State governments are well within their rights to raise mining royalty rates.
THE move by the NSW government to raise royalties on the state’s mining operations is an understandable reaction to federal government policy.
While it may seem obvious that the newly minted NSW Liberal government has chosen to undermine federal Labor’s mining tax by increasing royalties, that is not the only reason the resources sector was chosen.
The Commonwealth Grants Commission administration of GST allocations is just as pertinent in this issue; it’s just that the mining tax helps make the decision easier.
Perverse as it may sound, if federal Labor had listened to the Western Australian government’s call for a review of the GST system it may not now have the issue where the mining states have a big incentive to erode the proposed new Minerals Resource Rent Tax.
The issue at the heart of this is the way GST is calculated.
As I have written before, the system is ridiculously constructed to incentivise the states to raise taxes and penalise those that lag or even cut taxes.
This is because the system is built around averages. The grants commission looks at each particular tax – such as mining royalties – and determines an average rate across Australia. It does that by combining all the taxable mining revenue and comparing it with all the royalty revenue to discover the average rate. Once it has that average it applies it to the mining revenue in each state and assumes that is what is raised.
That assumed figure then adds to the particular state’s overall revenue, which is divided by population to determine how much GST it will be allocated.
So a state that collects below-average royalties loses twice: because it receives less in royalties per dollar of mining revenue than other states; and, because it is assumed to have collected more, it also receives less GST. Arguably the state can bear the first by creating some form of comparative advantage to encourage investment, but when it is then multiplied by the impact on GST it becomes harder to stomach.
Now, mining royalties are not quite as simple as that. Apart from royalties specially agreed with the Commonwealth, like those from the North West Shelf, the grants commission has split the royalty base into two general types – low-value commodities and high-value ones.
Low-value commodities command royalties below 5 per cent, while the high-value ones sit above 5 per cent.
At a royalty rate of 7.38 per cent, export coal, which is the key commodity taxed by NSW and Queensland, was in the high-value area in 2008-09. That was at or around the high value national average of 7.39 per cent.
WA does alright in this area on a state-by-state basis. It is nearly on par with the national average, which means the actual revenue it earns from high-royalty minerals – $890.6 million in 2008-09 – was very close to the assessed value of $898.6 million given to it by the grants commission that same year.
But NSW was clearly underperforming by having a state average tax rate of 6.77 per cent in 2009-09, earning it just less than $1.16 billion in actual revenue from high-royalty minerals when the grants commission assessed it as having earned more than $1.26 billion. That is more than $100 million that the commission pretends NSW earned when making its calculations.
Queensland was in the opposite camp, having a state average of 7.71 per cent for high-royalty minerals, which earned it almost $3.17 billion, while the commission assessed it as having raised a little more than $3.03 billion, suggesting it earned about $130 million more from this income stream than was included in the GST calculations.
That is background against what is taking place now.
While the grants commission’s 2010 report shows that the fines iron ore average rate was 4.69 per cent nationally, keeping at the top end of the lower value royalty bracket, the WA government’s rate in the 2010 budget was 5.625 per cent. That meant it was at the lower end of the high-value bracket and would, therefore, be costly to the state because it was well below the bracket’s average and would most likely significantly increase the difference between the amount assessed and the amount actually raised.
If that had been the rate in 2008-09 I calculate the actual income from iron ore royalties (fines and lump) would have been more than $400 million less than the amount the grants commission would have assumed for its assessment. That would have significantly affected the amount the state would otherwise have received from GST redistributions. Presumably that happened last year when the rate was actually at that level, but the most recent grants commission report doesn’t provide the numbers for me to work that out.
No wonder WA announced it would lift the royalties on iron ore fines to 7.5 per cent by 2014. In the context of the GST allocations alone that would have been a reasonable decision, at least from a state government perspective. Of course, there could be an argument from the miners that this cost would impact on investment decisions, but that is for the state to balance with the threat of significant erosion in GST grant income.
With the imminent arrival of the minerals tax, however, the move to raise rates is an absolute no-brainer, because the mining companies now face a much bigger tax from the federal government and the state can claim that if it doesn’t take the royalties it is simply transferring wealth to the Commonwealth.
So, in my view, the federal government is hoist on its own petard with this one.
Prior to the mining tax, the states’ arguments about GST allocations were falling on deaf ears because, in reality, the states had signed up to the deal and their various treasury departments ought to have considered this issue in their advice.
Furthermore, the states had it within their power to raise taxes above the national average, especially WA, which had a lot of room to move on iron ore royalties.
The problem for the states was that pushing individual taxes up, including royalties, was bad for business. That is why they chose, instead, to complain about Canberra’s formula for its application by the grants commission.
The mining tax changes that with respect to royalties. It is such an expensive attack on the profits of mining companies that it has become a much bigger threat to investment than royalties.
Furthermore, the federal government agreed (although it has backpedalled somewhat on this) to include royalties as a cost for the purpose of calculating the mining tax. That means it has given the states a free hand to capture revenue and race each other to raise royalties rates because they no longer see that as a significant impact on mining investment.
It is another massive policy blunder by Prime Minister Julia Gillard and Treasurer Wayne Swan.