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Alistair Watson
Fiscal Affairs DepartmentInternational Monetary Fund
Key Issues in Natural Resource Taxation in Developing Countries
RESOURCE MOBILIZATION IN SUB-SAHARAN AFRICA
Nairobi, Kenya, March 21-22, 2011
“There are few areas ofThere are few areas of economic policymaking in which the returns to good
decisions are so high – anddecisions are so high and the punishment of bad
decisions so cruel – as in the management of natural
resource wealth”
PrefaceDominique Strauss-Kahn
Managing Director, IMF
2
Diverse Experience so far…Diverse Experience so far…
Receipts from Natural Resources, averages 2000–07
90
100
p , g(selected countries, percent of government revenues)
60
70
80
20
30
40
50
0
10
20
Iraq
Om
anuw
ait
iger
iaui
nea
Liby
ang
ola
ahra
inbl
ic o
fA
rabi
aem
enlg
eria
Lest
e A
rab …
Qat
arIr
anba
ijan
Suda
nzu
ela
nist
anw
ana
publ
icob
ago
mé
& …
Mex
ico
etna
mhs
tan
Chad
eroo
non
esia
orw
ayua
dor
Bol
ivia
Rus
sia
uine
aui
nea
Chi
leta
nia
ombi
aG
abon
ngol
iaib
eria
mib
iaPe
ruAf
rica
Leon
eor
dan
3
O Ku Ni
Equa
tori
al G A B
aCo
ngo,
Rep
ubSa
udi A Ye A
Tim
or-
Uni
ted Q
Azer
b SVe
neTu
rkm
enB
ots
Syri
an A
rab
Rep
Trin
idad
and
To
São
To M Vie
Kaza
k
Cam
eIn
do No
Ecu B R
Papu
a N
ew G G
Mau
ritCo
lo GM
on LiN
a
Sout
h A
Sier
ra L Jo
Significant PotentialSignificant Potential
• Only 20% of Africa’s natural resources• Only 20% of Africa s natural resources discovered so far (Collier)
• If correct flows from natural resources may• If correct, flows from natural resources may dwarf other sectors
P i l f T f i P j• Potential for Transformative Projects– Oil: Ghana, Uganda, Niger, (Sierra Leone? Liberia?
Tanzania?)Tanzania?)
– Iron Ore: Guinea, Liberia; Sierra Leone; Tanzania
– Nickel: Tanzania, BurundiNickel: Tanzania, Burundi
– Uranium: Niger, Tanzania, Namibia4
Mobilizing Revenues from Natural Resources
1 Id if h1. Identify the resources2. Allocate rights3. Design the fiscal regime4. Administer the fiscal regime5. Manage the revenues
• All of these need to be done right• Focus today on (3) - resource tax design• Focus today on (3) resource tax design
What’s So Special About Resources?What s So Special About Resources?
• Size of sector (even individual projects) relative to the• Size of sector (even individual projects) relative to the economy
• Tax revenue is the central benefit to host country
– Leveraging other economic development an ongoing challenge
• High sunk costs long production periods• High sunk costs, long production periods
– Create ‘time consistency’ problem
• Substantial rentsSubstantial rents
– The ideal of a non-distorting, immobile tax base!
• International considerations loom large
– Foreign tax rules matter
– Tax competition
UncertaintyUncertainty
• From geology technology price volatility• From geology, technology, price volatility…
14,000
Copper (real 2010 prices)
130
Crude oil (real 2010 prices)
8,000
9,000
10,000
11,000
12,000
13,000
onne80
90
100
110
120
el
3,000
4,000
5,000
6,000
7,000
,
$US
per m
etric
to30
40
50
60
70
$US
per b
arre
d li i l i k
0
1,000
2,000
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 20100
10
20
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
• …and political risk
Forecasting Prices is Hard
U.S. Department of Energy Annual Energy Outlooks (AEO) 1982-2004 (2006 U S Dollars per Barrel)
Forecasting Prices is Hard…
80
90
100
(2006 U.S. Dollars per Barrel)
AEO 1982
50
60
70
$ pe
r ba
rrel
AEO 1985
10
20
30
40US
$
AEO 1991
AEO 2000AEO 1995
AEO 2004
0
10
Sources: U.S. Department of Energy Outlook (1982,1985,1991, 1995, 2000 and 2004); and IMF World Economic Outlook (2003,2004,2005,2006,2007, 2008, and 2009). After Ossowski et. al. (2008)
Note: Solid lines on the left chart are spot WTI oil prices, on the right chart are WEO average of WTI, and Fateh. The dashed lines are price projections.
What Else?What Else?
• Asymmetric informationAsymmetric information
Few of these are unique to resources—they’re just bigger. gg
What is unique is:
• ExhaustibilityExhaustibility
– Opportunity cost of extraction includes future extraction forgoneg
– Views differ on how important this is in practice
– Ideally: recognize revenues as transformation ofIdeally: recognize revenues as transformation of finite asset in the ground into financial asset
Menu of MechanismsMenu of Mechanisms
• Taxes on inputs – import duties excises• Taxes on inputs import duties, excises
• Taxes on revenues – royalties
fi i• Taxes on profits – corporate income tax
• Taxes on rent – resource rent tax
• State equity participation
• Many variations on each themeMany variations on each theme– progressive royalties, windfall taxes, variable
income tax, free equity vs. carried equity, etc.income tax, free equity vs. carried equity, etc.
• Production sharing (petroleum) 10
Economic RentEconomic Rent
P1
Not viable
i bl
sts/
pric
e
Rent
Viable
P j t BProject C
DE
F
uctio
n co
s
Project AProject B
Pro
d
Cumulative Production Prod1
Effect of RoyaltyEffect of Royalty
P1Royalty
P
sts/
pric
e
Rent
RoyaltyP2
P j t BProject C
DE
F
uctio
n co
s
Project AProject B
Pro
d
Cumulative Production Prod2
Effect of Import DutiesEffect of Import Duties
P1
P2 I Duties
I. D.
I.D.
Royalty
osts
/pric
e
Rent
P2
Import Duties
I Duties
I Duties
I Duties
j AProject B
Project CD
EF
oduc
tion
co Import Duties
Project A
Pro
Cumulative ProductionProd3
Resource Rent Tax – “Neutral”
P1
Rent tax Rent taxRent Tax
osts
/pric
e
Rent
Rent tax
Project BProject C
DE
F
duct
ion
co
Project Aj
Pro
Cumulative Production Prod1
Rent TaxesRent Taxes
• Various possible forms, with differing revenue paths p , g pand risk sharing– Brown tax, Resource Rent Tax, ACE*
• For true neutrality, relief required for exploration costs and loss-making projects
• Government taking on risk and deferral of revenue• Government taking on risk, and deferral of revenue• Norway perhaps closest today• Australia’s proposed RSPT; now MRRT• Australia s proposed RSPT; now MRRT• For a developing country RRT useful, but maybe not
as the primary fiscal sharep y
* Allowance for Corporate Equity
How Important Is Progressivity?How Important Is Progressivity?
...in sense of government’s share being larger the...in sense of government s share being larger the higher are prices/profits/lifetime project return?
• Yes, if government better able to bear risk than , ginvestor– But opposite likely true in many developing countries
• Political pressures may make progressive systems more robust and credible– Long accepted objective in Petroleum fiscal systems
– Increasingly recognized in Mining
Multiple Instruments Neededp
• In order of efficiency taxes on: (1) Rent (2) Profits (income y ( ) ( ) (tax) (3) revenues (royalties) (4) inputs
• Taxes on inputs usually exempted
• Royalties distort but may still have an important role:– Revenue from day 1 of production
– Easier to administer – no need to measure costsEasier to administer no need to measure costs
• CIT usually applied– Create creditable tax and consistent treatment with other sectors
• Common framework: (1) Royalty + (2) CIT + (3) rent capture mechanism (RRT)
• But significant diversity in detail• But significant diversity in detail…
Careful Evaluation is CriticalCareful Evaluation is Critical
• Developing countries do not do this well
• Project economic modeling is vital
Four key indicators • Average effective tax rate (AETR): the tax share of net cash flow
discounted at a chosen rate
• Marginal effective tax rate (METR): the tax “wedge” between the g ff ( ) gpre- and post-tax rate of return
• Breakeven price: the output price required to yield a specified post-tax return to capitalp
• Progressivity: E.g. variation of government’s share with project return
plus measures of effects on risk sharing… plus measures of effects on risk sharing
Detail matters
Government share of Total Benefits Discount rate 15 percent2004; 4% Royalty;
Detail matters
30%
35%
40% Tanzania 1997
Tanzania 20042004; 4% gross royalty
00 ; % oya ty;0% equity;
20% Resource Rent Tax
10%
15%
20%
25%
Tanzania 4% royalty2004; 4% Royalty;
0% free equity
2004
Difference 1997 - 2004:15% uplift
0%
5%
10%
10% 15% 20% 25% 30% 35% 40%
P T IRR
Tanzania 4% royalty; 0% free equity
Tanzania 4% royalty; 0% free equity + RRT
1997 terms 75% (2004) versus 100% (1997) debt
Pre Tax IRR
▫ Depreciation rules ▫ Indirect taxes (import duties, VAT)
• FAD’s models can be used for detailed evaluation of fiscal terms changes:
22 April 2010 19
▫ Royalty rates and basis ▫ Government equity participation
▫ Thin capitalization/Debt leverage ▫ Ring fencing
The Pros and Cons of AuctioningThe Pros and Cons of Auctioning
• Get investors to compete with each other not• Get investors to compete with each other, not the government
• Use auctions to soak up perceived rent• Use auctions to soak up perceived rent
• But, requires a competitive situation with h lenough players
• Design matters—including bid variables
• Implementation matters as much (or more)
• Why so little used for minerals?Why so little used for minerals?
Set Generally Applicable TermsSet Generally Applicable Terms
• Developing countries often end up negotiating• Developing countries often end up negotiating deals for major projects case by case– Lack of legal framework and effective fiscal regime– Lack of legal framework and effective fiscal regime
– Huge burden on technicians and decision makers
An uneven contest– An uneven contest…
• FAD advice: set generally applicable terms and id b ti tiavoid case by case negotiation
– Cross reference generally applicable terms (e.g. t l ) i d l t ttax law) in development agreements
21
Administration— is it That Hard?Administration is it That Hard?
• Technical complexity, new to administratorsTechnical complexity, new to administrators
• Dealing with complex MNCs always hard
• Use reference commodity prices• Use reference commodity prices
• Do the simple things right; exercise audit rights!
• Royalties not as easy to administer as may seem• Royalties not as easy to administer as may seem…
• … But rent taxes maybe not as hard
• Building capacity:• Building capacity:– Specialize – Large Taxpayer Office
– Hire in expertsHire in experts
Stability and CredibilityStability and Credibility
• Takes years to develop (Norway)Takes years to develop (Norway)
• Easy to lose (Australia?)
• But credibility does not mean no change (UK )• But credibility does not mean no change (UK )
• Potential for future discoveries may help
• Fiscal stability agreements?• Fiscal stability agreements?– Can be over-generous and create administrative problems
– Effectiveness unclear—renegotiation always possibleEffectiveness unclear renegotiation always possible
• Some designs more credible than others– Flexibility and Progressivity?y g y
The Book…The Book…
• Overview: Concepts and low pincome country issues
• Sectoral issues (oil, minerals, )gas)
• Special topics (evaluation, RRT, state participation, , p p ,auctions)
• Implementation( d i i i i i l(administration, international tax)
• Stability and credibilityStability and credibility
AimsAims
• Consolidate and take forward current knowledge inConsolidate and take forward current knowledge in the field (topic fell out of fashion).
• Link public finance and resource taxation literaturep
• Wide audience: academics, practitioners, companies, government and civil society.g y
• Best practice? No – concentrates on principles, criteria and methods to apply in different circumstances.
• Combines theory and practice
IMF (FAD) Actively EngagedIMF (FAD) Actively Engaged
2626
ThanksThanks
The Taxation of Petroleum and Minerals:
Principles, Problems and Practice
Edited by Philip Daniel, Michael Keen,
and Charles McPherson
Routledge / IMF, 2010
www.imfbookstore.org
www.routledge.com/978-0-415-56921-7www.routledge.com/978 0 415 56921 7