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Resource-rich countries need to get their mining tax systems right

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Once more governments around the world are considering whether to increase the tax-take on mining. From Chile and Peru, to Papua New Guinea, Mongolia and Zambia, the industry is under scrutiny as demand increases for commodities and prices rise. 

Mineral prices are soaring as big economies rev up after the pandemic. Additionally, for those commodities that are in high demand because of the shift to cleaner forms of energy there is talk of another supercycle. This raises the question: are politicians justified in seeking higher tax revenues during periods when prices rise?

My answer, based on several decades of assisting governments and working alongside highly experienced economists, tax officials and investors, is yes. With good planning and analysis, governments are well positioned to develop mineral sector tax systems that readily accommodate price cycles while allowing investors healthy returns on their investment. 

Unfortunately, even a well-designed mining tax system is vulnerable to seat-of-the-pants politics, which can be triggered by price cycles, nationalistic fervour and protectionism, and can evolve without rationality and good planning and analysis. 

For example, in Chile, a nation replete with excellent resource economists and experience, its lower house recently passed a bill that would introduce a royalty of up to 75 per cent on the value of minerals sold that would cause most currently operating mines to become economically unviable and new mines uneconomic to build. Time and time again natural resources have proven to be an easy target for opportunistic politicians seeking to gain popularity.

But if a country can move beyond politics on taxation, it needs to devise a system that seeks to maintain or grow the tax base, by encouraging the development of new mines while not putting current marginal mines out of business, and maximise the amount of revenue collected through a mix of tax types. But finding the right balance that both encourages investment while still adequately filling the coffers of the state is the challenge for governments.

A good system is one that allows investors to maximise profits while governments can maximise revenues. Politics aside, this is do-able.

If tax levels are raised too high, new investment will diminish and marginally profitable mines will close, leading to a fall in the tax base, But if tax levels are set too low, the government will forgo revenues that could have been collected without affecting levels of new investment. The challenge for governments is implementing the optimal set of tax types and rates. 

The historical approach of many governments is to raise taxation rates when prices rise (usually in the form of higher royalty rates) and then to lower them or offer various investment incentives when prices decline. For example, Australia, Mongolia and Zambia all raised mining taxes during the previous minerals supercycles but rescinded them when prices fell. 

This approach, with its lack of predictability, is the bane of investors who need some visibility at the feasibility stage of what tax system will apply to their potential project, at least through the period where they recoup their initial investment.

During the previous supercycle, Chile and then Peru introduced new royalties based on the level of annual profitability. When annual profitability is high, an increased rate is applied to a specially calculated tax base.

Unlike traditional systems, such as that in Papua New Guinea, as well as the formula recently developed by the IMF for Liberia, where an additional tax is applied when the cumulative rate of return exceeds a threshold, the Chilean and Peruvian systems respond quickly to price cycles. Obtaining a fair share is not difficult — it is just a matter of deciding on that share and selecting the best tools to get the job done.

Taxation is not a zero-sum game. Governments and investors can enjoy win-win scenarios. One thing that the current calls for tax reform tells me is that gaining the ongoing “trust of the people” in order to maintain a good tax system may be more challenging than devising it.

James Otto is an attorney and mineral economist. He is the lead author of Mining Royalties: A Global Study of Their Impact on Investors, Government, and Civil Society, World Bank 2006

The Commodities Note is an online commentary on the industry from the Financial Times

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