Modelling the Excess Burden of Royalties

Abstract

The Australian Treasury contracted KPMG Econtech (2010) to estimate the efficiency cost of Australian taxes, using the MM900 Computable General Equilibrium model. The resultant report, endorsed by Treasury, was a major input into the Henry report into Australia’s Future Tax System (AFTS) and into the policy decisions that ensued. It was also widely cited in the debates that followed as justification for a new Commonwealth tax on mining. KPMG Econtech (2010) found an average excess burden (AEB) of 50%: royalties cost the economy 50 cents for a dollar of revenue, making royalties the second most inefficient major tax, after gambling taxes. KPMG Econtech also found that miners earn excess profits, by way of resource rents. Subsequently, AFTS recommended that royalties be replaced by an excess profits tax.

In MM900, in response to the fall in mining output and exports, private after tax income has to fall to restore foreign balance. So the first round impacts of royalties on mining output and exports are crucial to the estimate of an AEB. In partial equilibrium, the simulated fall in mining output of 7.5% means an AEB of 3.75%; general equilibrium effects apparently boost the AEB to 50%. However, we show that it is difficult, if not impossible, to understand from the report quite how such large effects are obtained or more generally, to reconcile the high estimated AEB with the data in the report. This is all the more troubling as KPMG Econtech’s own account of the industry — that, having paid royalties, it was still earning excess profits by way of resource rents — suggests that royalties had a low excess burden.