KPMG and the stupidity of Rudd's resource rent tax
Gerard Jackson
In what it evidently thought was a major strike against the opponents of its resource rent tax the Rudd Government hauled out a paper by KPMG Econtech purporting to show that not only would the tax increase real wages and spur economic growth it would also cure baldness and halitosis, at least that's how it sounded. Naturally Rudd's media mates thought KPMG had thoroughly skewered the tax opponents. What it actually proved is that media commentators like Laurie Oakes should be kept away from sharp instruments. Having people like this expound on economic matters is like getting a plumber to remove an appendix.
To understand what is wrong with KPMG's conclusions we must first determine why the theory upon which they are based is absolutely false. Once that is done no amount of fancy statistical techniques can salvage it. When economists speak of rent they do not do so in the sense that the layman does. For him rents are correctly perceived as time payments for the hire of a service, whether it be a house or a car. In orthodox economics, however, rent is an unnecessary surplus, a differential created by the appearance of marginal land. As such it can be safely taxed away for the 'benefit' of the community without harming investment, output or unemployment.
There is a myth that the theory of economic rent originated with David Ricardo and that it was accepted as a sound doctrine by all of the classical economists. Neither is true. Not only did the economic rent doctrine preceded Ricardo it was soundly rejected by his contemporaries, James Stuart Mill being a notable exception. They pointed out the obvious fact that rent is determined by supply and demand and that the price of land is set by the value of its services and not the emergence of marginal land. More than 180 years later we now have a government with the full support of the Treasury trying to impose on the country a tax based on this economic fallacy.
In plain English, what is grossly misnamed "economic rent" is in fact nothing but a profit. That KPMG cannot grasp this was made clear by its statement that the tax would not have a detrimental effect normal profits. There is no such thing as normal profits. All profits are abnormal. What it calls a normal profit is what would prevail in a state of general equilibrium a condition in which profits and losses cannot exist and would in fact be the rate of interest. This is an interesting point because KPMG admits that it used a general equilibrium model to obtain its results. What it didn't say is that these models have been embarrassing failures.
Now it's true that you can use and should both the partial and general equilibrium approach in explaining the effects of a tax. To conclude from this that these effects can be quantified and the path of the economy predicted with any degree of precision is to make a grave error. The situation is particularly bad with respect to the resource rent tax because the model is based on false assumptions about the nature of the tax and profits. KPMG asserts that the tax "has an excess burden of zero". Why? Because
[t]he incidence of the RSPT is also a result of the immobile nature of the natural resources on which it is levied. Since there is no change in the supply of mineral resources
. This outcome rests on the modelling assumption that the RSPT only taxes the economic rents earned from immobile factors, in this case mineral reserves.
This is plain silly. It is not mobility that matters but accessibility. If theses resources are accessible in other parts of the world and they are and capital is mobile and it is then in a sense this means that minerals are as mobile as capital. Therefore the argument that the tax is justified because of the "immobile nature of the natural resources" collapses. In addition, the theory properly understood does not recognize minerals as factors of production otherwise they would be earning what Alfred Marshall defined as 'quasi-rents' but as land which can be transformed into higher-valued goods, including capital goods.
KPMG asserts that the tax has a "zero economic cost". This is in keeping with the orthodox view (we might call it the Ricardo-Mill view) that treats "economic rent" as an unearned surplus that drains resources away from the rest of the community. A ridiculous opinion that Treasury head Ken Henry like the majority of economists seems to have completely swallowed, believing as did Mill, that the
The incomes of landowners are rising while they are sleeping, through the general prosperity produced by the labour and outlay of other people. (John Stuart Mill, Public and Parliamentary Speeches, University of Toronto Press, 1988, p. 422.)
Mill made the above statement in a speech to the Land Tenure Reform Association in May 1871. For Mill like Ken Henry and the geniuses at KPMG it was blindingly obvious that a tax on economic rent was vital in order to improve the country's economic welfare. Unfortunately for Mill prices for agricultural land had already passed their peak and were heading down and, apart from WW I, did so for about 70 years. An acre of land that cost $100 in 1870 could be bought for $10 in 1930. If Mill had have had KPMG's model he would have been able to claim that it had been proven with mathematical precision that a resource rent tax would be costless because wait for it the "immobile nature of the natural resources".
In economics there is the concept of opportunity costs. This is what has to be given up in order to obtain a good or service. Hence the true cost of a television set is not the mount you pay for it but the other goods and services you had to sacrifice to buy it. It's exactly the same when a business makes an investment decision. So when KPMG asserts that a resource rent tax will have a zero cost for the mining industry it is in fact declaring that the tax has no opportunity costs.
In other words, rather than invest this so-called 'surplus' the mining industry has apparently been burying it. My God, where in heavens name do those economic sages at KPMG and the Treasury think the mining industry gets the funds to continually to buy masses of costly equipment, pay the highest wages for labour in the country and continue with exceedingly expensive exploration projects while at the same time attracting more capital?
Incredible as it might seem, KPMG says it doesn't matter if this funding is denied to the industry because it simply involves a transfer "from these industries to the government sector". For sheer economic stupidity this takes some beating. Talk about Keynesianism running amok. What KPMG is saying is that ultimately it doesn't matter whether politicians and bureaucrats spend the money or the mining industry because total spending remains the same.
Let's return to Mill for. What is remarkable about his statements regarding the taxation of economic rent and the ownership of land is that they display a total ignorance of historical and economic reality. For example, the so-call economic rents that emerged during the Napoleonic Wars resulted in an enormous increase in agricultural techniques and investment, which naturally required a great deal of supervision and entrepreneurship. Yet according to Mill landowners simply accumulated wealth in their sleep without the slightest effort. Even if Mill had been right at the time he wrote, how can this possibly justify the Rudd Government's tax on the mining industry?
As for KPMG's figures, they are utterly worthless. It's truly depressing to see people swallow these phony statistics. The present world-wide economic situation should have finally destroyed what faith anyone had in economic models. If cutting corporate taxes increases investment it follows that raising taxes on the mining industry will have the opposite effect. The fact is that Rudd used taxpayers' money to get the result he wanted. For those who think I am impugning KPMG's reputation, chew on this little morsel: On Wednesday 2 June the Australian Financial Review carried a story in which it quoted KPMG as stating:
The [RSPT] report backs the industry concerns that miners will find it hard to raise project funding under the government's 40 per cent guarantee, leading to higher and more complex finance arrangements than Treasury has forecast.
This the very same KPMG that has now announced that the RSPT cannot hurt the industry because "in theory there is no economic cost to the RSPT"! Readers can draw their own conclusions regarding KPMG's integrity or lack of.
Note: It used to be said that a government should never set up a Royal Commission unless it knows beforehand what the results will be. This now seems to be the case for outside economic reports.
Rudd's disastrous resource rent tax: how the right let the country down again
Kevin Rudd and the mining industry's super profits myth
Ken Henry's fallacious resource rent tax and the mining industry's failed response
The Treasury wants to impose the fallacious rental resource tax on mining companies
Ken Henry's dangerous fallacy of taxing "imputed rent"
Gerard Jackson is Brookesnews' economics editor
BrookesNews.Com
Monday 14 June 2010