Australia Mining Super Tax Blunder Will Squeeze Global Economic Recovery

By: Money_Morning

Martin Hutchinson writes: Australia just this week unveiled a mining "super tax" that the country plans to levy against its natural-resources sector starting in 2012.

This is bad news.

It's not just because mining is Australia's most important economic sector: Australia is also an enormously important supplier of resources to the fast-growing economies of East Asia, where so many of the world's products are now manufactured. The mining super tax will cause prices to rise on the raw materials that are the key ingredients in so many of those products. And that means the levy from "down under" truly is bad news for the overall global economy.

With the newly announced mining super tax, Australia has shot itself in the foot. In doing so, unfortunately, it may also have peppered the rest of us with buckshot.

The Not-So-Super Tax
The rationale for the mining super tax (apart from ordinary government greed) was that the percentage of mining revenue taken in taxes and royalties by Australia's state and national governments has declined during the past few years as mineral prices have risen.

That's occurred because royalties are set at a fixed price per metric ton, and therefore decline in relative importance and prices rise. The new super tax would take an additional 40% of mining-company earnings - over and above a "reasonable" return on capital, defined as the yield on long-term Australian government bonds.

From the mining companies' point of view, this is an extra heavy burden. Since Australia's corporate tax rate is already 30%, the new super tax would raise the marginal rate on most profits to 70%. That's grossly excessive. It will badly discourage new exploration in boom years, since the additional profits to the mining company from a new discovery would be modest, indeed.

From an economic perspective, this is very dangerous.

You see, mining is a highly cyclical business. Every now and then, prices zoom up. When that happens, a surge in new exploration takes place - everybody gets out his pick and shovel ... and starts bashing away at rocks. That big up-tick in activity eventually results in a surge in production (after a delay that depends on the mineral concerned, and that may be prolonged by environmentalist opposition). The production surge brings prices back down, and brings the overall market back into balance.

Australia - the world's major source of several key raw materials - has actually created a disincentive to new exploration, which adds to the delays that are already caused by environmentalists, government permitting, and other parts of the exploration process.

That will make those already-existing mineral cycles that we described much more extreme. Indeed, it may do major economic damage if a particular crucial mineral (copper, for example) is in short supply: The price of that now-scarce resource - instead of collapsing after a year or two - may actually keep rising.

The Fallout
Looking at it from the other end, you can see why Australian Prime Minister Kevin Rudd wanted the new tax - it will give him lots of juicy new revenue to spend on pet projects (after all, he faces an election in October).

But here's a fact that's sure to shock you: Instead of improving Australia's budget position, the new mining super tax will actually make it much more difficult. And here's why. When prices are high, the tax will generate a bonanza of revenue - which will no doubt be funneled into all sorts of new projects and programs. But when prices fall, the tax will serve as a spigot that shuts off the revenue stream - leaving officials to search for funding for those new programs and thus exacerbating the cyclicality of Australia's resource-based economy.

The effect will be similar to that of California's capital gains tax, which left the state with a horrendous budget problem when the dot-com bubble burst in 2001. The only saving grace of this super tax is that - even if passed by parliament after the October election - it will not come into effect until 2012, by which time resources prices may have declined, making it irrelevant.

The worst effect of the new tax on the world's mining companies is the boost it gives to government greed in other countries. Australia is one of the world's main mining centers and is generally regarded as a business-friendly country.

Up and down Latin America and Africa, dodgy dictators and sleazy socialists will now feel themselves empowered to renegotiate existing mining contacts to give themselves more of the loot. In short, worldwide-mining-company profits have been endangered by Australia's foolish action.

There are at least three countries in which mining company profits may be less-affected by new super-tax-type levies - namely the United States, Canada and China.

In the United States, a change in mining company taxes of this kind would not bring in all that much revenue - relative to the U.S. budget problems - and would provoke a huge-and-prolonged political battle.

Canada - like Australia - is a major source of global-mining-company profits. Canada - unlike its Australian counterpart - is run by a conservative, pro-business government that is well aware how fortunate the north-of-the-border nation is to have the large resources sector that has deflected the fallout from its southern neighbor's financial-crisis-spawned recession.

And China, whatever its faults, has shown no inclination to copy the mistakes of foreign countries, so whatever deals are now possible there will remain possible.

Companies to Watch
As mining company investors, we have been badly affected by Australia's action - regardless of where the companies we've invested in operate.

Of course, BHP Billiton Ltd. (NYSE ADR: BHP), headquartered in Australia, has been badly stung by the move: Most significant of all, its iron-ore joint venture (JV) with Rio Tinto PLC (NYSE ADR: RTP) has been put in doubt. Rio and BHP, the No. 2 and No. 3 iron-ore exporters, are seeking to combine their Australian operations in 50-50 JV; Bloomberg News reported that a "material-change clause" in the deal agreement could be triggered by the super-tax law, enabling Rio to pull out of the venture.

However, companies such as Cliffs Natural Resources Inc. (NYSE: CLF) - which has only moderate exposure to Australia - have also been badly affected, and even mining companies like Teck Resources Ltd. (NYSE: TCK), which have no substantial operations in Australia, have been knocked back.

Truly the Australians have managed to shoot us ALL in the foot.

Source : http://moneymorning.com/2010/05/07/mining-super-tax/

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