I explain how a scaled variable royalty does the job of a super-profits tax while avoiding the accounting trickery in order to share risk and get a better public return from resources.
I guess the practical issue that comes up is how you price the large capital works the lessee has invested in if you want to buy out the lessee.
Once they have the capital built, you can't really separate the resource right from the capital. And remember, as the relevant government, you already own the resource rights.
My view is that royalty regimes taking a percentage of nett in situ value have been too readily dismissed. Let's look at two reasons for dismissal that have been suggested by Cameron.
It was claimed that the Petroleum Resource Rent Tax (PRRT) has not collected enough money for government, in contrast to the Norwegian regime that is based on realised nett value of petroleum resources in situ. That is a reason to prefer and look seriously at the Norwegian regime, not to reject all regimes purporting to be based on realised nett value.
The PRRT rate is much lower than the Norwegian rate. Also, the PRRT allows carry-forward of undeducted expenditures at ridiculously generous, arbitrarily determined rates of interest (to "play safe"). This has been accompanied by an exploration tenement regime that induces explorers to bring forward exploration to find something so as to obtain secure tenure. This incentive has been reinforced by the high carry forward rate. Together, these arrangements undermine the base of the PRRT and consequent revenue. In contrast, the Norwegian Government adopted a "go slow" policy that avoided premature exploration to capture tenure. Also, it avoided allowing ridiculously high carry forward rates. The Norwegian system has evolved over time, and it is now a cash flow levy that captures economic profit by effectively exempting the relevant firm's actual minimum required rate of return from the levy (sometimes called a Brown tax, as it was put forward by E. Cary Brown (1948)). So, it avoids the PRRT flaw of allowing unduly high carry-forward rates. If governments want to avoid immediate refunds to explorers for and development of natural resources that accompany a cash-flow based regime, they could guarantee future full deductibility and therefore drop the carry forward rate under a resource rent royalty/tax to or close to the long-term bond rate. They could also require carry forward of unrecovered depreciation of exploration and development expenditure, rather than the outlays as spent. These things are explained in the Henry Tax Review report (2009).
It has been claimed that administration difficulties and costs associated with effort to avoid a levy on realised nett value in situ or economic profit are reasons to opt for another form of royalty regime. However, the Norwegians have been able to administer a levy on realised nett value in situ, and collect a vast amount of money after deducting administration costs. Why can't Australians do this too? Can't we learn from the Norwegians? I believe we can.
If there is a large amount of money at stake, surely it is worthwhile to engage smart people to work out how to collect that money and then do so. The Norwegians did.
The Norwegians sensibly recognised that the levy rate needs to be kept well below 100 per cent to avoid an incentive not to realise the nett value in situ. Cameron reported that the Norwegians still collect 78 per cent. Surely, we can too. They have shown that it is not necessary to set a low rate like the PRRT rate of 40 per cent.
If we want to collect a higher proportion of realisable nett value than 78 per cent or if we think that rate provides too much incentive to avoid the levy, competitive cash bidding could be used to allocate exploration tenements. Making bids deductible or not when calculating liability under the levy on realised nett value will alter the timing of government revenue. Cash bidding also would help avoid dissipation of realised nett value through premature exploration to capture tenure.
The suggestion by a commentator to impose a levy on unrealised value of resources in situ at the tenement holder's valuation with a government option to acquire it at that valuation is worthy of consideration.
Nearly 60 years ago, Mason Gaffney made a case for imposing a levy on unrealised value of resources in situ (Extractive Resources and Taxation, Madison: University of Wisconsin Press, 1967, pp. 402-409). He observed that the assessment or valuation was an obstacle needing to be addressed. The option proposal would be a good place to start in overcoming this obstacle.
I am not a fan of the type of royalty regimes favoured by Cameron and Tim that apply higher marginal rates to revenue at higher prices. These regimes ignore costs which differ between commodities, between extraction operations, and between units of extraction/production within an operation. These regimes do not adjust automatically to differences between prices and marginal costs. They require constant tinkering to adjust to changing realities. Critics often focus and make misleading statements about the level of higher rates, but a commonly overlooked issue is the level of lower rate settings. These can cause great damage when commodity prices are falling while marginal costs are rising.
That's enough from me for now to stir up some debate.
Until I retired 5 years ago, I had pondered for more than five decades the issue of pricing extractable natural resources like coal, petroleum, and minerals vested in the Crown in right of States and Territories onshore and the Commonwealth of Australia offshore. Royalties collected by State and Territory Governments are de facto and de jure prices of extractable resources. The Commonwealth Government's Resource Rent Tax is a de facto price for extractable petroleum resources offshore.
As Cameron commented in Fresh Economic Thinking and as Mason Gaffney observed about 50 years ago, charging a market price for the right to extract natural resources is rational capitalist behaviour, not socialist activity. It is government behaving like a private landowner. Our governments have failed to do this over the past 57 years in which I have been interested in pricing of natural resources.
The right price for extractable natural resources is their value in situ. That amount is nett of exploration costs, development and operating costs of extraction, and costs of transport to the point of sale. Charging this nett price is consistent with the principle of efficiency in the allocation of resources (economic efficiency) because it does not undermine minimum required returns to capital and labour (including skills) involved in exploration and extraction. It is also consistent with the benefit principle of equity (charging in accordance with benefits received) in public economics/finance.
Eminent economists such as Adam Smith (1776), David Ricardo (1817), William Vickrey (1967), and Mason Gaffney (1967) pointed out that the nett value of extractable natural resources in situ is like land rent. Later, many economic observers referred to it as economic rent or economic profit, noting that it is a pure economic surplus that can be priced or taxed away without adversely affecting the allocation of resources. Ross Garnaut and Anthony Clunies-Ross (1975) initiated the now common practice of referring to resource rent.
Unfortunately, many economic commentators have tossed around the terms, economic rent, economic profit, and resource rent, without clearly explaining what they mean. This has caused confusion among observers and created fear (based on ignorance) among bureaucrats regarding administrative difficulties of targeting resource rent or economic profit. And when bureaucrats have perceived that royalty administration could get harder for them if there is a shift to royalties based on nett in situ value, they have chosen personal comfort/convenience over advancing the wellbeing of constituents. So, they have recommended persistence with royalties charging a percentage of revenue (I have read reports by bureaucrats acknowledging that royalties based on resource rent are best on equity and economic efficiency grounds but then dismiss such regimes on administrative efficiency grounds ........... bizarre analytical outcomes indeed.). These considerations have contributed to the Australian States universally avoiding royalty regimes that target the nett in situ value of extractable natural resources. All States have persisted with ad valorem royalty regimes, which capture a percentage of revenue. The Northern Territory has departed from this practice for minerals, but not petroleum. Its royalty regime for minerals is based on accounting profit (a larger base than economic profit because it includes the minimum required return to capital).
Royalty regimes that apply a single rate to revenue perform dismally on economic efficiency and equity grounds. At high rates, they knock out higher cost production and may knock out whole extraction operations. So, they may yield little revenue. At low rates, they may only eliminate really high-cost production and would not knock out whole extraction operations. However, they will yield little revenue meaning that a high proportion of the nett in situ value of natural resources flows to those with an interest in extraction operations. Governments typically have tried to compromise by applying moderate royalty rates to revenue. Consequently, they have lost some revenue by knocking out higher cost production and a great deal of revenue by greatly undercharging for low-cost production and in circumstances when commodity prices are relatively high. As a result of persistence for many decades with royalty regimes applying a single percentage rate to revenue, governments have scandalously gifted a massive proportion of nett in situ value of natural resources to private sector explorers and producers. But when commodity prices have been low relative to costs, they have come under pressure to provide royalty concessions to avoid knocking out production and jobs.
It seems that the clear inequity and inefficiency of royalty regimes applying a percentage to revenue, along with concern about perceived difficulties of administering a regime charging on the basis of nett value in situ prompted the Queensland Government to move to royalty regimes for coal and liquid petroleum that apply higher marginal rates to revenue at higher price. The article above indicates that Cameron Murray and Tim Helm have proposed such regimes on the basis of similar considerations.
I think there should not be a uniform way for society (via state) to charge for exploitation of natural resources
When it comes to energy, there is very little financial risk on the major capital investments (due to energy demand being very inelastic) so state ownership is the best approach.
When it comes to mineral commodities that go through demand boom and busts, adjustable royalties seem to be better
Why not just charge 5% per annum on the declared unimproved value of the resource with the option to buy the lessee out at his own valuation?
Yeah, you can do a Harberger-type tax like this.
I guess the practical issue that comes up is how you price the large capital works the lessee has invested in if you want to buy out the lessee.
Once they have the capital built, you can't really separate the resource right from the capital. And remember, as the relevant government, you already own the resource rights.
You can compensate for the book value of depreciated capital works.
And revalue annually
Part 2 of my comment follows.
My view is that royalty regimes taking a percentage of nett in situ value have been too readily dismissed. Let's look at two reasons for dismissal that have been suggested by Cameron.
It was claimed that the Petroleum Resource Rent Tax (PRRT) has not collected enough money for government, in contrast to the Norwegian regime that is based on realised nett value of petroleum resources in situ. That is a reason to prefer and look seriously at the Norwegian regime, not to reject all regimes purporting to be based on realised nett value.
The PRRT rate is much lower than the Norwegian rate. Also, the PRRT allows carry-forward of undeducted expenditures at ridiculously generous, arbitrarily determined rates of interest (to "play safe"). This has been accompanied by an exploration tenement regime that induces explorers to bring forward exploration to find something so as to obtain secure tenure. This incentive has been reinforced by the high carry forward rate. Together, these arrangements undermine the base of the PRRT and consequent revenue. In contrast, the Norwegian Government adopted a "go slow" policy that avoided premature exploration to capture tenure. Also, it avoided allowing ridiculously high carry forward rates. The Norwegian system has evolved over time, and it is now a cash flow levy that captures economic profit by effectively exempting the relevant firm's actual minimum required rate of return from the levy (sometimes called a Brown tax, as it was put forward by E. Cary Brown (1948)). So, it avoids the PRRT flaw of allowing unduly high carry-forward rates. If governments want to avoid immediate refunds to explorers for and development of natural resources that accompany a cash-flow based regime, they could guarantee future full deductibility and therefore drop the carry forward rate under a resource rent royalty/tax to or close to the long-term bond rate. They could also require carry forward of unrecovered depreciation of exploration and development expenditure, rather than the outlays as spent. These things are explained in the Henry Tax Review report (2009).
It has been claimed that administration difficulties and costs associated with effort to avoid a levy on realised nett value in situ or economic profit are reasons to opt for another form of royalty regime. However, the Norwegians have been able to administer a levy on realised nett value in situ, and collect a vast amount of money after deducting administration costs. Why can't Australians do this too? Can't we learn from the Norwegians? I believe we can.
If there is a large amount of money at stake, surely it is worthwhile to engage smart people to work out how to collect that money and then do so. The Norwegians did.
The Norwegians sensibly recognised that the levy rate needs to be kept well below 100 per cent to avoid an incentive not to realise the nett value in situ. Cameron reported that the Norwegians still collect 78 per cent. Surely, we can too. They have shown that it is not necessary to set a low rate like the PRRT rate of 40 per cent.
If we want to collect a higher proportion of realisable nett value than 78 per cent or if we think that rate provides too much incentive to avoid the levy, competitive cash bidding could be used to allocate exploration tenements. Making bids deductible or not when calculating liability under the levy on realised nett value will alter the timing of government revenue. Cash bidding also would help avoid dissipation of realised nett value through premature exploration to capture tenure.
The suggestion by a commentator to impose a levy on unrealised value of resources in situ at the tenement holder's valuation with a government option to acquire it at that valuation is worthy of consideration.
Nearly 60 years ago, Mason Gaffney made a case for imposing a levy on unrealised value of resources in situ (Extractive Resources and Taxation, Madison: University of Wisconsin Press, 1967, pp. 402-409). He observed that the assessment or valuation was an obstacle needing to be addressed. The option proposal would be a good place to start in overcoming this obstacle.
I am not a fan of the type of royalty regimes favoured by Cameron and Tim that apply higher marginal rates to revenue at higher prices. These regimes ignore costs which differ between commodities, between extraction operations, and between units of extraction/production within an operation. These regimes do not adjust automatically to differences between prices and marginal costs. They require constant tinkering to adjust to changing realities. Critics often focus and make misleading statements about the level of higher rates, but a commonly overlooked issue is the level of lower rate settings. These can cause great damage when commodity prices are falling while marginal costs are rising.
That's enough from me for now to stir up some debate.
Ken Willett
Until I retired 5 years ago, I had pondered for more than five decades the issue of pricing extractable natural resources like coal, petroleum, and minerals vested in the Crown in right of States and Territories onshore and the Commonwealth of Australia offshore. Royalties collected by State and Territory Governments are de facto and de jure prices of extractable resources. The Commonwealth Government's Resource Rent Tax is a de facto price for extractable petroleum resources offshore.
As Cameron commented in Fresh Economic Thinking and as Mason Gaffney observed about 50 years ago, charging a market price for the right to extract natural resources is rational capitalist behaviour, not socialist activity. It is government behaving like a private landowner. Our governments have failed to do this over the past 57 years in which I have been interested in pricing of natural resources.
The right price for extractable natural resources is their value in situ. That amount is nett of exploration costs, development and operating costs of extraction, and costs of transport to the point of sale. Charging this nett price is consistent with the principle of efficiency in the allocation of resources (economic efficiency) because it does not undermine minimum required returns to capital and labour (including skills) involved in exploration and extraction. It is also consistent with the benefit principle of equity (charging in accordance with benefits received) in public economics/finance.
Eminent economists such as Adam Smith (1776), David Ricardo (1817), William Vickrey (1967), and Mason Gaffney (1967) pointed out that the nett value of extractable natural resources in situ is like land rent. Later, many economic observers referred to it as economic rent or economic profit, noting that it is a pure economic surplus that can be priced or taxed away without adversely affecting the allocation of resources. Ross Garnaut and Anthony Clunies-Ross (1975) initiated the now common practice of referring to resource rent.
Unfortunately, many economic commentators have tossed around the terms, economic rent, economic profit, and resource rent, without clearly explaining what they mean. This has caused confusion among observers and created fear (based on ignorance) among bureaucrats regarding administrative difficulties of targeting resource rent or economic profit. And when bureaucrats have perceived that royalty administration could get harder for them if there is a shift to royalties based on nett in situ value, they have chosen personal comfort/convenience over advancing the wellbeing of constituents. So, they have recommended persistence with royalties charging a percentage of revenue (I have read reports by bureaucrats acknowledging that royalties based on resource rent are best on equity and economic efficiency grounds but then dismiss such regimes on administrative efficiency grounds ........... bizarre analytical outcomes indeed.). These considerations have contributed to the Australian States universally avoiding royalty regimes that target the nett in situ value of extractable natural resources. All States have persisted with ad valorem royalty regimes, which capture a percentage of revenue. The Northern Territory has departed from this practice for minerals, but not petroleum. Its royalty regime for minerals is based on accounting profit (a larger base than economic profit because it includes the minimum required return to capital).
Royalty regimes that apply a single rate to revenue perform dismally on economic efficiency and equity grounds. At high rates, they knock out higher cost production and may knock out whole extraction operations. So, they may yield little revenue. At low rates, they may only eliminate really high-cost production and would not knock out whole extraction operations. However, they will yield little revenue meaning that a high proportion of the nett in situ value of natural resources flows to those with an interest in extraction operations. Governments typically have tried to compromise by applying moderate royalty rates to revenue. Consequently, they have lost some revenue by knocking out higher cost production and a great deal of revenue by greatly undercharging for low-cost production and in circumstances when commodity prices are relatively high. As a result of persistence for many decades with royalty regimes applying a single percentage rate to revenue, governments have scandalously gifted a massive proportion of nett in situ value of natural resources to private sector explorers and producers. But when commodity prices have been low relative to costs, they have come under pressure to provide royalty concessions to avoid knocking out production and jobs.
It seems that the clear inequity and inefficiency of royalty regimes applying a percentage to revenue, along with concern about perceived difficulties of administering a regime charging on the basis of nett value in situ prompted the Queensland Government to move to royalty regimes for coal and liquid petroleum that apply higher marginal rates to revenue at higher price. The article above indicates that Cameron Murray and Tim Helm have proposed such regimes on the basis of similar considerations.
End of part 1 of comment.
Ken Willett
I think there should not be a uniform way for society (via state) to charge for exploitation of natural resources
When it comes to energy, there is very little financial risk on the major capital investments (due to energy demand being very inelastic) so state ownership is the best approach.
When it comes to mineral commodities that go through demand boom and busts, adjustable royalties seem to be better