with a stake in the profitability of business. In addition, substantially more of us are direct shareholders than are trade union members.

Taxing a sector that represents a fifth of the value of the stock market as if earnings greater than the government bond rate might not be as popular as its architects think. Nor is taxing economic rent at too high a rate necessarily good policy, as a simple example shows.

In 2009, BHP Billiton earned $2.47 a share, but paid only $1.01 in dividends. It remains a growth play, rather than a yield play, because the difference was invested in developing new mines and oil resources. Would it be better public policy to have invested more of margin in more insulation or more COLAs for schools under the rhetoric of an education “revolution”?