Does a Resource Rent Tax Solve the Problem of Sovereign Risk?

By Winton Bates, on May 10th, 2010

I have been a supporter of resource rent taxes for as long as I can remember. More precisely, my view has been that taxes on rents are better than most other taxes because they extract funds with minimal distortion to production and investment decisions.

I think the best way to think your way around the question of resource rent taxes is to imagine initially that you are the sovereign of a territory in which there has been no previous mining or exploration. You want to obtain revenue from the minerals in your territory by the inducing mining firms to use their expertise to explore and to mine.

One way of obtaining revenue from minerals is to auction off mining rights and promise mining companies that there will be no further taxes on the minerals they find. A major problem with such a ‘finders keepers’ policy is that on the basis of past experience mining firms have good reason to be skeptical that sovereigns will keep their promises to let them keep what they find. When valuable resources are found sovereigns (and democratic governments) have a habit of changing their minds and wanting more revenue. As a consequence of this ‘sovereign risk’, mining companies are not likely to be willing to pay anything like what an exploration lease would be worth to them if they could believe the sovereign’s promise of finder’s keepers.

Another way that governments can obtain revenue from minerals is through a system of royalty payments based on the volume or value of minerals extracted. This is like imposing an additional cost on mining activities and can deter mining that would otherwise be commercially viable.

By contrast, under a well-designed resource rent tax the sovereign is, in effect, a silent partner in the venture. The sovereign shares in the rents and risks of the project without distorting investment and production decisions in the process.

So far so good, but Australia is not a country in which there has been no previous mining or exploration. There is currently a great deal of mining being undertaken in this country under long-established systems in which state governments obtain revenue from royalties. In that situation it becomes important to consider how to make the transition from royalty payments systems to a resource rent tax without disturbing the reasonable expectations of miners of rewards that they are entitled to receive for the risks that they have taken. If the transition to a new tax is used by the government to grab a larger slice of rents from successful mines, the miners are likely to perceive that they have under-estimated sovereign risk in this country. They will also perceive that there is a chance that the rate of resource rent tax could be increased in future, particularly if there are further increases in mineral prices. If they factor that into their calculations of expected returns they will reduce their investment in further exploration and new mines – even if the structure of the new tax minimizes disincentives to investment.

As is well known, the Australian Government has recently announced the introduction of a resource rent tax and its intention to grab a substantial additional slice of mining profits on top of revenue raised from existing mining royalties. The main source of this sovereign risk, Kevin Rudd, has defended the tax grab on the grounds that ‘what we are doing is to recover national sovereignty over our own resources’. Actually, I must confess that I don’t think Mr Rudd has actually used those words. Those words were used by Hugo Chavez, president of Venezuela. As far as I can see, however, the main difference is that Hugo is less verbose than Kevin. Here is what Kevin Rudd has been saying:

‘Over the last decade the mining companies generated $80 billion in higher profits. At the same time governments, on behalf of the Australian people, received only an additional $9 billion over that period of time. What we’re saying is that the mining companies deserve a fair return on their investment – that’s important – but we also believe the Australian people deserve a fair return on the resources which they themselves own, and remember, these companies- you mention in your introduction BHP and Rio. BHP’s 40 percent foreign owned. Rio Tinto’s more than 70 percent foreign owned. That means these massively increased profits, the $80 billion that I referred to before, built on Australian resources, are mostly in fact going overseas’ (Interview on AM, ABC radio, 3 May, 2010).

Why is the percentage of foreign ownership of BHP and Rio relevant to the issue of resource rent taxation? The unmistakeable message is that Kevin Rudd views foreign investors as fair game. Tax reform has become a cover for expropriation of rents from assets owned by foreigners. All we can hope is that the more sensible members of the Australian government will encourage second thoughts about the rate of resource rent tax that should be imposed – and urge Kevin to restrain his rhetoric – before too much harm is done to Australia’s reputation as a safe location for investment.



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War, Gold and American Express

By Bron Suchecki, on May 10th, 2010
Surfing around I found this excerpt from the history of American Express interesting:

During the summer of 1914, approximately 150,000 American tourists were stranded when war engulfed Europe, many without access to funds. Banks had ceased to pay against foreign letters of credit or any other form of foreign paper. Panic-stricken travelers lined up inside and outside the offices of American Express in whatever city they happened to be visiting. American Express was able to cash all travelers cheques and money orders in full, enabling quick passage home for thousands. Many of those remaining were able to book passage home soon after a decision by American Express and a consortium of nine U.S. banks to ship $10 million in gold to Europe so that local banks could once again honor foreign drafts.

During 1938 and 1939, as the prospect of another world war loomed over Europe, there was still a sizable group of longtime American Express managers and employees who had worked for the company 25 years before, during World War I. Their past experiences – and their advance planning, in this instance – helped the company survive World War II. Even before the official declaration of war, American Express had mounted extensive preparations to protect its financial and real estate assets, including its principal offices in Berlin, London, Paris, Rome and Rotterdam. Throughout Europe, American Express offices continued operating until the last possible moment in countries about to be invaded – often long after American embassies and consulates had been ordered to evacuate.

The history is interesting not for the reminder that in war fiat is worth nothing, but that AMEX had an organisational memory of WW1 that enabled them to prepare for WW2. The two events were close enough that those who had experienced the first were still employed and had not retired.

I think that what is necessary for an organisation (which is really just a collection of individuals) to see the need for “advance planning” is not experience of a crisis, but experience of the period prior to a crisis. Only then can one see similarities between the period that preceded a crisis and one’s current situation and thereby identify the potential for a future crisis.

I also think that what is important is direct experience. One has to have personally experienced the pre-crisis environment – it makes for a strong imprint on the mind. Indirect experience is not the same. Reading the history of a period that draws parallels to now does not have as powerful a call to action. Words on a page can also be rationalised away.

For example, do you think giving Paul Mylchreast’s 4th May Thunder Road Report history of the US and Sterling crises during the Johnson and Nixon administrations in the 1960s and 70s (pages 24 to 35) to someone in their 30s raising a young family will result in them buying gold? It is too distant and academic.

I would also argue that the minimum age for direct experience of economic/financial events to really register would be no younger than say 20 years old. This means that the youngest person to have experienced the 1970s and punishing inflation and a real gold bull market is now 60 years old. Anyone younger than that would probably not really “get it”, at a visceral, emotional level that only direct experience can give.

My only “economic awareness” memory of the 70s would be my father suggesting I invest the $200 worth of Christmas and birthday money I had squirreled away up to my then 10th birthday into State Rail Authority of New South Wales bonds at 15% (my father was a train driver and they were offered to staff first). Getting a $30 cheque each year for 5 years seemed like a good deal. I remember being disappointed that I didn’t hold out longer, because subsequent bond series peaked at 18%, if my memory is correct.

That is the extent of my experience of inflation, as a 40 year old. It makes me reflect on where I would be now if I had not made that fateful decision in 1994 to take a job with the Perth Mint. It is likely that my economic literacy would be negligible, my awareness of the potential for inflation and the role of gold as a wealth preserver in an investment portfolio, zero.



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Jobs Growth In April Adds Over A Quarter Million New Positions

By Eldon Mast, on May 10th, 2010

The U.S. added 290,000 jobs in April, the biggest increase since March 2006, with broad gains throughout the economy.

Most of the net new jobs came from the private sector — excluding temporary Census workers — non-farm jobs rose by 224,000, the Labor Department said on Friday.

In addition, payroll data for the prior two months was revised to show that 121,000 additional jobs were created than initially reported. The Labor Department said 230,000 jobs were created in March, instead of the original figure of 162,000, and the February measure was revised from a loss of 14,000 to a gain of 39,000.

As we speculated back in November 2009, net jobs growth began around Christmas and hiring has now netted new jobs in the first four months of the year. The additions reverse nearly two straight years of net job losses.

The string of employment growth represents the best four-month performance for jobs increases in 10 years. The return to jobs growth following a recession is perhaps one of the swiftest on record in the U.S.

Many naysayers scoffed at our linear trending charts claiming that a return to substantial jobs additions by spring 2010 was too optimistic. The reality is that the positive trend toward strong jobs creation continues — with summer projections for U.S. labor market improvement firmer than ever.


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