Sharing the Boom

With resource prices rising far faster than expected, my AFR op-ed today discusses the arguments for and against a windfall profits tax on mining companies. Full text over the fold.

Lucky miners can dig deep, Australian Financial Review, 24 June 2008

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 1 July 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?

Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.

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24 Responses to Sharing the Boom

  1. Labor Outsider says:

    Andrew

    This is one of your most poorly thought out op-eds in quite some time.

    Let me make a few points.

    First, corporate tax rates are already relatively high in Australia and company tax revenue as a share of GDP is far higher than in most other OECD countries. It is the previous proceeds of the resources boom that have provided this and the previous government with the revenue that has been splashed out on tax cuts and increased government expenditure. So, what is the argument that the government should claw back even more of this revenue? And are you confident that the money would be spent wisely?

    Second, foreign investment in Australia is not a one-shot game. By announcing a higher tax on mining profits ex-post, the government would be signalling to foreign investors that it is prepared to change the rules of the game without notice or compensation. That increases sovereign risk and might raise the hurdle rate of return for Australian projects. Think about it this way, if you were a foreign investor, and had made an investment decision based on a particular profile for tax rates, and then after the decision had been made, the government raised that rate of tax considerably, wouldn’t you be more circumspect about investing in that country in the future? You ackowledge this but then say that the government could give a guarantee that it wouldn’t happen again. How would such a guarantee have any credibility?

    Third, the Blair/Brown government’s record on taxes isn’t something I would cite as evidence in your favour. When new labour came to power, they argued that higher taxes were needed to fund necessary increases in health, education and welfare spending. 10 years later, a number of reports have suggested that much of the increased spending was wasted, with little improvement in outcomes. Citing the new Italian government’s position on taxes is even more laughable.

    Fourth, are you in favour of one off reductions in tax if resource prices eventually fall to historic lows? Commodity prices have gone through an enormous boom in recent years, but before that they were in the doldrums – I didn’t hear anyone claim at the time that mining companies deserved a tax-cut. So, why the asymmetry?

  2. James says:

    I understand the arguments for and against this and am wondering if there would be a way of diverting extra royalties into exploration & infrastructure. That way it would be seen less as a tax grab and more as slicing the top off the boom to support the lows.

    On the matter of recuctions in tax when prices fall, it would seem to make sense to me. So you could have, for example, tax rates based on the average price compared to last year:
    50-75% = a reduction
    75-110% = a slight reduction
    110-130% = no change
    130-160% = a slight increase
    etc. Downsides would be administration cost.

    Two other points, should this just apply to mining companies, or resource companies or all companies which experience windfall revenues / profits.

    And where are the states in this? Aren’t they the ones who get the mining royalties (hasn’t QLD increased its coal royalties). To me, it seems a better fit to increase royalties rather than company tax rates – the above sliding scale could just as easily apply to royalties.
    Expecially if the states are they responsible for explorations & investment?

  3. Labor Outsider says:

    You are right, the state governments currently impose royalties on some mining profits. The problem with using this vehicle only is that it isn’t of much beneift to resource poor states.

    In theory a royalty is different to a tax – a royalty can be seen as as ongoing payment to a government for the right to dig minerals out of the ground and sell them – in practice, from the investor’s point of view – both mean that the the gross rate of return on the asset needs to be higher to achieve the same net return…

  4. Labor Outsider says:

    One more thing.

    One of the things I find most frustrating in discussions of taxation, is the failure to recognise that a constant rate of taxation will generate an increasing stream of government revenue when profits are increasing. So, if mining profits more than double, so does government revenue. Isn’t that a windfall?

    At the end of Andrew’s piece, he claims that the additional revenue could be stored for the next recession. But unless I am missing something, that is already occurring. In the most recent budget, the government announced two new investment funds – the funding of which was coming from the increase in the forecast surplus – and where did the increased forecast surplus come from? In large part the forecast increase in commodity prices.

  5. notimportant says:

    Are you claiming that mining investors don’t take into account the probability of a resource boom in their investments? And that if they do, they don’t deserve the outcome if it turns out in their favour?

  6. Eric says:

    Perhaps the case of coal is a special one – our industry has been getting a free kick from the lack of appropriate restrictions/taxes on pollution.

  7. Patrick says:

    I agree that thid was a ridiculous idea. I work with some mining companies and they are well used to changing ground rules in Indonesia, Thailand, etc.

    This is the kind of behaviour that is assumed not to happen in civilised countries, to be blunt.

    But most critically, what possible grounds are there for thinking that our massively under-geared over-cashed government could need more tax revenues?? The best that you appear able to come up with is setting aside a slush fund for rainy days – Keynesianism on steroids? Why not just borrow now to set aside that money, or indeed just divert existing surplus revenue to that task?

    Or indeed why not just borrow when the time comes? The rate is unlikely to be that high, given the luxury of practically nil existing debt. Oh, wait, that’s it, the only thing likely to materially raise the price of our debt in the foreseeable future would be arbitrary post-facto regulatory changes !!!

  8. ARC says:

    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?

    Terrific idea. mining was basically a shit industry that struggled for 25 years and the minute it begins to stir you want to slug it with another tax over and above the amount they pay.

    That’s a sure way of attracting more investment into the sector. NOT!

    want less investment in mining? Add more taxes.

  9. Jono says:

    Andrew. I am appalled by this op-ed and it deserves a thorough debunking:

    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.

    What fairness is there in a windfall tax ? Why are you only allowed to keep profits when you produce a better product or service ? Aren’t global markets supposed to place the value on the product a firm produces instead of your subjective factors ?

    The greed and envy towards succesful mining companies is palpable. As if it weren’t enough that they already pay company tax on profits. They are *already* contributing a windfall tax because company profits are soaring and their contribution to the tax base has already skyrocketed !

    In one sweeping statement, you show incredible arrogance. Are you in a position to declare, with full certainty, that mining companies are not producing a better product or service ? Can you say with 100% certainty that they haven’t innovated and improved in any of their operational practices ? I doubt you can.

    The mining companies have operated for decades and have done so under huge risks. Why their very presence, every single effort to extract precious metals from the earth, is done so partly because they expect/hope/anticipate that the commodities will be in demand in the future. It seems only fair that they deserve to keep their profits. At least as much as they would have under the current tax system – why should there be a windfall tax on top of company tax?

    This op-ed shouldn’t be called “Sharing the boom”. It should be called “Stealing the boom”.

    So on top of company tax and thousands of oppressive regulations, and the spectre of new environmental regulations and escalating energy costs, you expect mining companies to continue to toil on bravely under the threat of these “windfall taxes” ?

    Working where you don’t receive the product of your labor. That is slavery. And you call it “squirreling away” the winnings of a lottery. What a euphemism.

  10. Sinclair Davidson says:

    Happy people should be taxed 🙂

    Grumpy people should have to pay a fee before leaving nasty posts on blogs.

  11. hc says:

    I generally like your op eds Andrew but this is a real dud. This tax would definitely discourage investment in mining because it is the hoped for boom that drives many investors. People who stake their dough when times are bad hope that boom times will come. Reduce this chance and they bwill invest less.

    Australian miners already do an indecent amount of their exploration outside Australia. The reason hefty taxes, state charges for rail, long delays in environmental approvals and ridiculous indigenous policies.

    Smarty pants policies which attack success without attacking success do not exist – lottery ticket winners must buy a ticket. The problem is that the deadbeat end of Labor will believe short-sighteed proposals such as this and damage our most valuable exporter.

    Think again.

  12. Spiros says:

    “Australian miners already do an indecent amount of their exploration outside Australia. The reason hefty taxes, state charges for rail, long delays in environmental approvals and ridiculous indigenous policies..”

    Harry, FFS learn some facts. Australian mining companies, Rio Tinto in particular, have a superb record in working with indigenous communities. They go far further than the “ridiculous” policies at which you sneer.

    As for their exploration, FFS stop being such a little nationalist. BHP and Rio are two of the three biggest mining companies in the world. Of course they are going to explore outside Australia. It’s a big world out there with lots of opportunities.

    Andrew, your tax suggestion is dumb for the reasons everyone says. One reason mining companies will invest here despite our higher taxes being higher than Bongo Bongo Land is political stability and No Nasty Surprises. BHP is thinking about investing billions at Olympic Dam. Do you really want to scare them away?

  13. ARC says:

    Andrew:

    No offense, but its possibly the dumbest 70’s retread of an idea I’ve seen for a while. Go back to bed and this nightmare should go away.

    You would be basically redirecting scarce capital from potentially profitable sectors to the less so or not at all.

    Great idea, lets behave like the South Americans.

    If you wish to partake in the boom I suggest you go and buy some resources stocks.

  14. christine says:

    Similar debate, unsurprisingly, in Alberta, Canada at the moment, and in Canada generally about the distributional effects of resource booms.

    I think they did raise royalties, and are ‘squirreling away’ the proceeds for the future. Part of it into higher education. But, no-one’s going to university in Alberta, coz they’re all working in the oil patch, so it’s not clear what the point of that is. (Note: this is a little exaggerated.)

  15. conrad says:

    “But, no-one’s going to university in Alberta”

    I believe we are seeing the same sort of effect in WA and Queensland for the same reason. I think the point is that once the mining boom ends, you are going to have a whole pile of mainly males that suddenly don’t earn the reasonable dollars they once did (a generation of them), and furthermore, they won’t be skilled to do anything excluding digging holes. If these guys don’t get retrained it’s going to be social problem city (think males that don’t have enough money for their typical lifestyle). If you let the universities die off, it’s not clear what you are going to do with these people (especially considering they will also be in competition with school leavers for places), because its not simple to simple expand/contract universities in short time-spans without lots of consequences.

  16. Jono says:

    From an American perspective, John Stossel already has demolished the idea of windfall taxes:

    http://www.theatlasphere.com/columns/080625-stossel-windfall-profit.php

  17. Mike Pepperday says:

    Excellent idea, Andrew.

    Squirrel it away for when ‘private’ enterprises fall on hard times and the govt is expected to come to the rescue (Mitsubishi comes to mind).

  18. reason says:

    There is one big argument that I’m missing here. The Dutch disease argument that (by pushing up the exchange rate and cornering most investment) miners hamper development in the rest of the economy where most people work. If there is a “enclave industry” it is mining. Of course this argument applies more to royalties than to a windfall tax.

  19. reason says:

    To put it blatantly and simply, digging up the country and shipping it overseas isn’t a great long term development strategy, no matter what those few with a special interest in the sector think.

  20. reason says:

    I see conrad sort of made the point. Sorry I missed your post.

  21. ARC says:

    Reason:

    The exchange has a buyer and seller every time a transaction is made. There is no such thing as over or undervaluation in a floating rate regime.

    If you think it is over valued you can always sell it. Two investment banks argue that fair value is currently 1.35 and 1.30 respectively.

    To put it blatantly and simply, digging up the country and shipping it overseas isn’t a great long term development strategy, no matter what those few with a special interest in the sector think.

    So let’s stop digging up resources all over the world, after all its not ” development”.

  22. reason says:

    ARC
    You clearly didn’t understand my point – perhaps because I left out five important words.
    Replace “Digging up the country …” with “Digging up the country as fast as we can … and perhaps what I should have becomes clearer. Everything we ship overseas is an asset we no longer have (sold perhaps at a price that in a couple of decades will look ridiculously low) and makes it harder for other export/import competing industries.
    A man has great difficulty in understanding something, when his job depends on him not understanding it.

  23. reason says:

    And yes I understand that a more expensive currency also helps people by making imports cheaper. The problem with mining is though that the income is very concentrated, many of the owners are foreign and mining occurs in remote places so that apart from making imports cheaper it has relatively small multiplier effects on the rest of the economy.

  24. reason says:

    ARC
    Nauru – discuss.

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