Economic rent has its origin in the labour theory of value. Classical economists couldn't understand why natural resources had value when human labour hadn't yet added value.
So the concept of economic rent was invented to fill the gap. For that purpose it worked well -- but economists now understand that costs do not determine prices; rather prices determine costs.
The taxation of economic rent should be seen in this light. The idea that economic value exists independent of markets, human ingenuity and entrepreneurship is simply wrong. Economic rent is a construct of a failed economic theory. Taxing rent is equally a bad idea. Of course, few see it that way. Most people are taken in by the idea that taxing economic rent is an efficient tax.
We're told in textbooks that these sorts of taxes have no deadweight losses. Yet, we know there are no free-lunches in any other area of the economy, so should there be one in public finance? The short answer is that there is no free tax. Textbooks are about pedagogy; not real life.
In modern terms people talk about economic rent as being a supernormal profit. That is the profit earned over and above the cost of capital. In principle, taxing this profit should have no economic consequences. But this requires tax officials to be able to estimate the cost of capital that organisations face when making investment decisions. It also assumes that these types of profits persist in the long-run. Standard economic theory, however, indicates that they don't persist. Competition and freedom of entry and exit ensure that only normal profits are earned in the long run.
So the bottom line is that even if these supernormal profits ever existed, they would be temporary. More likely they are the result of mismeasurement or government fiat. Resource rents in Australia, for example, are defined as returns in excess of the long-term government bond rate plus five percentage points. This measure is almost certainly too low. The government has defined an arbitrary tax base and then taxes it.
The Henry Review is going to recommend a federal resource rent tax. The arguments in favour of this proposal are already doing the rounds. They are fallacious. The idea that mining is extraordinarily profitable over-looks the characteristics of mining. It is very risky. Projects have long lead times and require high levels of on-going investment. The salvage value of most mining operations is close to zero. Mining companies sell their product into highly competitive global markets.
The resource rent tax was invented in the context of a developing economy that couldn't capture the benefits of mining operations. That is hardly true in Australia. Mines contribute to the economy through employment opportunities, local investment and knock on effects. Not to mention corporate tax. According to the latest ATO taxation statistics the mining industry paid 13.9 per cent of Australian corporate income tax with net tax to taxable income being 27.8 per cent in 2007-08. The average rate for all Australian firms was 24.55 percent. The Australian government does very well out of the mining industry.
There is an argument that a rent resource tax would constitute some sort of profit-share arrangement. But the appropriate mechanism for profit sharing is the equity market. Not only do miners already pay their fair share of the corporate income tax, but their profits are widely distributed through the community via equity ownership and compulsory superannuation. The structure of the rent resource tax could reduce miners' capacity to pay franked dividends increasing the government's tax take at the expense of those shareholders with low marginal tax rates.
The worst argument doing the rounds is that it doesn't really matter if a rent resource tax adversely impacted the mining industry. After all that industry is contributing to a "two-speed economy" and an over-valued currency. Bringing mining back to the pack would make macroeconomic policy making a whole lot easier. Not only is this argument economically defeatist; it is obscene. Taxing winners in order to provide essential government services is the very nature of modern taxation. Taxing winners in order to inhibit comparative advantage and undermine the imperative for ongoing economic reform is irresponsible.
The implementation of a rent resource tax will be fraught. To the extent that it only applies to new projects, we might not see any revenue gains for some time. Applying the tax to existing projects constitutes a sovereign risk hazard. Of course, it could substitute for existing royalty payments that miners already pay to State governments. It is not clear why the States should transfer those property rights to the Commonwealth at a zero price.
When evaluating the rent resource tax proposal some tough questions need to be answered. The Rudd government doesn't need new sources of income; it needs to cut spending. It can't really afford to place an additional cost on a highly productive sector of the economy without very careful analysis. Simply conjuring up a free-lunch and then taxing it is hardly sufficient.
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