Forrest told Henry it would devastate his company Fortescue Metal’s legendary ability to raise funds to expand. To back his claim, he asked a senior banking executive from NAB at the same table to explain why the finance industry placed no value on Henry’s proudest and most unusual design feature: a government guarantee of 40 per cent of project costs, even for projects that failed.
The banker was unequivocal. It would be completely useless in helping miners get financing, he said. Banks didn’t believe in the government version of an IOU and were never interested in investing in projects that might fail.
According to Forrest, Henry looked extremely surprised by this revelation, saying that if it were true, the “whole logic” of the tax was broken.
I have a paper coming out in Tax Policy talking about the RSPT. This is what I say on this very point.
It is very important to realise that the government would make no upfront contribution to meeting any of the costs of any project. Rather mining firms would have to raise all the finance themselves and undertake the initial investments. The government would have a virtual ownership stake and only ‘pay’ its share in the form of reduced tax liabilities over the lifetime of the project. Mining firms would, in effect, own two assets when investing in a project. The first asset being the project itself. The second asset being an income-contingent government guarantee. The dispute over the RSPT revolved around the value of that government guarantee and the impact that guarantee would have on mining projects.
The first problem with the RSPT related to the fact that the government would not be providing any capital for their ‘share’ of projects. Miners would have to raise all the capital before any project could be undertaken and pay the full cost of capital. The design of the RSPT was such that the government only provided for the cost of risk-free capital. Mining projects, however, are not risk-free and the miners would have to bear the cost of the risk premium on the government’s share of the investment. It is important to note that this criticism of the RSPT is independent of any criticism of taxing rent. This was a design flaw in the actual RSPT. The RSPT would have taxed the risk premium in addition to taxing ‘rent’.
An argument could be made that, over time, capital markets would provide a form of financing to cover the differential between the total financing of any project and the mining firms share. In other words, financial institutions would be willing to lend money to mining firms on behalf of the government at the long bond rate. This argument, however, is difficult to sustain. If financial institutions wanted to lend money in order to earn risk-free returns all they need do is buy government bonds. It is not clear that there would be any benefit to banks in lending money to miners at risk-free rates as opposed to buying bonds. The advantage to banks of actually buying government bonds is that rating agencies and other banks are more likely to recognise a government bond as being risk-free as opposed to a loan to a mining project. Furthermore the market for government bonds is highly liquid, while the market for mining projects is not. In any event, all this argument suggests is that tax credits could be sold on the open market. But no such market has ever developed. If such a market could have evolved, it is likely that it would have done so already.