Why Twiggy Forrest should have got behind a super profits tax

Coinciding with the government’s tax discussion paper last week was a report from the Minerals Council of Australia evaluating the industry’s tax burden (tax paid divided by profits).

The report, written by Deloitte economist Chris Richardson, aimed to dispel the public view that the mining industry does not pay its fair share of tax.

A key point is that while the proportion of mining company profit paid in tax had decreased in 2008/2009 leading up to the debate on the introduction of the Resource Super Profits Tax (RSPT), it is now at or above historical levels.

As pointed out in Richardson’s report, the nature of taxation of mining plays a big part in explaining why the ratio of tax paid to profits has increased amidst a significant drop in the price of minerals such as iron and coal.

In a nutshell, mining companies pay royalties and company tax. Up until recently, mining companies also paid the Minerals Resource Rent Tax (MRRT), which was a compromised rent tax introduced by the Gillard government to circumvent the industry opposition to the RSPT. For a variety of reasons, related mostly to its design, the MRRT did not raise a great deal of revenue and so the focus here is on the other two taxes.

While royalties are typically levied on revenue, company tax is levied on profits. So, faced with a reduction in prices, production becomes less profitable. Firms, however, will still pay 30% of their profits in company tax, so any increase in the ratio of total tax paid to profits has to be explained by royalties.

As Richardson points out, not only has the ratio of royalties to profits increased because profits decreased, some States have also increased the royalty rates. They were likely incentivised by the MRRT design, under which companies received a credit for the royalties they paid on coal and iron ore projects with annual resource profits above A$50 million. For these projects, an increase in the royalty would have no impact on the bottom line.

Here is the rub, as pointed out by the Henry Review, the Minerals Council itself and a group of 20 economists; royalties distort production decisions. For example, a company that would exploit a mine for which revenue is just greater than costs in the absence of royalties, would not exploit a mine in the presence of royalties.

While royalties do capture some of the rents – the super profit associated with the exploitation of a finite resource that is owned by Australians – they are inefficient. In contrast, a tax on super profits does not distort production decisions. As long as revenue exceeds costs, the company will exploit the mine. This was the key rationale for the proposal of the RSPT to replace royalties.

How times have changed

Fortescue Metal Group’s Andrew “Twiggy” Forrest was one of the most vocal opponents of the super profits tax. Fortescue’s financial position is currently under significant pressure due to falling iron ore prices caused by oversupply, and the slowing Chinese economy. Ironically, it would likely be better off today under a well-designed RSPT than under a royalties regime.

A well-designed RSPT would have impacted Fortescue in two different ways. First, a super profits tax is designed so companies pay more tax when times are good and less tax when times are bad.

Second, an RSPT would also have increased the cost of increasing production for the major iron ore producers. This is because the price at which smaller, higher cost producers would shut down production would have increased, necessitating even larger increases in production for the major producers’ strategy of displacing small producers to pay off. This would depend on how world prices responded to increases in supply by the large companies.

All worth considering in light of Andrew Forrest’s recent controversial call for a cap on iron ore production.

The RSPT proposed by the Rudd government had some flaws, as discussed in Richardson’s report. But had the industry been successful in engaging with the policy process, securing the replacement of royalties with a super profits tax, it would be in a better position today.

Nevertheless, mining companies have invested a trillion dollars in new mines and infrastructure and the boom and bust nature of the industry is unlikely to change. While profits are lower now, the need for a better taxation system for minerals remains. It is not a good omen for tax reform in this country when the only reference in the recently released tax discussion paper to a mining tax is in the foreword, and it refers to the abolishment of the MRRT.

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Flavio Menezes does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.