A week or so ago I was interviewed on the telephone by Keri
Phillips of ABC Radio National for a Rear
Vision program which was to explore the parallels between the efforts of
the 1970s Whitlam Government and the Rudd/Gillard Government to secure for the
public a greater share of the economic benefits of Australia’s mineral wealth.
The program went to air on Sunday 20 May, with the title Labor, Mining and Scandals, and it contained
quite substantial slabs of that pre-recorded interview. More importantly, it is
a good piece, well worth a listen.
Live audio of the broadcast, or a download of the podcast,
are accessible here.
The question of whether or not the purchase of Australian farmland by foreign governments or foreign government agencies or enterprises, or indeed by any foreigners at all, will have an impact on Australian food security continues to bubble along in the nation’s political discourse. Associated with these concerns are claims that the purchase of Australian assets by foreign government owned agencies or companies involves a loss of Australian sovereignty.
The two hot items currently giving momentum to this debate are the purchase of farmland in Western Victoria by a Qatar Government-backed entity, and the purchase of 43 farms outside Gunnedah by the Chinese Government-controlled Shenhua Watermark Coal Corporation, whose interest in these farms is clearly the coal that lies under them.
One of the latest contributions to the debate is an opinion piece by CIS Research Fellow and Senior Lecturer in Economics at UTS Business School Stephen Kirchner, in The Weekend Financial Review, 2-3July 2011.
Kirchner sees no problem in foreign investment in our farm sector – he says it will enhance our food security – and he sees only base motives in those who wish to “meddle” in commercial transactions and thereby prevent Australian farmers from getting the highest sale price they can for their farms:
What unites politicians on this issue is not so much xenophobia but their conviction they have the right to meddle in commercial transactions they don’t like.
….
Xenophon’s proposed national interest test is more prescriptive than the existing national interest test under the Foreign Acquisitions and Takeovers Act, which is deliberately open-ended.
Ironically, this would open the door to administrative and judicial review of the Treasurer’s unbounded discretion to reject foreign acquisitions that fall within the terms of the act.
This may not bother Xenophon, but it certainly bothers other politicians and Treasury, who want to preserve their ability to meddle without scrutiny by the courts.
…
The FIRB is just a fig-leaf of bureaucratic respectability for political decisions to interfere in commercial transactions and deny the resident owners of Australian equity the right to realise its full value by selling to the highest bidder.
There is some silly ideological stuff here: Kirchner appears to believe that nothing should be permitted to get in the way of a “commercial transaction” – being “commercial” puts it off limits, apparently – and his imputation of base motives to anyone who believes otherwise almost obscures the key policy point he makes in his article:
In the unlikely event of a serious international conflict or crisis, foreign-owned assets in Australia can be nationalised or exports of food restricted.
There are some important issues to be considered in relation to large scale foreign investment in Australia, but as Kirchner’s comment immediately above indicates, they have little do with either food security or sovereignty.
To deal with the latter point first, investment in Australia by sovereign entities or sovereign-owned or –controlled entities involves no compromise to Australian sovereignty. This is because, while the entity might exercise the powers of the sovereign in its own country, it can only be present in Australia as an Australian natural or corporate person, its actions within the Australian jurisdiction entirely subject to Australian law. Foreign entities farming in Australia, for example, are subject to the same rules about land clearing, control of noxious weeds, plant and animal health, use of agricultural chemicals etc. as everyone else, and to tax laws including those relating to transfer pricing.
Similarly, any entity, sovereign or not, wishing to convert farmland for purposes of mining will be subject to the approval of the responsible State and Commonwealth authorities. There is a debate to be had about whether or not 43 farms outside Gunnedah should be made over for coal mining, but that debate has nothing to do with the fact of the 43 farms now being owned by a Chinese Government-owned company.
Unlike Mr Kirchner I do not believe that nothing should be permitted to get in the way of a commercial transaction and I think that from time to time particular transactions raise important matters of national interest for consideration by the Government of the day.
Nor do I share his view that Treasury officials are motivated in this matter by a desire to meddle. In the days when I was directly involved in advising on foreign investment in mining (1970s-80s, as a senior officer of the Department of Trade and Resources) I was far more often concerned by the desire of Treasury officials not to meddle in transactions that I saw as raising serious national interest questions. This was particularly the case when John Howard was Treasurer; to my recollection John Howard never saw a foreign investment proposal he didn’t like, and most of the relevant Treasury officials were of a similar view.
The principal reason [why the application should be declined] is not, as often asserted in the media, the fact that Chinalco is a state owned enterprise (SOE), and might not therefore behave in accordance with normal commercial considerations. The most important reason is that Chinalco is a major player in its own right in the international minerals market, which is why it wishes to increase its stake in Rio Tinto, and likely to become more so. Either now or in the future, its commercial interests as a buyer and investor elsewhere might well diverge from the Australian national interest as a seller. We should examine carefully for its potential impact on the national interest every proposal for a major foreign purchaser of minerals to take a stake in the Australian minerals industry.
Issues raised by proposed investments which establish foreigners in a position on both sides of the commercial negotiating table are:
- Transfer pricing issues
- Access through taking a minority stake to commercially sensitive price information – very important in relation to monopsony buying practices of the Japanese steel industry before market conditions put market power in the hands of the producers rather than the consumers.
- Issues to do with foreign government coordination of purchasing by enterprises within their jurisdiction, public or private. Two examples will suffice:
(1) In the late 1970s when the contracts were being negotiated, the sum of the amounts that the nine Japanese power utilities wished to take from the Northwest Shelf LNG project was vastly in excess of the amounts that the project would produce. Having secured from the NW Shelf consortium a rather unwise undertaking that they would not sell any of the gas to other than Japanese customers, the Ministry of International Trade and Industry then proceeded to allocate amounts determined by it to the individual power companies, so that suddenly Japanese demand was equal to Australian supply, and there was no price auction. I will leave it to the reader to judge what impact this may have had on the project’s revenue stream.
(2) In 1986, when China ceased buying all its wool through a single government agency (Chinatex, represented at the Australian wool auctions by the formidable Mme Zhu Youlan) and four separate agencies began to compete with each other in the market, there was a major spike in the Australian wool price – a fact which Mme Zhu in conversation with me attributed to the inter-agency competition. Clearly the reduced coordination in China was good for Australian woolgrowers.
- The willingness of foreign executives to abide by Australian Government policy (very difficult in my experience with US companies which for entirely understandable reasons put US laws such as the Trading with the Enemy Act and the extraterritorial reach of US antitrust law ahead of Australian law).
The above examples should be sufficient to indicate that large-scale foreign investment does indeed raise national interest questions which it is proper for governments to consider. To those who find it troublesome that the national interest is nowhere defined in legislation, and believe that it ought to be, my response would be that determination of the national interest is properly a matter for the elected government of the day, in the circumstances at the time, and the capacity of a present or future government to determine the national interest should not be constrained by an attempt to define it in advance in legislation at a particular moment in time. There was a time when State Governments felt that it was in the public interest to legislate that no Asian person can own an interest in a mining lease or a boat, and sooner or later such legislation can become, well, downright embarrassing. As a 1963 article in Time magazine noted (see here):
Whim Creek. The White Australia policy is often carried to absurd, esoteric extremes. Recently, five Japanese technicians employed by a Japanese-controlled mining concern—at, of all places, Whim Creek in Western Australia—were convicted of violating an obscure 1904 law specifying that "no Asiatic or African alien shall be employed in any capacity whatever in or about any mine claim." As a result, Western Australia's state legislature last week repealed the law, but virtually negated its action by adopting an amendment specifying that Asians must still get government permits to work in the mines.
As for those governments who believe that they are increasing their resource or food security by investing in production in Australia, my advice would be that the investment achieves very little by way of security over and above that which can be obtained simply by signing a commercial contract with an Australian-based supplier.
On the one hand, contracts are enforceable at law, and there is every reason for the buyer to expect them to be performed if at all feasible. On the other hand, the Australian Government has clear power under the Constitution to prevent or control exports, and nothing written into a commercial contract will prevent an Australian Government from exercising that power if it saw it as being in the national interest to do so. In the unlikely event that Australia ever faced food shortages, it is hard to imagine an Australian standing idly by and permitting food supplies needed in the home market to be exported.
There can be all sorts of valid reasons for foreign governments and their controlled entities to invest in Australia, but security of supply is not really one of them.
There can be all sorts of reasons for Australian Governments to decline to approve proposed investments by foreign government entities, but loss of sovereignty is not one of them.
As a sweetener to the Western Australian public Prime Minister Kevin Rudd has promised Western Australia $2 billion for infrastructure development to be funded from the proceeds of his proposed resource rent tax on the mining industry. He has made a similar promise to Queensland.
Two comments:
(1) The merit of a tax has nothing to do with all of the wonderful things that a government could spend the money on. The merit of taxes is all about tax principles and tax design, a key aim of the latter being to raise revenue without distorting business decisions.
(2) Things being as they are, a Kevin Rudd promise is not exactly a bankable document.
As one of his justifications for the sudden imposition of a resource rent tax on the production of Australian minerals the Prime Minister evokes economic nationalist sentiment by asserting that the Australian community is not getting its fair share of Australia’s mineral riches.
There is some truth in this, but the absence of a resource rent tax is not the principal reason for this, and the imposition of a resource rent tax is not a sure solution.
My perspectives on this issue and past attempts to deal with it:
(1) When the Whitlam Government was elected in December 1972 there was comparatively little beneficial ownership of Australian mineral resources on the part of Australian companies or the Australian public, and there were few companies with the resources and access to capital to undertake minerals exploration and development in their own right. BHP was one, Western Mining was another.
(2) The situation was exacerbated by an engineered oversupply of steel making raw materials and, later, of steaming coal. The steel making raw materials were sold into a monopsonistic market in which Nippon Steel conducted the purchase negotiations on behalf of the nine Japanese steel mills, and China, Korea, India and Pakistan had contracts in which they took product at the Japan price with a discount of about 5 per cent. Oversupply was maintained by the signing of new long-term contracts, even as existing contracts were being seriously underperformed.
(3) The Minister for Minerals and Energy in the Whitlam Government, Reginald Francis Xavier “Rex” Connor, had three principal measures for dealing with this:
(i) The Government required all companies proposing to develop Australian mineral resources to seek at least 50% Australian equity. The policy was applied flexibly; in the early days companies that came to talk to the Department were told that if they made a diligent effort and came with a proposal that had anything over 25% they would not have trouble.
There was one exception to the flexible application of foreign investment in minerals. Since the days of John Gorton there had been a rigorous policy of 85% Australian equity in any uranium development, and that policy was maintained.
(ii) The Government introduced legislation to establish a Government owned statutory corporation, the Petroleum and Minerals Authority, which would have power to take an equity stake in selected ventures. As a Government owned company it would never have the capital to become a big player in the mining industry but it meant that the Government could test the bona fides of foreign companies seeking an Australian partner – how could they say they could not find an Australian equity partner if they had not talked to the PMA? And the Government would always have the option of taking an equity stake in a mining project if it felt that it was in the national interest for it to do so.
This was a high stakes game and both the mining industry and the Opposition resisted the creation of the Authority with a passion. The legislation was frustrated in the Senate and the Petroleum and Minerals Authority Act 1973 was one of the Bills passed by the historic Joint Sitting of the two houses of the Commonwealth Parliament following the double dissolution election of 1974.
(iii) Export controls were imposed on all minerals, in order to enable the Government to maintain surveillance of prices and contract terms in long-term export contracts. The principal aim was to counter the monopoly purchasing power of the Japanese steel mills or the coordinated buying practices of the Japanese power companies; there was very light-handed regulation of commodities like silver, lead and zinc, which were traded on the London Metals Exchange.
(4) The cries of the wounded rang out over the minerals policy battlefield throughout the three years of the Whitlam Government. Civilisation as we knew it was coming to an end, we can never do business on this basis. The foreigners hated the foreign investment restrictions, they hated the export controls, everyone hated the PMA. Foreign companies said that it would be “very difficult” for them to invest here in the future, and “very difficult” for them to go on buying from us.
(5) Nevertheless there were some creative responses. CRA (Conzinc Rio Tinto of Australia), now Rio Tinto, was at that time about 63% owned by its British parent RTZ, with most of the rest in the hands of the Australian public. Its CEO, Sir Roderick Carnegie, came to the Government with an interesting proposal. He said that under the policy as it stood, CRA would always have to look for an Australian joint venture partner. He said that CRA did not like joint ventures, and proposed to Whitlam and Connor that, in return for an undertaking to sell down the parent company’s equity over time, CRA be recognised forthwith as an Australian company. This led to an intense period of negotiation, in which I was involved, and a deal was done.
(6) Some other interesting things happened over time as a result of the policy. In 1975 the PMA took over 50% of Delhi Petroleum’s production interests in the Cooper Basin, and 25% of its exploration interests (from memory these were taken over by CSR when the PMA’s portfolio was liquidated). BHP began to expand its role, acquiring Utah Mines Ltd and its major coal assets in 1984, and CSR took an increasing interest in the minerals sector. By 1986 RTZ’s equity in CRA had dipped to below 50%. BHP bumped American Metals Climax (AMAX) from its Pilbara iron ore assets in about 1990.
(7) When the Fraser Government took over in 1975 the Petroleum and Minerals Authority was quickly despatched, but the foreign investment policy remained, and export controls were kept in place, and although controls on minor minerals and LME minerals were relinquished, the controls on iron ore, coal and uranium were maintained.
(8) The Treasury hated, and actively subverted, the whole framework from the start. In 1975 I attended meetings of the Treasury-chaired Foreign Investment Committee as the representative of the Department of Minerals and Energy. Treasury never saw a foreign investment proposal it didn’t like, and could never be persuaded that a proposal was non-compliant.
My former Treasury colleagues seemed to live in a parallel universe in which the government of no other industrialised country intervened in the market place – they all left everything to the wisdom of the market and so should we. These people seemed never to have heard of the US Army Corps of Engineers, or the US Atomic Energy Commission, or the National Aeronautics and Space Administration, or indeed the US Department of Defense. And they seemed touchingly unaware of the extent to which the governments of Continental Europe occupied the commanding heights of their respective economies, and had equity in all sorts of private-looking companies.
When the Whitlam Government fell at the end of 1975, it turned out that one of the Assistant Secretaries in the Treasury’s Foreign Investment Division had Liberal pre-selection for a Victorian Senate Seat. Many years later Canberra Times editor Jack Waterford revealed that the Division Head had been the real “Mr Williams” who had leaked damaging information about the Loans Affair to the then Opposition, and who in return for this sterling service which contributed so much to the demise of the Whitlam Government, became a kind of protected species under the Fraser Government.
(9) As noted above, when the Fraser Government took over the foreign investment policy and the export controls were maintained. The export controls were administered by Doug Anthony and his Department of Trade and Resources, and Doug made valiant efforts to uphold the national interest, taking considerable political heat in the process. It was hard yards on the foreign investment side, however, especially when John Howard was Treasurer; like the Treasury itself, Howard never believed in any of that stuff. We worked long and hard doing the due diligence on the various petroleum and minerals proposals that came in, but it was all steadfastly ignored, and some crazy things were approved.
(10) In the neo-liberal reformist atmosphere of the Hawke and Keating Governments the export controls were maintained after a fashion, but the foreign investment controls were increasingly symbolic – it would be a bad look to abolish the Foreign Investment Review Board, but let’s not have it say no to anybody. In 1995 the Australianisation of CRA became a dead letter with the dual listing of Rio Tinto on the London and Australian stock exchanges.
(11) When John Howard became Prime Minister the game was up and the companies knew it. Rio Tinto completed the reversal of the Australianisation project by taking all of the strategic functions back to London, and in 2001 BHP was allowed to merge with the British-Dutch company Billiton, on terms which suggested that BHP needed Billiton more than Billiton needed BHP. John Howard’s principal concern was that the headquarters of the merged company remain in Melbourne – seeing the icon leave the country would have been a bad look. The one big surprise was Peter Costello’s refusal to permit Shell to take over Woodside.
The point of all of the above is to indicate that if the Australian public is not getting a fair share of the benefits of Australia’s mineral wealth, it is to a substantial extent because a succession of Australian Governments have been asleep at the wheel in relation to resources policy. There is a certain irony in the Treasury’s newfound obsession with the economic rents it sees accruing to the large mining companies. When the rents were accruing to the Japanese steel mills through their monopsonistic purchasing practices, or to the aluminium multinationals through fancy transfer pricing tricks, they were relaxed and comfortable.
If the Rudd Government really wants a larger share of the proceeds to accrue to the Australian public, there are instruments available to it apart from a completely untested approach to resource rent taxation:
(1) It could start taking foreign investment policy seriously. We have a Foreign Investment Review Board; why not use it? Is every foreign investment proposal that comes forward in the national interest? Really?
(2) It could direct the Future Fund to purchase shares in BHP, Rio Tinto etc. They are traded on the Australian stock exchange, they are freely available to anyone who wants to pay the market price. If the benefits of the assets they control are so self-evident, how could there be any objection to that?
(3) Better still, it could establish a proper sovereign wealth fund, into which all of the Petroleum Resource Rent Tax and any resource rent tax on minerals could be paid for the benefit of future Australians, rather than paying it into general revenue and frittering it away on middle class welfare.
All of the above policies are debatable – none of this is easy. But let us have the debate and make robust, rational decisions, rather than sleepwalking into another policy debacle on the basis of an insufficiently considered new approach to taxation of one of our major industries.
In its editorial today The Australian Financial Review comments:
The only honourable course for the government now is to release all of its RSPT-related modelling so the public – aided by independent experts – can decide.
While it is about it, the Government might like to explain to us why it chose to use a General Equilibrium model (the KPMG Econtech model) rather than an input-output model like Treasury’s own PRISMOD model on which Treasury normally undertakes its tax and price effect modelling.
I am no econometrician but I do know a little about mathematics. What I know about mathematical models like a GE model is that they are, in mathematicians’ terms, models of complex non-linear systems in which everything is connected to everything else, leading to feedback loops all over the place. Classic examples of such systems are ecological systems, weather systems and economic systems. They are chaotic in a strict mathematical sense, leading to the mathematics of these systems being known in the popular literature as “chaos theory”.
One of the defining characteristics of these complex non-linear systems is acute (and I mean acute) sensitivity to initial conditions, leading to the notion that the beating of a butterfly’s wings in the Amazon can trigger a tornado in Texas. This phenomenon was discovered by meteorologist Edward Lorentz in 1961. He was running weather simulations and decided to check something that was occurring part of the way through a particular simulation. He re-started the calculation by feeding the output from his simulation as data for the new run, and noted to his surprise that the simulation very quickly diverged from the simulation he was checking. On considering what was happening he realised that, whereas his normal input data was to six significant figures, the model’s output data was only to three significant figures. If you restart the model with a number like 0.493 instead of 0.493127, the whole simulation goes off course.
It should be noted that these models are completely deterministic – there are no random elements in them, and you can calculate a unique set of results from the data input. The problem is that a tiny variation in the initial data can produce a quite different unique set of results.
GE models have their uses, which mainly revolve around understanding the processes going on in the system – a small change in A produces a big change in B but only a modest change in C – but they are almost useless as predictive tools because they are so sensitive to the data they are fed. That is why we can never hope to predict the weather more than a week (at best) in advance – we can feed more and more data into bigger and bigger super-computers, but it will never be enough.
To return to the specific subject of the KPMG Econtech modelling of the RSPT, acute sensitivity to “initial conditions” includes of course acute sensitivity to the assumptions which are fed into the model. AFR journalist John Kehoe has some interesting things to say about that on page 6 of today’s Australian Financial Review:
It is believed Treasury directed KPMG Econtech to assume the 40 per cent RSPT would not distort mining investment and the modelling projections were arrived at independent of key design features of the tax, including the rate, uplift factor, depreciation allowances and transition arrangements.
These design features are all assumed to be “perfect” so only pure resource rents are taxed by the RSPT.
Of course what those of us in the real world want to know is whether or not the tax will in fact distort mining investment. We want to see modelling which demonstrates that, not modelling which assumes it.
To turn to the PRISMOD model, this was the model which was developed by the young Ken Henry and his team on the instructions of Treasurer John Kerin at the end of the Hawke era, and which was used to such devastating effect in the Keating era by Treasurer John Dawkins to destroy John Hewson’s Fightback! package.
So I would like to see what that traditional Treasury tool, the PRISMOD model, would show us about this proposed tax, and I would like to know why the KPMG Econtech model was chosen in preference to it.
Too complicated and too greedy is how Brian Toohey described the proposed new resource rent tax in his weekly column in last weekend’s Australian Financial Review. A good case could be made to sustain both of those charges:
- Removing $9 billion per annum from the cash flows of the successful mining companies is no trivial matter, especially with an approach to resource rent taxation which has never been tried anywhere else in the world. The risk of unintended consequences is very large.
- In my public service career I was always taught that public policy which is not understood by the general public is not sustainable: it will either fail to be implemented or it will in due course be abolished. The Government should have learned that lesson from its failure to get its emissions trading scheme over the line, a fact which is in large measure due to its failure to communicate the scheme to the public at large. The lesson was not learned, and the Government has launched its resource rent tax on an utterly unprepared industry and public. It could have been handled a different way (see Resource rent tax: what happened to the nemawashi?) but it wasn’t.
Some more comments on the proposed tax:
(1) There is indisputably a case for a resource rent tax. Whenever a company is granted a mining lease, it is granted access to a finite, publicly owned resource. The quality of the resource is known to a certain level before a company commits itself to the development, and a project financier is prepared to lend the money, but the full extent and quality of the resource is often revealed only progressively over time.
How remunerative the project turns out to be will depend upon the quality of the resource, the mine planning and management skills of the company, and the technology it employs. It also depends upon the future trajectory of the price of the commodity being mined, which is beyond anyone’s control – it depends upon future economic conditions, changes in the demand for the commodity due to technological change, and the worldwide investment decisions of other mining companies.
In the event, some mines will make a “normal” level of profit, and the company will simply pay the royalties plus company tax at the normal rate. Some will make an extraordinary profit – an economic rent – and the policy question is how, not whether, the public should share the economic rents with the mining company which is profiting from the exploitation of the finite publicly owned resource.
(2) The argument by the mining companies that they pay more tax than the Government claims because the Government is not including the royalty payments to the states is disingenuous. The royalty payments to the state are a price for access to the resource and are simply a cost like exploration or operating costs. The question is whether the companies pay their “fair share” of company tax once all allowable deductions have been taken into account, i.e, do they pay the full 30% of their profits.
(3) The short answer to that question has to be in the affirmative. I do not think that anyone is suggesting that companies like BHP or Rio Tinto are not compliant with the tax law, and if they are not, there are the normal legal remedies for that.
(4) The more complex answer, which nobody seems to be bothering to explain, is that the proportion of their total revenues which mining companies actually pay under our tax laws is an artefact of the tax law itself and of the ongoing resources boom.
This is because the Australian tax law, like the tax law of every country with a significant mining industry, provides for accelerated write-off of mining investment, in recognition both of the risks of mining investment and of the fact that we are all competing for mobile capital. When the industry is expanding rapidly there is a lot to write off; once the boom conditions fade, much of the write-off has already taken place and the companies pay more tax.
During the Whitlam years Minerals and Energy Minister Rex Connor commissioned Sydney financial journalist Tom Fitzgerald to write a report on the Australian mining industry, a report the production of which was greatly accelerated by the calling of the double dissolution election in 1974. The Minister gave him a very broad brief – what is Australia getting from its mining industry? – and left to get on with it.
It is best to let Tom Fitzgerald tell the story himself (see The Life and Work of Tom Fitzgerald on the Curtin University website here):
The approach to join Minerals and Energy came from Lenox Hewitt. He asked me, before I could join, to come and meet the Minister which I did. I was impressed with the Minister, Mr Connor’s, range of issues that he thought the Department should apply itself to. They were all intelligent questions. He wasn’t of course seeking anything like immediate responses. But he gave me an outline of things that he thought the Department should consider. They were good ideas.
I moved into that Department the day after the budget, probably in September, 1973.
To sum up very briefly I think there were three elements of my thesis. The first was the scale of the taxation concessions granted by the federal government to the mining industry. And the way in which some of those concessions which were not outright reductions in tax but deferments of tax could in practice lead to an enormously advantaged acceleration of growth in the industry. Which may not have been contemplated by the people who drew up the tax concessions in the era of the Chifley government when Australia was thought to be barren of minerals. The taxation concessions greatly advantaged expanding mineral companies. The emphasis being on expanding.
The second part was the extent of the overseas ownership of these advantaged mineral exploiters. And the third, in a way to me the most interesting, was the power and disposition of state governments, without any reference to the federal government, to grant great mineral rights to companies, foreign or local, which would automatically mean granting extraordinary federal taxation concessions to the expansion of those deposits. And I had to spend quite a substantial part of the paper trying to set out the nature of the tax concessions and the real meaning of what was commonly and loosely described as ‘deferred tax’ provisions made by the companies.
Fitzgerald was raising sophisticated arguments about the public policy issues posed by Australia’s emergence as a major, and largely foreign-owned, force in the world minerals industry, arguments which he saw as requiring careful though and analysis.
In the hothouse atmosphere of the double dissolution election, however, the issues he had raised were misused. Treasury, which had already secured the launching of an Industries Assistance Commission inquiry into taxation of the mining industry, seized its chance and in effect ambushed the Government to secure a dramatic change in the applicable tax regime, without the inconvenience of waiting for the IAC Report. The write-off regime was changed from immediate write-off of 100% of capital expenditure to write off over 40 years or life of mine, whichever was less. This was a novel experiment; at that stage Canada and Brazil, our principal competitors then as now, had similarly rapid write-off regimes – indeed one of them (I don’t remember which) allowed immediate write-off of 130% of capital expenditure, against which our 2.5% per annum was a sorry sight indeed.
Unfortunately for the Treasury that was not the end of the matter. Treasury got caught in the revolving door of its own cleverness when, shortly after the Fraser Government took office, the Industries Assistance Commission Report on the Taxation of the Mining Industry hit the deck and the whole question was reopened.
I represented Deputy Prime Minister Doug Anthony’s Department of National Resources at the months of interdepartmental committee meetings that ensued to examine the IAC Report and prepare recommendations for the Government on each and every aspect raised by the IAC, and when it came to the Cabinet meeting Doug dragged me into the Cabinet room to help him make the arguments against the wall-to-wall Treasury and Tax Office officials that were already there, this being Budget Cabinet.
In the event Cabinet settled upon an accelerated regime which was less generous than the previous immediate write-off – capital investment could be depreciated on the basis of deducting 20% of the declining balance, i.e., 20% of expenditure which had not yet been deducted.
One conversation from that era sticks in my mind. At one stage I spoke to the head of the Economic Division of the Prime Minister’s Department to make the point about the rapid write-off that was available in Brazil and Canada. The response of this former Treasury officer was, “Just because other countries have silly policies doesn’t mean that we have to have silly policies” – thereby revealing a rather tenuous grasp of the implications of an open global economy, of which he was a staunch advocate.
(5) Accepting the case for a resource rent tax, which I do, the question is, how best to capture the economic rents. The scheme devised by Ken Henry is an elegant and sophisticated one, but it has two fatal flaws: it is too difficult to explain, which makes it impossible to carry in an hostile political environment; and it deals with the industry as a whole without adequate consideration of its impacts on particular categories of players, and it would appear, inadequate consideration of how mining projects are selected for development and financed.
As has been pointed out by a number of writers, companies like BHP Billiton and Rio Tinto do not value the fact that the proposed tax system will cover 40% of their losses. This is because they do not set out to make losses, and they are very good at what they do. Companies like that will not invest in a new mine unless they are confident that when it goes into production it will be in about the bottom quartile of costs for that particular commodity, so that if there is a downturn with accompanying decline in the market price for the commodity, a lot of other people will get hurt before they do.
Junior and would-be miners, on the other hand, may well value the new regime because a marginally economic discovery might be worth a punt if the Government is going to assume 40% of the risk. For my part, I am not looking for an opportunity to co-venture with Fly By Night Minerals NL to the detriment of the value of my superannuation fund’s shares in BHP and Rio Tinto.
What I would welcome would be a regime, along the lines of the existing Petroleum Resource Rent Tax (PRRT), which allowed the mining companies to develop their discoveries at their own risk, and taxed profits above a certain level at a higher rate. We have such a system in place, and everyone understands it. As Toohey comments in his article, sometimes second best can be the superior solution.
(6) The claim made by the mining industry that the proposed regime would make Australia the highest taxed country in the world undermines as much as helps their case. According to the letter to shareholders from BHP Billion Chairman Jac Nasser, the current effective rate of tax in Australia is 43%, compared with 23% in Canada and 27-38% in Brazil. On these figures Australia is already significantly levying higher taxes than its principal competitors. As far as one can tell the companies are pretty happy to be here. My experience is that countries which charge low tax rates (tax holidays, 15% company tax etc) do so because they need to in order to overcome the disadvantages of investing there. Here as elsewhere there is no such thing as a free lunch.
(7) The claim that the new regime should apply only to new investments is entirely without merit. No country grandfathers all the decisions it makes that impact upon investors – changes in the tariff, the decision to float the dollar, the decision to allow in foreign banks and on and on the list goes. On the argument being put by Jac Nasser and others the Government would have to maintain an individually tailored tax and tariff regime for every company in Australia.
(8) The claim that the regime should not apply to all mineral commodities is extraordinary. If we are talking about taxing economic rents on finite resources, it doesn’t matter whether the super-profit is made mining gold or gypsum. And if the industry is not particularly profitable, it will only be subject to normal rates of tax.
(9) The Prime Minister and Treasurer are loudly proclaiming that the resources in question belong to all Australians. That is a view which is consistent with their strong centralising tendencies which would have State Governments simply serving as branch offices for Canberra. The fact is that the resources belong to the Crown in right of the State – that is, the public to which these finite publicly owned resources belong is the public of each individual state and territory.
That is why royalties are levied by the states, and to this extent the proposed imposition of resource rent taxation by the Commonwealth is a cash grab from the states, and the fact that the Commonwealth has shirked the hard yards of rationalising the ramshackle royalties regimes of the states gives the states a strong incentive to increase their royalty rates, with adverse effects on state and national welfare, particularly where royalties are levied on a unit of production basis. The issue raised by Tom Fitzgerald regarding the capacity of the States to take unilateral actions that trigger the Commonwealth’s accelerated write-off regime also remains unaddressed.
Perhaps an elegant solution would be for the Commonwealth to take over the whole business and levy royalties and a PRRT-type resource rent tax for and on behalf of the states, perhaps with the retention of an agreed share.
My proposed solution will not come to pass, of course, and this will stand as one of the worst examples of public policy making since the Government’s inept approach to emissions abatement.
Unfortunately for the chances of what could have been one of the great Australian reforms of all time, the establishment of a well designed resource rent tax, it did not take long for the case for it to be couched in terms of the class struggle. The big miners aren’t paying their fair share of tax, they are big multinational corporations, they are foreign owned.
These are emotive, populist arguments and none of them supports a case for a resource rent tax. Nor does the prospect of all of the wonderful things that we could spend the money on – lowering the company tax rate, increasing the superannuation contribution or whatever. The case for a resource rent tax rests solely on the fact that the mining companies, large or small, Australian or foreign owned, are being granted access to publicly owned finite resources, the exploitation of which will in some cases yield economic rents, i.e. super-normal profits. The public is entitled to a share of those super-normal profits. It is as simple and unemotive as that.
Unfortunately, running the case on emotive, resource nationalist lines undermines the prospect of successfully achieving the reform, as does the abject failure to prepare the ground (see Resource rent tax: what happened to the nemawashi?). I am all for resource nationalism, and have more than a few scars to prove it, but we have to be smart about it.
The government’s inept handling of a series of major and complex reforms has landed it in deep trouble with the electorate just months before an election – trouble from which only Opposition figures Tony Abbott, Joe Hockey and Julie Bishop are working effectively to save it.
Failure to get this one up and being swept away on the electoral tide may help Mr Rudd to go down in history as a great Labor hero in the tradition of Jack Lang, Ben Chifley or Gough Whitlam, but it won’t do much for the rest of us.
The Japanese have a marvellous expression, nemawashi, which refers to the processes to be undertaken in advance of any complex negotiation between powerful competing interests. Taken from bonsai cultivation, it means literally “going around the roots” and refers to the spreading and pruning of the roots that is the essential foundation of repotting the plant and shaping its future growth.
In a business or government negotiating context it refers to a process of lower level operatives sounding out in advance the positions of all the other parties, with a view to finding a position upon which it might be possible to gain consensus, before the senior leaders find themselves sitting across the table from each other. The aim is to achieve an outcome that everyone can live with, without the need for shouting, screaming, table thumping or other unseemly behaviour, without the need for bruised egos, and without giving rise to lasting enmities at the leadership level that make it hard to do business in the future. It sounds cumbersome, and might appear more time consuming, but it is actually both more efficient and more effective than launching powerful players into a doomed process which leads to a standoff, so that no one is happy.
Nowhere is the need for this more evident that in the chaotic process that has left the Government and the mining industry trading insults. How did it come to this, the national government and one of the nation’s most important industries at each other’s throats?
There are impeccably sound reasons for the Government to introduce a resource rent tax on the mining industry. The miners will not like it, because it will reduce their revenue. That is not the issue. The issue is to design it in such a way that it has minimal effect on their investment and production decisions. We do not want them to invest elsewhere, we do not want them to defer investment, and we do not want them to cease production prematurely.
I have been around this buoy. In 1976-77 the Fraser Government had on its agenda the pricing of domestically produced crude oil. This arose because when crude oil was discovered in Bass Strait in the mid-1960s the Esso-BHP joint venture unwisely asked the Commonwealth Government to fix the price of domestically produced crude oil. They said that the cost of production from the Bass Strait fields would be such that it would be only marginally profitable in competition with comparable imported crudes; they needed an extra few cents per barrel. The message was clear: without this assistance, Esso-BHP would sit on their discovery. The Commonwealth agreed to use its powers under the Customs Act to require all sellers of petroleum products to uplift Australian crude in proportion to their retail sales of “white products”.
After the dust settled on the 1973-74 Middle East oil shocks, when the OAPEC (Organisation of Arab Petroleum Exporting Countries) producers placed an oil embargo on the United States and others following the Yom Kippur War, the Whitlam Government, and then the Fraser Government, and Esso-BHP were left in a position where the domestic crude oil price was about $US 2.13 per barrel and the internationally traded price was about $US 12. Because of the framework put in place at Esso-BHP’s request, the domestic price could only be raised by decision of the Commonwealth Government.
The Government realised that it would have to move in the direction of world parity prices – which meant that over time it would be raising the price of the major input to Australian petrol and diesel to about six times its current level.
Equally, it realised that the price rise when it did occur could not be allowed to accrue as a massive windfall gain to Esso-BHP. Accordingly, it was decided that some form of super-tax would have to be levied on Bass Strait production. Critical to the design of this tax was that, while it should limit the windfall gains from known oil deposits (“old” oil) due to the oil price rise, it should not act as a deterrent to explore for oil that would be economic at the new international price level. It was also decided that it should not apply to small fields. At the end of the day a crude oil excise was levied on “old” oil, with an exemption for the first 30 million barrels so that small onshore deposits would not get caught up in the system.
Consultations with the industry took place over several months before the design of the scheme was settled. It was left to me as head of the Energy Policy Division of the then Department of National Resources to conduct the consultations with the Australian Petroleum Production and Exploration Association (APPEA).
It was made clear to the industry from the start that we were not there to ask them whether an additional tax was a good idea, we were there to advise them of the Government’s intentions and talk about the design of the scheme with a view to avoiding unintended consequences. Officers of other Departments attended the meetings, we duly reported back to the Government, and we had a lot of debate between Departments about the significance of what we had heard.
We got a range of reactions. Most of the large companies were pretty mature about it. Some insisted that this had to be a departmental stunt that the Government didn’t know about because we now had a Liberal Government and it was in favour of free enterprise. Some of the smaller explorers, like the American solo oilmen who had sold or mortgaged their houses to chance their arm wildcatting for oil, could see the long dark night of socialism descending.
The point in the current context is that this was an orderly process, conducted without high drama. The Government did not announce the policy and then have the public treated to the sight of the Prime Minister jumping into aircraft and rushing around the country to consult irate industry leaders who felt that they had been ambushed. They were consulted, they had their say, and what they said was taken into account in designing a scheme they would have preferred not to see introduced.
So for my money the Government would have been well advised to publish the Henry Tax Review the day it was delivered to them, accompanied by a statement that this was an independent review, and the Government would consider it carefully and announce its decisions in due course after consultations with affected parties and relevant experts.
Even better, the Government could have issued the Henry Report as a Green Paper, called for comment upon it over a period of months, then considered the responses and issued a White Paper.
Once they had decided to sit on it they were committing themselves to springing their policies fully formed upon a startled world once they did release it, a move that Sir Humphrey Appleby would undoubtedly have described as “courageous”.
Better do the nemawashi next time, Prime Minister.
Some of the commentary in favour of approving proposed Chinese investments in Australian iron ore producers has hearkened back to the Hawke-era Chinese investment in the development of CRA’s iron ore deposit at Mount Channar in the Pilbara.
This was project was a great step forward in the Australia-China relationship, but the reasons for that need to be seen in the light of the circumstances of the day and they have only limited bearing on the current proposals.
The question of direct Chinese investment in an Australian iron ore mine first arose during the March 1983 visit to Australian by then Premier Zhao Ziyang.A Chinese evaluation team from the Ministry of Metallurgical Industry (MMI) was in Australia at the same time, seeking an investment opportunity in an Australian iron ore project. It visited all of the proposed new projects, spoke to the companies involved, and in due course settled on CRA’s Mount Channar project as the preferred target.
Zhao Ziyang’s visit was followed in 1984 by a visit by the Minister of Metallurgical Industry, Li Tongye, who visited the sites and the companies.
The strategic significance of these developments is that they came very early in the process of what the Chinese Government called “opening to the outside world”, a process that began in 1979 with important agricultural reforms sponsored by Zhao Ziyang and then General Secretary Hu Yoabang, who himself visited Australia in April 1985 and stood with Bob Hawke atop the Channar deposit.
Those of us who were involved in the Government to Government discussions of the project (which were very intense and drawn out) realised that this first major offshore direct investment represented a fundamental departure from the traditional “economic autarchy” thinking of centrally planned economies, under which the country should be self-sufficient in all important products.Under this model, importation of foodstuffs and steel-making raw materials was seen by the more doctrinaire as a stop-gap measure pending the country reaching the level of economic maturity that would make it self-sufficient in all important respects.This model was underpinned by national security doctrine as well as economic doctrine.
Thus while China was already a regular and important purchaser of Australian iron ore, there was no assurance of how long that would continue. As a result of self-sufficiency thinking, internally China undertook energy intensive magnetic separation processes that beneficiated “ore” containing 27% iron up to 52% - less than the 54% cut-off grade below which Pilbara producers did not even stockpile ore for potential future use, as they did with ore in the range 54-63% iron.
The proposal to invest in offshore facilities was a first step away from the economic autarchy doctrine, one which was marketable to the traditionalists within the Chinese central bureaucracy because it involved a level of State ownership of the resource, even if the resource itself were offshore.A couple of times during the two-year process that brought the investment into being I observed to the MMI officials that security of supply could be assured simply by signing a long-term contract with an Australian mining company, but this was not the real issue - the strategic issue was “opening to the outside world”, integrating China into the world economy, truly revolutionary thinking at the time, and this investment was a key part of it. A lot was at stake; China has never been very forgiving of those who made “mistakes”, which is why there was a lot of discussion at Government to Government level, a lot of high level visits in both directions, a lot of confidence building over a couple of years before the end result was achieved.
These considerations are absent from the current proposals – China has many resource investments in many countries, it is fully a part of the global economy, and the current round of investment proposals does not represent the breaking of new doctrinal or policy ground.
It should be noted also in relation to Mount Channar that China was seeking only to establish a joint venture in a mine, not to purchase equity in a major mining company as the Chinalco-Rio Tinto proposal does.
None of this is means automatically that the current proposals ought not to be approved (the Fortescue Metals one already has been) – simply that there were different issues at stake in the early 1980s.
In State-owned is not the main problem I have argued that the Treasurer should decline to approve the Chinalco investment, on grounds centred on the undesirability of having major customers sitting on both the buyer and the seller side of the table, and in Time to calm down about China I have argued that the Treasurer was right to have national security concerns about granting a Chinese enterprise access to the Woomera Prohibited Area. In the latter piece I also acknowledged that respectable arguments could be constructed against both of these viewpoints, and that it should not be beyond the wit of man to find a mutually acceptable solution to the problem of the Prominent Hill mine within the prohibited area (as seems to have happened).
Whatever the outcome on Chinalco, Channar is not much of a precedent and I doubt that it will play much of a role in the Treasurer’s thinking.
