High School Economics

A Notion by Grog’s Gamut – Originally posted 27/5/2010 on Grog’s Gamut’s Blog

This morning at the bright and early time of 7:50am, the Secretary of the Treasury Ken Henry, fronted Senate Estimates (the pdf Hansard file is here). In the two hours he answered questions, he handed out some pretty big (but subtle) smacks to the critics of the RSPT. When asked about various responses to the RSPT he used wonderfully understated phrases like: “I don’t want to say the miners are wrong…”, and when Barnaby Joyce said to him that oil drilling was different to mining for minerals he deadpanned: “It’s amazing what one learns”. He also had to do a few “If by that you mean …” to try and give the Senators’ questions some sort of logic.

He was at his best when he was talking about two topics – the first that the mining industry kept Australia out of the recession, and the second that the RSPT will increase prices.

He knocked the first one on the head pretty easily saying:

“I’ve heard it said on a number of occasions, in fact I have lost count, that the mining industry saved Australia from recession. These statements are not supported by the facts”.

He pointed out that employment in the mining industry during the Global Financial Crisis went down 15 percent. And made this rather scary pronouncement:

“Had every industry in Australia behaved in the same way our unemployment would have increased from 4.6 per cent to 19 per cent in six months.”

Sam Maiden noted in her excellent summary of Henry’s appearance that both Julie Bishop and Tony Abbott – ie our prospective PM and Deputy PM (don’t worry, you weren’t the only one who just felt a chill run down your spine at that thought) – have recently made claims concerning the brilliance of the mining industry in saving Australia from recession. Here was Bishop on Sky News on May 4:

“Kevin Rudd likes to say that he saved Australia from the global financial crisis. In fact it wasn’t his pink batt scheme or his scandalous school building program that saved us from the recession. It was the mining sector that continued to export our resources to booming economies like China.”

Then Abbott at a May 6 press conference said:

“It is China’s demand for Australia’s raw materials which has kept us going through the global financial crisis and, more than anything else, prevented us from falling into the recession.”

Henry’s response might be worth remembering the next time you hear a friend say Rudd [or now Gillard] is trying to kill the golden goose.

Henry also dealt with the issue of the RSPT increasing prices. This was something I wrote about yesterday – and I have to say it was rather gratifying to hear Ken Henry point out that my economic knowledge had not led me astray. He said in a very cutting remark:

“I learnt in high school, from the study of economics, that profits-based taxes can’t affect prices.”

This is because taxes on production – like royalties – increase prices because they shift the supply curve (what this means is the cost of “supplying” or producing a thing – in this case minerals – becomes more expensive no matter how much you produce), whereas a tax on profits does not.

The Commonwealth Bank’s economist Michael Blythe put out a report straight after the Budget which showed this nicely. Here’s what the royalty regime does to the industry:

The royalty regime DECREASES supply (ie decreases mining). It doesn’t increase prices because the world price of minerals is taken as being flat – that is what people pay for iron ore is the same regardless of whether the iron comes out of Australia or Brazil or wherever.

This isn’t technically true for all minerals as BHP and Rio for eg will negotiate prices for iron ore with China, but when it comes to minerals such as gold, well there is a gold price (they usually mention it each night) and every gold mine in the world is beholden to it. In other industries such as those which sell minerals to local business it would. Eg if there was a royalty on granite mines.

So what the RSPT actually does (and I know this is counterintuitive – it’s why Tony Abbott really gets lost when he tries to argue against it) is that because the RSPT refunds the royalty regime (ie renders it null) it will actually be cheaper for miners to mine, and thus this “tax” will increase production – that’s because it is not really a tax, but is a rent.

Why then don’t the mining companies want the RSPT I hear you ask?

Under the RSPT the more profit they make, the higher their percentage of effective tax – pretty much just like income tax – a person who earns $150,000 pays a higher level of income tax than does someone on $40,000. The current arrangement would be like someone on $40,000 paying 45% income tax, but someone on $150,000 only paying 35%. Does that sound fair to you?

Me neither.

The mining company would be paying over 5o% effective tax – which is the figure that the Mining Executives like to bandy about (actually they cite 56.8 percent). But to pay that much tax would mean they are making well over a 50 percent return on their investment. Yes well over 50 percent! (Kinda makes your bank account interest seem a bit shabby, doesn’t it!)

In fact Ken Henry pointed out today that You only get a rate of tax of 56.8 if the rate of return is infinitely large. Last year BHP made around a 31 percent return. So you can see why they don’t like the RSPT. But does it increase prices of anything? No.