MRRT hurts our silicon valley

HAVING given the Greens their tonne of flesh with the carbon tax, Julia Gillard is repositioning as quickly as she can to the middle. The "surprise" trip to Afghanistan, the Trans-Pacific Partnership, the proposed uranium sales to India and Barack Obama's visit to Australia all give the government a new, more mainstream gloss.

Two votes in parliament will also go in that direction: the conscience vote on gay marriage, which dooms the proposal to defeat; and the legislation for the mineral resources rent tax.

The Greens had wanted the tax rate on mining to be nearly double that of the MRRT. As for the Coalition, they oppose the MRRT but have not come up with an alternative way of funding the superannuation increases they now endorse. So Labor will stake a claim to the centre, positioned between extremist Greens on the one hand and a fiscally imprudent "Mr No" on the other.

That may well be good politics. For in terms of the distribution of costs and benefits, the MRRT is like the carbon tax in reverse: the carbon tax imposes a hidden slug on the many to benefit a handful of Greens and a gaggle of their cronies; the MRRT taxes the few to finance highly visible giveaways to the many. For a government addicted to raising taxes, that is as good as it gets.

But, no matter its popularity, the MRRT is shockingly bad policy. That should hardly come as a surprise. It was, after all, born out of a bargain between a desperate Gillard government and mining's big three. The government needed to buy the big three miners' silence; but it also needed to raise revenues. The result was a tax that is bad for mining generally, but especially harsh on the smaller miners that were not in the room.

These differential impacts arise because the MRRT is a tax that depends on a miner's rate of return -- that is, the profits it earns compared to the capital it employs. And the rate of return at which the tax cuts in is the same for well-established mining operations as for new, still speculative, ventures. However, the latter are far riskier than the former. So just to compensate investors for bearing that greater risk, the more speculative projects have to earn a high return. But when they do pay off, the MRRT cuts in, taxing those high profits away. The result is a much higher effective tax rate on risky ventures than on those that have well-established profit streams.

In a recent paper, Jonathan Pincus, Mark Harrison and I find an MRRT tax rate that is five times greater on a hypothetical risky project than that on a project with relatively stable earnings. And the effective tax rate on the risky project works out at a whopping 70 per cent, surely enough to discourage investment.

But the MRRT's defects do not end there. The justification for the original super-profits tax was that it would replace royalties or at least reduce the distortions they created by reimbursing miners who had paid them. That meant royalties would no longer lead miners to produce less than they otherwise might, or shut down sooner than they otherwise would.

But the MRRT is perverse in that respect. Because royalties can be offset against MRRT liabilities, it encourages states to increase their royalty rates, as they indeed have.

But it does not reimburse royalties to projects that are not sufficiently profitable to have offsetting MRRT liabilities. Marginal projects will therefore be even more adversely affected by royalties than they previously were.

In short, the MRRT worsens an existing distortion -- the one associated with royalties -- while adding a new one, the tax on mining projects that are viable only at high expected rates of return. Moreover, those distortions interact, since risky projects face the prospect of paying higher royalties if things do not go well, and high effective MRRT rates if they do.

That is bad news for all miners, big or small, as it reduces the attractiveness of risky projects they would otherwise have undertaken. But it is especially bad news for smaller miners, as they depend on those projects to a greater extent. And it is even worse news for the community as a whole.

For the MRRT is a tax on precisely the kind of entrepreneurship that has underpinned Australia's high living standards: the entrepreneurship involved in pioneering new uses of our natural resources. That has been this country's Silicon Valley; but it is also a graveyard where, for every Lang Hancock, there are scores of failures.

That, however, is not the mindset from which the MRRT springs. Rather, the MRRT betrays a mindset that views mining not as an unending challenge, carried out in some of the harshest environments this planet holds, but as a source of easy profits, born of merely digging holes in the ground. And that mindset, while putting manufacturing on a pedestal, ignores the fact that mining is now at the forefront of technology, deploying processes of staggering complexity.

None of that will stop the government, cash-strapped as it is, from going ahead with the MRRT. But to limit the damage, Fortescue Metals has proposed the legislation be amended so that smaller miners do not pay higher effective tax rates than the big three. No doubt, FMG's proposal is self-interested. Yet there is enduring merit in the principle of "no taxation without representation". Governments should not be allowed to use backroom deals to impose higher taxes on those excluded from the deal-making than on the government's (however reluctant) mates.

This should not, however, let Tony Abbott off the hook. He is right to oppose the MRRT. But he needs to set out an approach that works with the states to put the taxation of our mining resources on a sounder footing. Ignoring the states' role as owners of those resources was an inherent flaw in Labor's approach; it has helped lead to a tax that is inefficient in itself and further damages our already battered fiscal federalism.

Abbott can hardly solve these problems overnight; but he should define a broad framework for doing so. As for Gillard, she can sing "clowns to the left of me, jokers to the right" as much as she likes: the test lies in the quality of her policies, not in the spin put on them.

Yes, reversing Labor's foolish ban on uranium exports to India is a good idea. But she can hardly claim the centre ground while undermining the risk-taking on which our future prosperity relies.