Introduction
It is a long established fact that the extraction of nonrenewable natural resources is the major source of government revenue in many countries. Based on the relationship between the government and extraction companies, there are various legal and economic approaches that can be used to maintain equity in this relationship.
For example, the company may be given ownership of the resource through purchase or lease, or may obtain a license permitting the exploitation of the resource (Lund 2008). Regardless of the approach used the extract should be subjected to some form of taxation in order to generate revenue from exploitation.
Within Australia the mining sector has long played a vital role in the development of the nation. Through political stability and regulatory arrangements the nation has managed to capitalize on mineral demand in partnership with experts in mining from other countries (Novak & Moran 2011).
Based on this trend it was long believed that benefits accrued from mining activities would flow into the future. However, recent trends prompted by a commonwealth budget deficit driven by a largely unproductive fiscal stimulus have led to the laying aside of such beliefs and the initiation of new taxation arrangements for miners (Novak & Moran 2011).
The basis for this new legislation is built upon the idea of extracting a fairer share of revenue from mining in comparison to other sectors of the Australian economy. The government suggests that this policy will play a role in the reduction of divergence in economic growth between resource rich and non resource rich regions of the country (OECD 2008).
The introduction of this new tax has generated significant debate about the merits of taxing economic success and policy issues related specifically to the mining industry (Novak & Moran 2011). It is necessary to thus analyze how this tax will affect the industry due to the fact that mining makes a major contribution to the Australian economy. In this report a review of literature on the subject will be used to make the analysis.
Literature Review
In review of literature it has been observed based on reports that in 2010-11 mining related activity accounted for almost 9 percent of the GDP compared to 5 percent a decade ago (Novak & Moran 2011). This current contribution to the economy is comparable to the resource boom periods of the early 1900’s and 1980’s.
The relative importance of the mining industry in relation to national output is also reflected in the significant increase in actual capital investments that have been made in the mining sector (Novak & Moran 2011). In relation to this fact data indicates that in 2010-11 mining investment contributed to 40% of total private investments compared to 12% a decade earlier (Novak & Moran 2011).
The increased contribution to the GDP comes at a time when there has been a general decline in productivity despite improved performance.
There are a number of arguments that have been made in relation to this reduction in productivity including, long lead time between investment in new mining capacity and output, logistic difficulties associated with extraction, labor market, regulations and quality of infrastructure (Novak & Moran 2011).
Whilst this reduced productivity remains a matter of concern it is believed that once existing projects reach their full production capacity there will be a reversal in trends related to productivity.
It should be noted that while the mining sector makes major contribution to the Australian economy, the mining sector bears the highest tax rate after accounting for state and territorial royalty payments (Novak & Moran 2011). It has been suggested that the increase in levels of taxation within the mining industry may diminish incentive to invest in Australia.
This notion is worth giving consideration given the fact that Australia receives 13% of the global mining exploration share. It is reported that the country comes only after Canada in terms of the amount of global funds invested to perform exploration activities for mineral resources (Novak & Moran 2011). This move has the potential to send potential investors in search of more fiscally hospitable venues.
In addition to that it has been noted that excessive taxation in any country with substantial resources will distort world development causing a reduction in international income levels (Novak & Moran 2011).
Diversion of activity to other locations thus can be particularly detrimental to Australia given the large amount of minerals available. This position suggests a need to reconsider the tax in order to prevent any adverse outcome based on the implementation of the legislation.
In another review of literature on newly implemented Minerals Resource Rent Tax (MRRT), it has been mentioned that the current global economic climate is not very favorable. This is based on trends that indicate Europe and the US are yet to fully recover from the 2007 economic crisis (Garnaut 2010).
The poor global economic environment raises important questions on whether contemporary governments of democratic capitalist countries have the capacity to implement policies in public interest that are contested by powerful private interests (Garnaut 2010).
It has been reported that governments in capitalist economies face constant challenges posed by citizens and lobby groups. The response to these challenges in relation climate change will play a major role in determining prospects for these countries (Garnaut 2010). Current statistics indicate that Australia is faring better than other rich countries after the Great Crash.
It has been suggested that this has been assisted by rapid growth in large Asian developing countries (Garnaut 2010). However, some reports indicate that the main reason for this position is the improved policy making processes in the past couple decades. This improved policy making approach is based on the increased interest in reform focused on national interest as opposed to private interests.
However, the implementation of the Minerals Resource Rent Tax (MRRT) appears to have reverted Australian political culture back to one which responds to pressure from vested sectional interests (Garnaut 2010). Therefore, the implementation of this tax has been seen to draw powerful negative response from businesses involved in the resources sector.
This policy appears to indicate that the Australian government has taken a preference for propositions that show greater potential with regard to national interest at the expense of private interests that provide significant revenue (Garnaut 2010).
This is based on the position that any system of taxation is expected to be as far as possible neutral. The ideal of neutrality suggests that in the absence of suitable justification, the tax should not alter decisions on investment, production or trade (Garnaut 2010).
This quest for neutrality is not meant to exclude use of special taxes to correct externalities. Thus, neutral taxation allows efficient allocation of resources after private participants have taken constraints of externalities into account (Garnaut 2010).
Since minerals lie under immobile tracts of land the relationship and identification of rent is clear and practical. The choice to use MRRT was based on the fact that rent based taxation imposes lower economic costs and provides proper representation of resources than other forms of taxation (Garnaut 2010).
However, it has been noted that the imposition of such a tax may have major impact on new exploration activity in Australia. This suggests that imposition of such a tax may have an impact on the currently large amount of exploration activity within Australia.
The above position is also reiterated in another article on the issue of Resource Rent Taxation by the same author (Garnaut 2010, p. 349). In this article title Principles and Practice of Resource Rent Taxation, the author describes various issues that relate to the MRRT. The author mentions that it is a fact that the more taxation can be focused on economic rent, the lower the economic burden of taxation (Garnaut 2010, p. 349).
In this article the author mentions that in cases when opportunity to impose rent tax arise it is important to be careful that the rent is not economists refer to as Quasi Rent. These quasi rents are payments that in the long term provide incentive to maintain an economically valuable resource allocation (Garnaut 2010, p. 349).
In relation to mining it has been mentioned that the total return received from natural resources must include some return for exploration activities. Such returns can be termed to be the quasi rent of exploration. Because of this a current mine will continue to operate despite taxation which limits its ability to cover exploration costs. However, on the contrary new exploration will be affected.
This is because this form of taxation will diminish the incentive for new mine development (Garnaut 2010, p. 349). This article provides support for the argument that the MRRT will most likely reduce the exploration activity in Australia.
The subject of the MRRT has caused some controversy within the mining sector and there is a need to address the situation to mitigate possible consequences of the action. In attempts to achieve this, the report identified an article discussing theoretical perspectives on resource tax design.
The report states that natural resources are a large portion of wealth in many countries. Based on this position the approach used in managing their revenue potential can play a major role in a nation’s prosperity and economic development (Boadway & Keen 2008).
It has been mentioned that the period between discovery and exploitation of natural resources can be long and may involve expenditure of hundreds of millions of dollars (Boadway & Keen 2008). In addition to that it has been noted that significant expenditure is made prior to the generation of any cash flow.
Such expenditure is considered sunk costs and cannot be recovered. Due to this position the imposition of rents should always give adequate consideration so that these rents do not distort decisions within the sector (Boadway & Keen 2008).
The possibility of distorting decisions within an industry suggests that there is an urgent need to address approach by which taxation should be implemented. The issue then becomes identification of features that prevent the application of taxation at 100 or close to 100 percent.
This brings to the fore the need of distinguishing rents from quasi rents (Boadway & keen 2008). It is believed that if this is done the quasi rents should be taxed less heavily so that there is little effect on decisions to undertake new exploration activity.
It has been suggested that one approach that maybe used in solving the problem posed by MRRT is the use of Production Sharing Agreements (PSA’s). It has been reported that such agreements are commonly used within the oil and gas industry (Boadway & Keen 2008).
Under this approach the government will share the profit from the resource after consideration and accounting for the production cost of the resource. This approach also allows for other measures to be put in place such as limits on the recovery cost to ensure the initial investment costs of the contractor are satisfied (Boadway & Keen 2008).
Another alternative is for the government to take direct ownership in resource based activities especially during the early stages of the venture. This approach can be handled in a number of ways which include the government receiving a short fully paid share of equity on commercial terms (Boadway & Keen 2008).
This approach to management of resources bears the advantage that it will mitigate the political risk involved given that the government has a stake in the arrangement. It may also play a role in reducing the effect of tax avoidance schemes. However, attempts at such arrangements have also revealed the downside of having state companies acting as fiscal agents (Boadway & keen 2008).
Another approach that has been suggested in the management of natural resources that may have varied results when compared to MRRT is the use of auctions (Boadway & Keen 2008). These auctions can be successfully used to allocate rights to exploit resources and generate revenues for the government.
To implement this approach simple rationing schemes may be used to allocate stakes on geographical areas. Though there is a high risk involved the owners can maximize profits once successful exploration is complete by charging rents (Boadway & Keen 2008).
In relation to auctions the use of simple rationing may not be effective in making the prospects attractive to large producers. Thus it has been suggested that a more suitable approach may be to use technically supported applications (Boadway & Keen 2008).
It is believed that this approach can generate more revenue provided governments are well informed on how to choose among applicants. It is also crucial that these governments are free from the effects of capture, political influence and corruption for the process to succeed (Boadway & Keen 2008). Using auctions provides the explicit advantage of selecting producers while generating revenue.
There are several taxation approaches that can be used to levy tax on resources. However, consideration must be given to the average effective tax rate and the marginal effective tax rates.
The main reason for this is to ensure that the rent tax imposed takes into consideration the distortion aspects caused by rent tax. This mode of taxation with some degree of sensitivity to underlying profitability issues may help in easing the pressure associated with such taxation.
Throughout the review of literature one consistent notion has been that MRRT my influence new exploration in Australia. For this reason there is a need to look into investment activity in the region. In this regard it is reported that global resource investment is driven by the need for resources in rapidly growing Chinese and Indian markets (Drysdale & Findlay 2008).
These economies have in recent years emerged to become major player in overseas investment and development. For this reason China and India have the potential to provide opportunity on a scale that already dwarfs established markets in Japan and the rest of Asia.
Australia has one of the most efficient mining sectors globally due t its openness in foreign investor competition and participation (Drysdale & Findlay 2008). Though still in early stages of industrialization both India and China are sources of substantial international capital.
This makes both active candidates for growing investment in the Australian resource industry. In the past few decades Australia and most developed countries have made efforts to convince voters that private sector and not government should take the lead in business management (Drysdale & Findlay 2008).
It has been observed that Foreign Direct Investment (FDI) plays a major role within the Australian resources sector. Based on statistics from 2006, it was mentioned that mining sector accounts for almost a quarter of the national foreign direct investment. This data suggests that mining produced accumulated stock of foreign investment amounting to almost AUD 77 billion (Drysdale & Findlay 2008).
In the same year the FDI in manufacturing was AUD 59 billion while FDI in services was AUD 164 billion (Drysdale & Findlay 2008). The main reason for the ability to attract FDI is the confidence in the Australian investment environment.
In addition to the above data it has also been reported that FDI accounts for over half the capital formation in all industries in Australia. In sectors such as mining in 2006, FDI accounted for half the capital formation and in some years forms an even higher proportion (Drysdale & Findlay 2008).
This fact is further complicated by data that indicates China is already Australia’s most significant trading partner (Drysdale & Findlay 2008). It has been suggested that the trade relationship with China stands to become the most significant economic relationship in Australia.
Despite the large FDI contribution by China there has been increased uncertainty about the treatment of Chinese FDI in the resources sector (Drysdale & Findlay 2008). Due to this uncertainty it has been mentioned that rent tax has the potential to damage future growth in resources sector and interrupt Australia’s participation in Chinese economic growth.
To dispel such uncertainty it has been suggested that Australia reassert the market framework to allow for all foreign investment proposals to be examined in Australia (Drysdale & Findlay 2008). In addition to that it has been suggested government to government initiation arrangements are made for routine consultation on issues of competition, corporate governance and financial transparency issues.
The management of natural resources is a major issue given that they make a significant contribution to revenue in most nations (Perrings & Vincent 2003). It has been observed that in recent time’s economic growth has seen half the world’s population double their income every decade (Torvik 2009).
It has also been noted that countries that report the most growth had relatively little natural resources and many people. This has led to a sharp increase in prices or resources in comparison to industrial goods (Torvik 2009).
In countries with properly established mechanisms to manage property rights and little corruption it has been observed that natural resources may contribute to growth (Torvik 2009). This situation informs on the role of institutional quality in terms of profits generated from natural resources.
Another observation that plays a role in revenue generated from natural resources can be attributed to the role of parliament in democracies. It has been suggested that natural resources tend to benefit the country more when a parliamentary system is dominant within a nation (Torvik 2009).
Proper management of natural resources is crucial given that the availability of resources has been known to feed corruption and affect quality of institutions (Bhattacharyya & Hodler 2009). In studies on the role of institutions in management of natural resources it has been noted that resource rents can increase corruption and reduce quality of institutions (Bhattacharyya & Hodler 2009).
Analysis
The suggestion to use MRRT comes in light of the failures associated with its predecessor the Resource Super Profit Tax (RSPT) (Ibp USA 2005). Controversy regarding use of RSPT began sometime in 2010 and ended with the eventual downfall of the then Australian Prime Minister Kevin Rudd (Ibp USA 2005). The response to the RSPT controversy created supporter and opposition groups composed of various stakeholders.
The supporters included the Federal government, Australian Council of Trade Unions, Mining Unions and The Australian Greens. The opposition included the mining industry and mining lobby groups. In light of this controversy and resultant issues a proposal to utilize a different approach (MRRT) emerged.
In designing an appropriate structure for resource rent there are three primary elements to consider namely, specified rate of return for imposition of the tax, specified tax rates imposed on net profits and the tax base (Daniel, Keen & McPherson 2010). This form of taxation is widely used in the Petroleum industry and has been considered fairly effective in management of natural resources.
Based on analysis of data from the petroleum industry it has been mentioned that resources rent provide ability to tie taxation directly to the projects profitability (Tordo 2007). In its pure form all taxes are deferred until all expenditure has been recovered and the project has yielded a defined target (Tordo 2007). If this approach is used in the Australian case it is likely to reduce the potential impact on exploration activity.
One shortcoming of MRRT is that potential gains may be reduced by some of its characteristics. The first issue is due to the fact that the proposed tax has been set at a relatively low level and thus the taxation of profits of mining companies may remain much lower than prior to the mining boom (OECD 2010).
In addition to that the efficiency gains promised by the MRRT are likely to be reduced by its coverage of only larger firms and certain sectors (OECD 2010). This suggests that for maximum efficiency the tax should be imposed on all sectors in the resources industry.
The suggestion to impose the tax on mining projects of coal and iron ore suggests that the imposition of MRRT is likely to distort investment incentives in mining projects involving coal and iron ore (OECD 2010). This is further complicated due to the fact that mining ventures will remain subject to royalties which provide a large disincentive for marginal projects such as exploration (OECD 2010).
To mitigate this condition it has been suggested that royalties should be replaced entirely by a well designed Resource Rent Tax. This approach is believed to have the potential to simplify the tax system and remove state incentives to increase royalties with counterproductive effects.
Despite the significant commotion that the imposition of MRRT has caused it should be noted that the increased revenues from resources are aimed at financing a number of novel schemes (OECD 2010). It has been reported that with these funds authorities plan to make gradual increments to the compulsory pension contribution rate (OECD 2010).
This action is meant to improve equity of the tax treatment of retirement savings for the currently disadvantaged low income earners in the country. It has been proposed that an increase of between 9 and 12% this contribution between the years 2009-20 (OECD 2010).
These funds have also been earmarked for infrastructure financing. In line with this the government aims to establish the new Regional Infrastructure Fund whose assets are expected to reach AUD 6 billion in the next decade (OECD 2010). The goal to improve infrastructure is of special importance given that Australia experiences a shortfall in infrastructure (OECD 2010).
This shortage of infrastructure could worsen due to demand pressures exerted by the mining boom currently being experienced in the country. In response to this demand and for the avoidance of potential bottlenecks, authorities have placed bolstering infrastructure at the top of their policy agenda (OECD 2010).
The increased expenditure on infrastructure has the ability of creating significant benefit given that this type of reform has a tendency of influencing both public and private investment choices (OECD 2010).
The imposition of the MRRT on the resource industry in Australia has varying implications for the sector. It has been mentioned that Resource Taxation has the potential to distort and inhibit investment and production within the sector at four different margins (Garnaut 2010).
These include the ability to constrain investment in exploration, investment in new mines, investment in expansion of old mines and production from each mine (Garnaut 2010).
It should be noted that distortion is not restricted to MRRT alone because specific and ad valorem royalties are also likely to have an effect on inhibition of investment in exploration. Such royalties have a minimal effect on investment in new mine development and even less effect on expansion of existing mines (Garnaut 2010). Based on this position it appears that MRRT will have some effect on the mentioned areas.
Another problem with the MRRT is that it raises questions on the Federal-State relationship which have the potential to destabilize access to the resources. It is important that these issues are resolved alongside settling of the structure for resources taxation and it is not an easy task (Garnaut 2010).
This is because of the issue in relationship to ownership of mined resources. Whereas treasury suggests Australian resources belong to all Australians, state officials argue resources belong to the people in the state where they are mined (Fenna 2012).
The issue of Federal-State relationship comes into play based on the fact that responsibility for mineral leasing is handled by the State. On the other hand, the Commonwealth has constitutional authority for corporate taxation which by dint of interpretation suggests over riding authority on fiscal matters (Garnaut 2010).
The apparent uproar by State based authorities appears questionable due to their inability to introduce better means of resource taxation.
In summary, it should be noted that the main advantage that comes with resource rent tax is its neutrality (Tordo 2007). However, the approach also comes with the disadvantage that tax can only be realized when defined rate of return or target payback is achieved (Vanoli 2005). The disadvantage can be avoided by using a suitable combination of royalty and/or corporate income tax (Smith 2012).
This also appears a suitable solution to the issue of the Federal-State relationship in Australia (Warren 2012). The main difficulty with resource rent tax is determination of an effective target rate. This suggests a deeper understanding of the project and exogenous conditions. In this case it is suggested that the government liaise with stakeholders in the industry to determine a fair target rate (Warren 2012).
Conclusion
In this report the discussion has attempted to analyze the move to change the approach used to tax organizations involved in extraction of some natural resources in Australia. This is essential given that extraction of these nonrenewable natural resources makes significant contributions to government revenue in many countries (Lund 2008). The exploitation of natural resources has seen the evolution of various taxes to manage revenue from natural resources.
In Australia, the mining sector has for a long time played a vital role in national development. The main reason that there has been steady growth in the natural resource extractions sector is due to the relative political stability and regulation arrangements (Novak & Moran 2011).
However, in light of changes in the commonwealth and an unproductive fiscal stimulus there was a need to identify mechanisms that could improve revenue generation.
This position thus formed a basis to improve efficiency in the taxation of nonrenewable natural resources. It is hoped that such a policy (MRRT) will help in reducing the divergence in growth between resource rich and non resource rich regions in Australia (Novak & Moran 2011).
It should be noted that the main advantage with the MRRT is based on its neutrality. Based on this characteristic the approach allows for maximum revenue generation. However, some have argued that the imposition of MRRT has the potential of influencing future investment decisions within the mining industry (Tordo 2007).
This point is a matter of concern given that a large portion of expenditure in the mining sector comes from FDI. This suggests that unless the MRRT is adjusted appropriately it is likely to cause loss of revenue from potential exploration organizations. In addition to the potential to lose FDI, there is the issue of the Federal-State relationship.
Despite these challenges it has been mentioned that if the effective target rate is properly calculated the risks associated with MRRT are likely to be minimal. For this reason it appears that for the success of this new tax regime close partnership between government and stakeholders in mining is necessary. It is believed that with such considerations, the MRRT regime should be successful in Australia.
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