Peter Smith

Wrong advice from Ken Henry

Where was Sir Humphrey when we needed him?

Is anyone else besides me getting as impatient with Ken Henry as he seems to get when asked testing questions by parliamentarians?

At the senate hearings on 27 May, he is reported to have said that taxes on profits don’t affect prices. That is apparently what he learned at ‘high school’. What is the school bit about? It seems so dismissive and patronising to make such a reference. Economics in the area of the incidence of taxation is very complex and not easily understood. It is reasonable to conclude that part of the incidence of increased taxes on companies will eventually fall on consumers. Someone has to pay them; companies are legal artefacts. People pay taxes in the end result.

In any event, Dr Henry is quite wrong. His school economics, unsurprisingly, was astray. (I once marked some school economics exams and it was not an elevating experience.) Increased taxes on profits might, in part, be passed on directly or indirectly to consumers, if the taxed entity has a degree of market power. Demand doesn’t have to be a straight vertical line as Dr Henry suggests but only ‘inelastic’; so that any increase in price is met with a less than proportionate decrease in demand. In the end result, less of whatever is the product is supplied at a higher price.

Let’s be fair and assume that Dr Henry actually meant taxes on rent rather than profit. Rent is akin to an OBE (Other Buggers’ Efforts); it accrues because of what one owns or leases rather than what one does. There is a stronger case for believing that in the case of rent, taxation will have no affect on production or price. The taxed recipient of the rent simply earns less of it. However even here, it is not necessarily true when capital is scarce and when rental earnings are available elsewhere. Capital will tend to flow to where rental earnings are higher. So taxing rent in one area can affect supply and therefore prices in that area and in related downstream areas.

Once account is taken of international trade, the issue becomes more complex. If the RSPT lowers the rental income miners currently earn through their leases (once they have deducted royalty payments to state governments), they will tend to take relatively more of their capital offshore where higher rent is to be earned. This will tend to lessen capital inflow into Australia and future foreign earnings and, through this, depress the exchange rate. A lower exchange rate will increase the price of imported goods and services and may have a flow-on affect on prices generally.

Dr Henry is also reported to have said to Senators Abetz and Joyce that the RSPT at higher rates than 40 per cent would not have an impact on mining investment; even apparently if it went to 70 or 80 per cent. When asked what would happen if the tax went to 100 per cent, he reportedly said, that in this case the government would have to finance all of the investment itself. And choose which investment to make?

This really takes the cake; it is divorced from reality. We are in cloud-cuckoo land. Mining is for miners and it is not a matter of fine calculation. Mining investment is jumpy, jerky, imprecise and discontinuous. It does not conform to economic models and it is incumbent on an economist, when asked by non-economist parliamentarians, to explain that. And who is best able, and should make these judgements on mining investments: the mining industry with its experience and with private capital or government bureaucrats with taxpayers’ money? It is not hard to answer that one. 

When a mining company is deciding to invest many millions, and sometimes billions, of dollars over a period of years before any return can be expected, it is not calculating that it might, if everything turns out well, earn one or two per cent over the government bond rate. Nor is it banking on the government picking up part of the tab if all those millions or billions are lost. It is expecting to earn a large after-tax profit. Otherwise, why bother? It is therefore without substance or sense to say that taxation, however confiscatory, will have no impact on the level of mining.

The situation is parlous. Instead of a reckless government (seeking to impose punitive taxation on Australia’s most important industry without consultation) being held back by its hard-headed economic adviser, we have it being cheered on. Where was Sir Humphrey when we, and the Government, needed him to caution against this embarrassingly flawed and ‘brave’ decision?

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