Is state sovereignty relevant to resource rent taxation?

The Henry tax review into Australia’s future tax system recommends:

‘Subject to transitional arrangements, the new rent-based tax should apply to existing projects, replacing existing charging arrangements. The allocation of revenue and risks from the new tax should be negotiated between the Australian and State governments’.

The federal government seems to be attempting to ignore this advice in imposing the new tax. It is proposing to reimburse mining companies for existing royalty payments rather than to replace existing charging arrangements. It has decided unilaterally how it proposes to use the additional revenue from the new tax. In selling the tax to the Australian public it is asserting that mineral resources are owned by all Australians, contrary to the legal position of ownership by the Crown, with state governments having constitutional authority for resource management.

The government of Western Australia is threatening a constitutional challenge to the new tax, but the federal government doesn’t seem to be particularly concerned about this. I’m no lawyer, but I imagine the federal government think they are on safe ground in calling the tax a profits tax rather than a resource rent tax.

However, even if the new tax is legal, I think the federal government should be concerned about the viability of their proposal not to reimburse mining companies for any new or additional royalties that might be charged by state governments. Whatever the High Court might decide about the validity of the new federal tax, it is not likely to rule that the imposition of a new tax by the federal government has extinguished the rights of state governments to raise royalty rates.

Are state governments likely to impose additional royalties? Some proposals for higher royalties were already in the pipeline in Western Australia prior to announcement of the new federal tax and it is possible that these charges will be accommodated in transitional arrangements. The state governments review their royalty charges from time to time and I imagine that they will continue to do so. It is quite possible that having read and digested the Henry report a state government could decide to change the basis of their charging arrangements to a resource rent tax and to increase revenues from the resources sector. In considering such a change the state government might note that there is nothing particularly magical about the 40 percent tax rate proposed by the federal government. They might even read in the Henry report that Norway imposes a total tax rate on petroleum rents of 78 percent.

The point I am leading to is that the new federal tax has not extinguished the potential for state governments to raise royalty rates. This remains a potential source of sovereign risk for mining investment in Australia. This consideration is additional to the argument in my earlier post (Does a resource rent tax solve the problem of sovereign risk?) that the proposed application of the new tax to existing mines would lead investors to perceive that they have under-estimated sovereign risks in Australia. Even if the federal government comes up with satisfactory transitional arrangements for the new tax, miners will still need to factor into their calculations an allowance for possible future increases in state government royalties.

In my view the federal government should take another look at the recommendations of the Henry report and seek negotiations with state governments about the allocation of revenue and risks from their proposed resources rent tax.