Sharing the boom

When British Labour assumed office in 1997, one of its first acts was to impose a one-off “windfall profits tax”. The rationale was simple - the previous Conservative government had undervalued and under-regulated the utilities, and the owners had made far larger profits than could have been reasonably expected. In a single budget, the government raised £5.2 billion, helping to fund its welfare-to-work reforms.

Fast-forward eleven years, and Australian coal firms are experiencing undreamt-of prices for their output. Over the decade to 2007, the price of coking coal doubled. This year, the price has tripled. Which raises the natural question: should the Rudd Government take a leaf from the Blair playbook and consider a windfall profits tax on Australian mining companies?

The arguments in favour of a windfall mining tax are easily stated. From a fairness perspective, the industry’s massive profits have come not through producing a better product or service, but because of an outside factor - China’s stratospheric economic growth. The coal leaving the docks today is the same stuff we sold a decade ago; it just happens to be six times as valuable.

From an economic standpoint, the strongest argument for a windfall tax is that it has the potential to be non-distortionary. A one-off windfall tax levied on past profits should not change firms’ behaviour, since it does not affect future costs and prices. For example, if the Australian government were to announce on July 1, 2009 that it was imposing a windfall tax on coal companies’ 2008-09 profits, there is almost nothing the companies can change about their future investment decisions that will cut their 2008-09 tax bill.

Now the counter-arguments. Morally, the mining companies would no doubt argue that they already pay company taxes. Moreover, they might point out that they made their investments in good faith, and responsible governments should not change the rules in the middle of the game.

These points deserve reasonable consideration. But if we regard Australia’s mining companies more like lottery winners than as toiling entrepreneurs, a windfall tax looks more reasonable. Taxing luck is fairer than taxing hard work.

The miners would also be quick to contest the claim that a windfall tax can have little economic impact on their future decisions. And it is true that as soon as mining companies hear of the tax, their decisions will change. As a result, surprise windfall taxes are more economically efficient than anticipated ones. This may be one issue on which a full and robust public debate does not lead to a better outcome.

Companies are also likely to raise the spectre of repeated raids on their revenue. Having been levied once, what is to stop a windfall tax being imposed again? To counter this, the government must be clear that the present minerals price increases are a once-in-a-lifetime event, and so is the windfall tax. The less credible this claim, the more the tax will deter future investment in the sector.

With its coffers flush, does the Australian government really need more revenue? In the short-term, the answer is probably no. But history suggests that the next slump cannot be avoided, merely delayed. When the downturn hits, it would be better to have a rainy day fund than to be forced to borrow internationally or raise taxes on a sluggish economy.

No government should lightly impose windfall taxes, but in the right circumstances, they can play a valuable role.

When the High Court declared certain state taxes unconstitutional in 1997, the Howard government imposed a federal windfall tax to claim the revenue. In the United States, Barack Obama’s pledge to impose a windfall tax on oil companies has met with significantly more approval from economists than John McCain’s proposal for a gas tax holiday. Even the newly-elected conservative government in Italy has approved a “Robin Hood” tax on the nation’s energy companies, and is trying to convince other European Union countries to do the same.

Few issues require such careful political management as a windfall tax. But implemented properly, it is possible to imagine that such a tax could be both economically responsible and in line with fundamental Australian values. Why not raise a little more from our lottery-winning miners today, and squirrel it away for the next recession?