RSPT: Lack of Transparency is the Issue

From the point of view of the mining industry and their potential financial bankers in the banking industry there are two key issues:

1. How are existing projects where the government hasn't been accounting itself as a passive shareholder to date to be dealt with.

2. Whether the government is really going to refund losses in the event of a project failing. The miners and banks are saying they place no value on this guarantee and, therefore, no-one will lend to mining projects at the long-term government bond rate. Here, there are two sub-issues. One is that it seems highly likely that the government would do a backflip in the future and in the event of a recession that resulted in many mining projects going under, refuse to hand over billions in tax refunds to "rich foreign mining companies". Rudd's rhetoric on the RSPT suggests that this is a real risk. Second, there is a lack of clarity of how the refund interacts with bankruptcy law. Will shareholder and creditors really have access to the tax refund in the case of a bankruptcy? I don't understand the details of the latter but it seems to be a real concern.

The government could assuage these latter concerns by adopting the full pure "Brown tax" by immediately refunding 40% of all costs upfront on a quarterly basis. But they don't want to do this. Obviously, they must think they gain by pushing these costs into the future rather than by funding them themselves at the government bond rate. If the government won't fund them at 6%, why should the mining and banking industries?

From the taxpayers' perspective the downside of the RSPT over royalties is the increase in the risky of government revenue that results. The Brown tax makes that explicit. Again the government would seem to be concerned about making that obvious to the public.

IPCC AR5 WGIII

The IPCC has just announced the authors for the Fifth Assessment Report, Working Group III (Mitigation of Climate Change). I am one of the selected authors and will be agreeing to participate. I will be working on a team working on Chapter 5: "Drivers, Trends, and Mitigation".

Exploratory Analysis of Chaves and Koenraadt

A couple of days ago I mentioned the Chaves and Koenraadt paper on malaria. I've looked over it a bit since but would really have to repeat the analysis myself in order to come up with anything conclusive as the time series analysis is so poorly documented. To recap, here is the temperature time series from Kericho in Kenya that they use:



One of the models they fit is the basic structural model. This model consists of a stochastic trend a seasonal component and residual noise. The stochastic trend is a local linear trend model:



Beta is a simple random walk with random error term Xi. It acts as the slope of the I(2) stochastic trend Mu which also has an additional random error term Eta. According to the paper this is what Mu looks like (I think):



The trend shows that temperature increased by about 0.08 C over the period when we remove the seasonal and noise components. Unfortunately, the authors do not provide a confidence interval in the chart and so it is hard to tell if this is a significant increase or not. But they do provide estimates of the standard deviations of eta and xi, which are 0.29 and 0.12 respectively.* Both of these are larger than the entire increase in temperature shown by the trend, suggesting that the increase is insignificant.


* They actually give the variances in the paper and these are the square roots of the variance.

CERF National Conference

In a last minute substitution I am going to be presenting instead of Regina Betz at the CERF National Conference at Old Parliament House on Tuesday at 1pm. Title will be "Modelling Global Energy Efficiency Trends". I'll try to cover both implications for Australian energy efficiency and Chinese and Indian emissions intensity targets in the 15 minutes allowed.

New Controversy on Malaria and Climate Change

For discussion of the 2011 paper in PLoS ONE see this new blog post.



Some of my coauthors on our work on malaria and climate change have an article (with others) in the latest issue of Nature. Their main point is that even if climate change has had an effect on the prevalence of malaria in the last century, that effect is swamped by everything else that has been going on. Also that the current distribution of malaria endemicity is no guide to future trends. Both these points seem pretty sensible to me but Joe Romm is outraged. He describes the authors of the paper as "sloppy" because he thinks they exaggerate the degree to which the IPCC support the "Malaria is increasing due to climate change hypothesis". This is a rather indirect criticism. He thinks the IPCC underplayed the threat and accuses them of saying the IPCC overplayed the threat. That's the best he's got against their paper... It's typical of Romm to trash a paper for extraneous reasons if it doesn't fit the global warming is always bad everywhere party line.

In passing, he notes the recent Chaves and Koenraadt paper which he quotes Science Daily as saying debunks our 2002 paper in Nature. I hadn't read it up till now, though citation tracking meant that I was aware of it. I need to do some background research before I can comment in detail on the paper. In the meantime, here is their monthly data for Kericho, Kenya:



Note that this isn't for 1966-2002 in fact despite the article claiming that that is the data they analysed. And here is the data we actually used for 1966 to 1995:



The series are not identical. In both cases the variance seems to go down a little and there does seem to be some possible increase in mean annual temperature. The question is whether it is truly statistically significant. Our answer was no, Chaves and Koenraadt suggest yes. If so, it is a very small change. People are still arguing about whether there is a significant trend in global mean temperature, where there is a much clearer trend...

More on the RSPT

I read a couple more papers on resource taxation and am not much clearer about things. Ben Smith wrote about the impossibility of a neutral resource rent tax and Diderik Lund wrote
a recent review.

It is pretty clear that a pure "Brown tax" where the mining company immediately gets refunded the tax rate (say 40%) multiplied by all losses minimizes the effect on investment decisions as long as the government is definitely going to keep on doing that. The government becomes an effective passive shareholder in 40% of each project. There is still a question of the government getting a free ride on the intangible capital/human resources of the mining company, which aren't usually expensed to individual projects. Under certainty, this would then be a neutral tax on investment.*

Further complications ensue when losses must be carried forward or some expenses are excluded. The RSPT carries forward losses at the long-term bond rate because the Henry review argues that as the government will eventually refund their share of any terminal loss the company is effectively lending money to the government. Whether this results in a tax that is still neutral in its investment effects is debatable, it appears to depend on modeling assumptions. Investors might not mind lending money to the government at the government bond rate but it is a different question to force them to do so when they have other investment opportunities. Emphasizing this point, the tax doesn't allow the deduction of interest expenses. The company's existing cost of capital is likely to be higher than the government bond rate. The Henry review lists a number of other expenses that cannot be deducted some of which seem reasonable and some not. All these variations on the pure Brown tax certainly reduce the neutrality of the tax.

I just read comments in the Australian from Ross Garnaut which further explain the reasoning behind the use of the government bond rate. If the government is promising to repay all losses then banks lending to the mining company should also be prepared to lend at the government bond rate. So, by this thinking there is no wedge between the returns on the RSPT capital account and the company's cost of capital. Garnaut is saying that this is a simplification which isn't likely to hold in reality. It certainly doesn't apply to existing projects - but accelerated depreciation is meant to deal with that issue. Shareholders will effectively put in 60% of the capital to projects and get the normal rate of return on that 60%.

I think I understand fully where the Treasury is coming from now.

* As Jerry Hausman argued after I wrote this blogpost originally things get more complicated even for this best case Brown tax when there is uncertainty.

Garnaut Says RSPT Needs More Study

Ross Garnaut says that the RSPT needs more study and analysis and that the government hasn't handled this well. Importantly, Garnaut co-authored the paper that initiated interest in such a tax.

I'm planning to produce a blogpost soon with some more discussion of the complications involved with this tax. My impression is that the authors of the Henry review did not read recent literature on the issue. But maybe I'm wrong.

Paper Accepted at Economics Letters

My paper Derivation of the Hicks, or Direct, Elasticity of Substitution from the Input Distance Function has been accepted for publication at Economics Letters. As I've mentioned before, the elasticity of substitution measures the difficulty of replacing one input to production such as energy with another such as capital, usually under the assumption that the level of output must be kept constant. This parameter is very important in the study of long-run economic growth and sustainability, the costs of climate policy, among many other areas. The traditional elasticity of substitution measured the percent change in the ratio of input quantities for a given percentage change in the ratio of their prices (or marginal products) holding output constant. The formula was derived using the production function. My paper derives the elasticity from the more general input distance function, which can have multiple outputs and can accommodate possibly inefficient production. I also show that "distance" or technical efficiency must be held constant when calculating the elasticity. This is an additional condition which was classically implicitly assumed to be the case rather than explicitly stated. This new derivation helps complete the classification of many different related elasticities.

Updated Versions of Papers

An updated version of my paper "Between Estimates of the Environmental Kuznets Curve" is now available in the CAMA Working Paper Series. Also my article "Energy Quality" has been published in Ecological Economics.

Public Policy Precinct at ANU

Lots of public policy initiatives are planned at ANU in which the Crawford School looks to play a major role:

ANU Media Release

SATURDAY 8 MAY 2010

ANU TO ESTABLISH $111.7 million PUBLIC POLICY PRECINCT

The Australian National University (ANU) will play a lead role in
boosting Australia's expertise through enhanced teaching and research in
public policy and will establish a new Australian National Institute for
Public Policy to complement the enhanced role.

The Commonwealth Government has committed a grand total of $111.7
million for this purpose.

ANU Vice-Chancellor Professor Ian Chubb said: "The importance of
teaching and research as a foundation for future policy will be
highlighted by the development of a public policy 'precinct' based
around the new JG Crawford building. We would like also to thank the
Federal Government for their commitment to education and research as a
means to build a solid foundation for Australia's future."

Announced by the Prime Minister today, the $111.7 million will cover a
number of elements:


* An Australian National Institute for Public Policy -
established to highlight under one banner the public policy expertise
available through ANU and its various specialist centres, including the
recently announced Australian Centre on China in the World and the
National Security College, and the Australia and New Zealand School of
Government (ANZSOG);

* $14 million to bolster public policy expertise at ANU, through
enhancing capacity in The Crawford School of Economics and Government
and establishing the H. C. Coombs Policy Forum, which will inform future
policy development;

* $7 million to support Sir Roland Wilson Foundation
scholarships for public servants to study at ANU;

* $17.3 million National Security College operations;

* A new $19.8 million building to house jointly the new National
Security College and the enhanced presence of ANZSOG in the precinct;

* The recently announced $53.1 million Australian Centre on
China in the World (including a building); and

* $0.5m to scope the need and nature of additional accommodation
for officials and students in Canberra for courses.


Professor Chubb said the 'precinct' would be a place where public
servants and others working on policy for the nation could engage with
leading researchers and educators from a wide range of disciplines.

"We welcome this announcement from the Commonwealth Government, and are
very pleased to see our strategic relationship with the Government
gathering such momentum," Professor Chubb said.

"Since its establishment in 1946 ANU has had very close links with
public service, whether that is through our researchers informing
Government policy or professional short courses.

"Today's announcement takes the relationship between the nation's
university, the nation's public servants and the nation's Government to
a new level. The public policy precinct is a very tangible sign that ANU
is a strategic endowment for the nation, working in the national
interest.

"The H. C. Coombs Forum will be a key part of the development, and will
be the venue for well-informed, spirited debate between academics and
public servants. It will also be the base for research-based evidence
informing public policy," Professor Chubb said.

Royalties vs. Rent Taxes

I'm now reading the Henry Review in more detail. The argument against royalties and in favor of a rent tax, which was put forward by Garnaut and Clunies Ross is based on the idea that both are taxes. Because the royalty allows no deductions for costs it acts as an incentive against development of more marginal projects that would have gone ahead in the absence of the tax. The Brown tax essentially has the government investing up front alongside the mining company by refunding 40% of losses in the early years of the project and later years too if the project fails to make a profit. The Garnaut and Clunies Ross rent tax and variants including this proposal, based on my current understanding, carry forward these losses at some rate of interest. This was theorized not to distort investment decisions, though there has been a lot of subsequent discussion of whether that is true or not.

But if we treat the government like any other landowner and the royalty as the rent (different meaning again here) it charges tenants then the royalty is no longer seen as distorting. It is just the payment required to use the asset in question. If some projects are discouraged at this point in time there might be a very good reason for that. Perhaps we as resource owners want to keep the resource in the ground for use in the future when prices are higher? I don't know if the latter is a good argument but I think that whether something is seen as an efficiency reducing distortion in economics can depend on your perspective.

If I am understanding this correctly the reason the mining industry is outraged is not the RSPT itself (which isn't a "super profits tax" at all) but the fact that the 40% tax will apply to all existing projects not just to future profits. I now understand that the government bond rate is has been chosen for carry forwards in new projects because of the view that the mining companies are effectively lending money to the government not investing in the project. The government agrees to eventually repay 40% of all losses with interest at the government bond rate even if the project fails and never makes any money.

ReSPecT

My immediate reaction to the RSPT proposal was to wonder if it will ever get through parliament as proposed and to suggest that at least the hurdle rate needed to be substantially raised. Today in the Australian, Henry Ergas discusses the "Brown tax" named after E. Carey Brown. I'll admit that I hadn't heard that term before. A quick search found a reference to this in a working paper by Ben Smith on the topic. Obviously, I need to study this further. But, would we want the ideal tax described by Ergas, where the government becomes a coinvestor on each mining project? After divesting assets such as Telstra in Australia partly because they were seen as too risky why would we want to take on the risk of investing in the mining industry?

Note that the "resource rents" referred to in this context are not the same thing as the resource rents referred to in the capital theory of sustainability. Some sort of royalty payment would seem to be the way to try to capture those, I think.

Also, see the very interesting commentary from Peter Martin.

The original proposal for the resource rent tax actually being discussed is in a paper in the Economic Journal by Ross Garnaut and Anthony Clunies-Ross in 1975.

EERH Working Paper Statistics for April 2010

This month's RePEc statistics are in. EERH saw a slight tick up in downloads, probably due to us getting more papers online. We now have 55 papers online.

It's the Economy Stupid

There is all this discussion in the UK about why the Labour Party looks set to lose the election and no-one makes the obvious point: there is (or was) a bad recession and the government has been in power for 13 years. Still it is going to be interesting what happens coalition-wise post-election. I'm a British citizen, so I have some interest I guess...

Will Today's Tax and Superannuation Proposals Actually be Implemented?

Based on the Rudd government's record to date I don't expect these "reforms" to be implemented as announced. The Liberal-National Coalition will oppose them. I expect that the Greens will like them. So, based on the current composition of the Senate, it will depend on Xenophon and Fielding and I have no idea what they'll think. Of course, the legislation would likely wait till after the election. The Henry Review argued for a normal return on capital equal to the long-term government bond rate in order to compute which part of profits are "super profits". That seems very low. It makes no allowance for a risk premium on equity. So I'd expect that rate to be raised and the tax rate possibly to be lowered if this is ever going to be enacted.

Angus Maddison Dies

Just heard that Angus Maddison died. The Economist has an obituary. I visited Gronigen a few years ago but didn't get to meet him. Just a few days ago I was checking his data on historical GDP. The work of my colleagues such as Astrid Kander and Paul Warde follows in this tradition in reconstructing the energy history of Europe.