Econometrics gets no RSPT

Update: I had a look at the ATO Taxation Statistics, specifically tables 8 and 9 of the corporate tax statistics. I calculate two measures of effective tax rate. First just the Net Tax to Net Income and second Net Tax plus Royalty expense to Net Income. Results are shown below in the table. Note that Mining has the highest effective tax rate after accounting for Royalty payments.

Original Post: Both Julia Gillard and Wayne Swan have been out today saying that the mining companies don’t pay enough tax.

Mr Swan used independent analysis included in the Henry tax review to argue “ordinary workers” were getting ripped off by the likes of BHP Billiton and Rio Tinto.
“In Australia, wholly-domestic mining companies paid an effective tax rate of only 17 per cent and multinational mining companies paid an effective tax rate of only 13 per cent,” Mr Swan said in his latest economic note.
“Both (are) dramatically below the headline company tax rate of 30 per cent.”
By contrast, domestic manufacturers paid 25 cents of company tax for each dollar earned, while local retailers paid 27 cents in the dollar, during the period 2003 to 2007.
An average worker pays 30 per cent tax on every dollar earned above $35,000. Wealthier Australians pay income tax of up to 45 per cent.
“An ordinary worker who earns an extra dollar through their hard work pays higher tax, but a mining company that earns massive amounts pays the same flat, low rate of company tax,” Mr Swan said.
“That’s simply not fair.”

Either Swan doesn’t understand what it is Treasury are telling him, or Treasury (and the Henry Review) don’t understand the underlying paper that they are quoting (subscription required).

That paper is an unpublished NBER Working Paper Do Multinationals or Domestic Firms Face Higher Effective Tax Rates? by Kevin Markle and Douglas Shackelford. In their paper Markle and Shackelford compare the effective tax rates paid by domestic and multinational firms across 10,642 firms from 85 countries over the period 1988 to 2007. So far so good. The work horse equation in the paper is show here.

The explanation of all of that is found on page 7 of the paper.

To estimate the corporate income taxes paid by multinationals and domestics around the globe, we regress firm-level ETRs on categorical variables for the domicile of the parent and whether the company is a multinational. The regression coefficients on the categorical variables provide estimates of country-level ETRs for both domestic firms, i.e., those operating in the home country only, and multinationals, i.e., those domiciled in the home country but operating in at least one other country. These ETR estimates enable us to compare domestics with multinationals, both within countries and across countries, industries, and years.

I also want to pick out two of their footnotes where they provide valuable additional information.

11 To estimate equation (1), one industry and one year have to be excluded from the regression. To determine which industry to leave out, we calculate the mean ETR in each industry (two-digit NAICS) and then determine the median of those means. The industry with the median mean (code 31) is the one left out. We implement a similar procedure on the years, resulting in 2005 being the excluded year. To improve comparability across estimations, we exclude the same industry and year from each regression.

NAICS industry 31 is (some sort of) manufacturing. They do need to leave out one industry and one year so that the model doesn’t have what is known as a singularity problem, but that normally means that the coefficients must be interpreted relative to to omitted industry and year and that information is captured by the intercept terms. In this case there is no intercept and I expect that its all captured in the beta (zero) coefficient. That coefficient captures the average effective tax rate for each country given the country, industry and firm characteristics on average over the period being analysed. As they admit in footnote 12 (emphasis added).

12 Note that the magnitude of the domestic and multinational ETRs cannot be directly compared with the actual ETRs from the financial statements, which serve as the dependent variable. The domestic and multinational ETRs are the tax rates, conditional on industry, year, and size. That said, our empirical analysis shows that the estimated ETRs are very similar to the actual ETRs from the financial statements.

They then estimate their equation (1) and find the average effective marginal tax rate for various countries and differentiate between domestic and multinational firms. Overall they find the model fits well and the estimated effective tax rates and fairly close to the actuals. Then they estimate industry specific equations – that is what the Henry Review and Gillard and Swan are referring to.

This is how Markle and Shackelford describe what they do when coming to the industry analysis.

To assess whether ETRs vary across industries, we estimate equation (1) using industry groupings. We form the industries using two-digit NAICS codes and the 2003-2007 sample with total income tax expense in the numerator. We group two-digit codes to ensure that each reported industry has at least 900 firm-years. All observations are included in the regressions, but only cells with twenty or more observations are reported. Manufacturers comprise 49% of the firm-years.

Here is their table 4.

Note what they are doing. A comparison between domestic and multinational corporations across countries within the same industry. For mining, to take one example, Australian domestic and multinationals don’t have a statistically significant difference, but UK multinationals do. Or we can compare across countries. Given firm characteristics Australian mining firms have the same effective tax rates as do Canadian firms. And so on. It seems that the table is best interpreted up and down the columns and not across the rows. Across the rows are results from different regressions and the results should not really be compared to each other. Markle and Shackelford do not test to see if the estimates are statistically different across the rows so we can’t really know if they are or are not. When looking across the rows we are not comparing apples with apples. Given the difference in firm characteristics across industries do we expect all firms to have the same effective tax rate? I would think not. (It is true that Markle and Shackelford do comment briefly on the variatuon across industries within the US, but they don’t make much of that issue). In order to test whether the different industries have significantly different effective marginal tax rates Markle and Shackelford would have to re-estimate their equation and interact the country and industry variables. I don’t know if they have done that exercise but they certainly do not report the results of an exercise like that in their paper.

The Henry Report shows this table based on the Markle and Shackelford industry analysis.

To make the argument that the Henry Review does, and Gillard and Swan have repeated, we would need to see tests of statistical significance across the industries – something that Markle and Shackelford do not do. Rather they present tests of statistical significance across domestic and multinational firms. The evidence does not support the argument the Henry Report, Gillard and Swan have made. It is unclear what the Henry Report means when it says, ‘Their country-specific estimates show significant variation in effective tax rates across sectors’ (emphasis added). There are no tests of statistical significance in the Markle and Shackelford paper to support that statement.

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34 Responses to Econometrics gets no RSPT

  1. Boris

    Is there any merit in comparing tax paid by companies and individual income tax? Isn’t company tax we are talking about on top of the income tax paid by its employeees?

  2. Sinclair Davidson

    What Swan is doing is very confused. He has compared an econometric estimate of average ETRs (controlling for Country and Industry and annual effects) to statutory marginal tax rates. It makes you wonder if he knows the differences between marginal, average and statutory rates at all, or if he is really being dishonest. I suspect more of the former than the latter.

  3. JC

    Sinclair:

    Do we know if the two researchers also include royalties as part the “effective tax rates” as I would tend to guess that they haven’t?

    Also could you please clarify if the term “effective tax rates” would be the taxes these firms actually paid as a % of their tax disclosed profit? That’s right?

    If that were the case it would be downright misleading particularly in Australia’s case.

    In the group categorized as mining you currently have numerous start-ups without a realistic hope of paying taxes for years, so how exactly is that allowed for (or obviously isn’t).

    I’m not suggesting these researchers did anything wrong, however it doesn’t really present a fair measure of what’s actually is going on in the industry.

    Of course the effective tax rate would be low in Australia as there are lots of start-ups at the moment recording taxable losses.

    A much clearer way of looking at this issue, I think, would be to look at the effective taxes paid by the mature firms, which are the two big players- BHP and RIO.

    In my earlier comment I disclosed (according to Morningstar) last year’s income and taxes paid for both firms. According to their respective income statements BHP was at around 50% taxes for accounting income reported while Rio was at near enough to 30%.

    Start up’s could take up to 10 years to pay income taxes as it can take that long from successful prospecting to finally digging stuff, sending it on a ship and using up the taxable credit from previous years losses.

  4. JC

    Just to make the point… start-ups would be incurring losses for years that are capitalized and used in later years when the company hopefully turns in a profit.

  5. Sinclair Davidson

    JC – probably not. They have used total income tax expense to Net Income before Tax (plus depreciation and R&D expense). I know the database they use (Osiris) and income tax expense often includes all taxes paid by the firm lumped together (but not employee withholding taxes). Also the R&D coverage is very patchy and that would bias some comparisons too (but probably not by much). Depending on how Royalties are accounted for they may or may not have been included but I suspect not.

  6. Sinclair Davidson

    Those industries with lots of depreciation would be biased down – that might explain the mining result via-a-vis other industries.

  7. JC

    Those industries with lots of depreciation would be biased down – that might explain the mining result via-a-vis other industries.

    Yes of course and it would also include the startup’s that have horrendous long-term carried forward losses, as result of the industry in which they operate.

    The more and more one look’s at this tax it seems to be based on false or faulty premises.

  8. Sinclair Davidson

    JC – the analysis would only apply to listed firms. So many start ups wouldn’t be included and given some of the data filters many of the penny stocks would be excluded too.

  9. JC

    Well if that’s the case it would make the government’s argument even worse then, no?

    The penny stocks are obviously accumulating capital losses so the profitability of the sector is actually much lower than they presume if these firms were in fact not included.

    It really seems to be a tax on the low cost efficient producers, that is, the big export earners that help to pay for our imports at a high Australian dollar (previously).

  10. A little bit OT, but an interesting article on what happens when you put cigarette taxes up a lot.

    http://www.adamsmith.org/blog/tax-and-economy/yes-virginia,-there-really-is-a-laffer-curve/

    A random sample of littered cigarette packs reveals that 75 percent of the cigarettes used in Chicago bring no tax revenue to the city, according to researchers at the University of Illinois at Chicago. The lost potential revenue totals about $10 million per month, said David Merriman

  11. Pingback: No RSPT for New Zealand at Catallaxy Files

  12. drscroogemcduck

    if there is some bias to mining companies in the tax system it is probably that you can carry losses forwards but not backwards. maybe if australia would let companies carry losses backwards the corporate tax system would be more fair.

  13. JC

    Duck,

    But it’s also the rate of tax which is most important. People’s investment decisions are not based on carried back losses or the expectations of such, I don’t think.

    This is truly a huge mistake.

    We were previously buying our imports at 90 cents in the dollar and doing this by selling assets (mining equity) based on very high multiples.

    We’re now basically forcing ourselves to compete in the bond markets to fund our deficit and that class of investor will be wanting their pound of flesh in terms of currency “discount” and interest rate premium.

    What’s they’ve done is total madness. I just can’t believe it.

  14. dover_beach

    Oh, come on, David Marr thinks the RSPT is great and is bewildered by the incapacity of Rudd et al to sell it effectively.

  15. “There are no tests of statistical significance in the Markle and Shackelford paper to support that statement.”

    Let’s see Homer accuse the authors and the of incompetence, statistical illiteracy and pointless claims and research…come on Homer, unless you want to be called dishonest for what you’ve been saying here a while, you MUST withdraw support for the RSPT.

  16. Paul

    Sinclair, I would take the ATO figures over a working paper any day. Put that table at the top, not the bottom of the post.

    This is just another shiny object from the government. Try to get the debate about the rate of tax rather than the core premise i.e. we don’t need another new tax. Especially after the government has wasted tens of billions already.
    If you start arguing about the rate, you have accepted the premise that the new tax is needed.

    My only nitpick with the ongoing debate from both sides is everyone saying Mining is the biggest earner, employee, industry in Australia. The ATO statistics clearly do not show that. Banks and Finance are, followed by Manufacturing.

    Cynically, the Banks don’t want a bull’s eye on their backs, and the Media narrative has always been that Australia has no manufacturing.

    Have Fun

    [Good idea – thanks for that. Sinc]

  17. JC

    Dover:

    What on earth would David Marr know about the efficacy of a super tax?

    The only thing he’s possibly worried about is that Fairfax is going broke, he won’t have a job and wants to milk the mining industry in case he’s visiting centreLink.

    In any event he’s too busy outing right wing gays but having a girly hissy-fit if left wing gays are.

  18. dover_beach

    JC, Marr’s a lefty; he thinks super taxes are, well, super.

  19. C.L.

    David Marr: taxation specialist.

    LOL.

  20. JC

    Marr should focus on his strengths though I think. These are, attack Howard for Rudd’s failed border control and out right wing gays.

    That’s about all there’s left for him to do these days.

    Oh yea and he’s a tax expert. He was a senior tax partner at Freehills before he went into journalism so he’s got a lot to say about tax. LOL.

  21. jose jones

    Thanks for the summary of the paper. I couldn’t be bothered reading it!

    Just to clarify, is it correct to include royalties in a measure of effective tax rates? I understand that they are deductible, and I always thought of the royalty payments as a type of rent for the resource.

  22. Myrddin Seren

    “THE Rudd government has told Fortescue Metals Group that it will be able to reduce its liability for the super-profits tax by charging itself commercial rates for transporting the iron ore on its own rail network.

    This will infuriate BHP Billiton and Rio Tinto, which are still trying to get clarification from Canberra about how, and at what point, their profits from iron ore mining will be assessed in terms of tax liability.”

    http://www.theaustralian.com.au/business/fortescue-deal-with-canberra-to-vex-bhp-and-rio/story-e6frg8zx-1225869818045

    I respectfully suggest to Twiggy Forrest that the Rudd government is just about the last people he should be taking tax minimisation advice from.

  23. JimOfSA

    Let me see if I have this straight. The take known ETR’s (dependent variables), use them to find beta’s in a linear model and then use the model to replace REAL known ETR’s with those that come out of the model. So you use something known exactly to estimate a model and then calculate what was known in the first place? This is what these braniacs do all day? LOL. My econometric knowledge is limited, but aren’t regressions meant to be done on stationary variables (i.e. I(0))? If you regress I1 or higher variables then unless the residuals are I0 you can’t say much about the significance of the parameters? Or has it been too long and I have forgotten?

  24. Hollingworth

    Sinclair,

    This later paper report by one of the authors, Sheckleford (April 2010), states that Australia is the only country … that does not have its … lowest ETR in either Mining or Information (at page 20).

    http://www.law.nyu.edu/ecm_dlv2/groups/public/@nyu_law_website__academics__colloquia__tax_policy/documents/documents/ecm_pro_065293.pdf

  25. Jim – I think you’re correct. I don’t think I(1) of an effective tax rate has any meaning though.

  26. Sinclair Davidson

    H – thanks for that. Look at the second paragraph on page 21.

  27. Pedro

    Well, what does it say? I gave up on the file download.

  28. Sinclair Davidson

    They drop Australian mining from their table 4 and in the intra-industry comparison find that Australia has the least variation meaning that Swan’s argument yesterday about mining companies getting very generous tax concessions is wrong – not just incorrect but exactly wrong.

  29. Pingback: Compare and contrast at Catallaxy Files

  30. What about some actual figures instead of stats?!

    Belows is BHP’s Tax Position based on its published half yearly result to 31/12/09, see http://www.asx.com.au/asxpdf/20100210/pdf/31nm6tjp1znl4q.pdf

    BHP Tax Postion based on half yearly result to 31/12/09
    EBITDA 10,838
    EBIT 8502
    Attributable Profit 6135

    Interest 232
    Income Tax 2494
    Roylaties 188
    Total 2682

    IT/AP 40.65%
    (IT+R)/AP 43.72%

    IT/EBIT 29.33%
    (IT+R)/EBIT 31.55%

    IT/EBITDA 23.01%
    (IT+R)/EBITDA 24.75%

    Perhaps not all that tax is paid in Australia, but it seems to pay quite a bit of tax.

    Note that the figures above do not actually add up! The EBIT less interest and tax gives a smaller profit than the one declared.

  31. Louis Hissink

    Sinclair

    Add the cash we have to pay the Native Title holders – that’s a tax as well – so that “might” drive it over 50%.

    I understand Rio Tinto are bleeding at Argyle because of the payments to the Aboriginals at Warmun etc. The mine does not seem profitable because of those “taxes”.

  32. At least the native title doesn’t double dip.

  33. Pingback: How much tax do miners pay? at Catallaxy Files

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