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Neutrality of the Resource Super Profits Tax

Neutrality of the Resource Super Profits Tax. Forthcoming 2011, Australian Economic Review This presentation June 22, 2011 at the 34th IAEE International Conference, Stockholm, Sweden By Diderik Lund, University of Oslo, Norway. Outline.

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Neutrality of the Resource Super Profits Tax

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  1. Neutrality of theResource Super Profits Tax Forthcoming 2011, Australian Economic Review This presentation June 22, 2011 at the 34th IAEE International Conference, Stockholm, Sweden By Diderik Lund, University of Oslo, Norway

  2. Outline • Topic: Is the Resource Super Profits Tax a neutral or distortionary tax? • Relate to theory and other tax systems • Relate to academic literature and public, political debate • What is the Resource Super Profits Tax? • Background: Debate in Australia • Literature review: Neutral taxation of firms • Real options • Conclusion

  3. What is the Resource Super Profits Tax (RSPT)? • Tax proposal by the government of Australia in 2010 • Targeted at the rent of extraction of natural resources; coal, iron ore, oil, gas,... • Similar to a tax proposed by Brown (1948), a tax on non-financial cash flows of a company • Full loss offset: Negative cash flows => negative tax • But payout of negative tax postponed with interest • If no future income to deduct against: Tax payout • Proposed tax rate 40 percent; on top of, but deductible against, corporate income tax

  4. Background for the proposal, and the events that followed • Henry (2009), Australia's Future Tax System • Among suggestions: Improved tax on resource rent • Resulted in RSPT proposal 2010 • Protests from industry and opposition; ads war • Report by Hausman (2010), funded by BHP Billiton • 20 economists signed statement supporting RSPT • Proposal was withdrawn, replaced with more modest proposal, Mining and Resource Rent Tax (MRRT) • Prime minister Rudd stepped down, Labor led by Gillard prevailed in elections 2010

  5. Previous literature • Neutrality results: • Brown (1948) on cash flow tax • Johansson (1961), Samuelson (1964) on corporate income tax • Boadway and Bruce (1984) general, full certainty • Fane (1987) extend to uncertainty • Taxation of resource rents • Garnaut and Clunies Ross (1975, 1979, 1983)on Resource Rent Tax (RRT) • Lund (2009) review article • Taxation of real options • McKenzie (1994), Sureth (2002)

  6. Two neutrality results • Based on value additivity, Brown (1948) • A true tax on non-financial cash flows is neutral • “True” means full and immediate loss offset • Proportional, with constant tax rate • With respect to cash flows: Government like another shareholder • Tax all alternative returns equally, Samuelson (1964) • Predecessor Johansson (1961) in Swedish • Nominal rate of return reduced from r to r (1 – t), where t is tax rate • For investment project: Allow deduction of economic depreciation

  7. Subsequent literature • Garnaut & Clunies Ross (1975): Resource Rent Tax • Modify Brown: Carry forward with interest instead of negative tax • Requires knowledge about firm's discount rates • Boadway & Bruce (1984): Extended cash flow tax • Neutrality still holds if deductions are postponed • Condition that present value of deductions are maintained • Fane (1987): Extend Boadway & Bruce to uncertainty • If deductions are certain: Carry-forward with risk free interest rate • McKenzie (1994): What if projects are real options? • Economic depreciation must include loss of option value • Sureth (2002): Cash flow taxation of real options

  8. Hausman's (2010) report • RSPT is not neutral because it does not give deduction for loss of option value • Based on Samuelson (1964), McKenzie (1994) • But not to the point: RSPT emulates a cash flow tax • RSPT may distort choices about termination of activities • If a company is out of tax position, carrying forward L • Could perhaps sell producing assets at a sum R • May prefer close down if t L > R • But rules should allow tax refund of t(L – R) • Neutrality: R > 0 implies R + t(L– R) > t L • RSPT introduction may harm Australia's reputation • Political risk may increase, but perhaps RSPT would be stable

  9. Main claim here • RSPT is neutral like a Brown cash flow tax • Only difference: some deductions postponed with interest, risk free • Hausman also assumes the effect is like a Brown tax • A project has positive value after tax if and only if it has positive value before tax • Neutrality also holds for real options, under standard theory • Option values also satisfy value additivity • If you have the claim to x percent of all positive and negative cash flows related to an option, your valuation will be x percent of the total, and you will want to exercise in same way as if you owned the total • As long as everyone trusts that the government has the same share of all cash flows, the tax is neutral

  10. Transition problems • At transition to RSPT: Existing assets would not be deductible at new tax rates • Projects with failure before RSPT is introduced get no tax relief, while projects with success are taxed • RSPT thus fails to mimick the effect of a neutral tax intoduced at an earlier stage • However, RSPT largely neutral for new investment • No income or wealth effect in standard theory of firm • But no payout of unused deductions from before RSPT introduced; “subidy” to projects securing this

  11. Conclusions • Apart from some transition problems, RSPT is neutral • Relies on postponed deductions being regarded as risk free • Relies on standard theory of the firm, value additivity, no income or wealth effects • Neutrality result of Brown, no reliance on reducing returns from all investment alternatives equally • If want such reduction (Johansson-Samuelson result), need deduction for lost option value

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