Sunday, May 9, 2010

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.

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