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Tuesday, 25 May 2010
Page: 4015


Mr TURNBULL (7:22 PM) —The foundations of the 2010 budget were laid in the panic of the 2009 budget. A little over a year ago the Rudd government was faced with an economic environment of considerable uncertainty. Concerned that the Australian economy would follow other developed economies into recession, the Rudd government embarked on the largest and most extravagant spending spree, or fiscal stimulus, in our history. The massive level of fiscal stimulus, over $60 billion, was one of the highest in the OECD, notwithstanding our economic circumstances were, and were recognised to be, much better than those of any comparable country.

First, we went into the downturn with no central government debt—in fact, thanks to the hard work of the coalition in government, we had cash in the bank. Second, our banking system was well regulated—again, thanks to the reforms of the coalition in government. Our banking system had a very small exposure to sub-prime lending and was in every respect financially stronger and more secure than its counterparts in America and Europe. Third, our economy was enjoying the benefit of strong and growing demand for our resources from strong economic growth in China and India, among other developing countries.

Faced with the inherent uncertainties of the circumstances we were in, and in the knowledge that we were better positioned than comparable countries, a prudent government would have spent less and spent it more wisely. That was precisely the counsel we gave the government at the time, and precisely the counsel they ignored. Had they heeded our advice there would have been no home insulation disaster, with all its tragic consequences; nor would there have been billions wasted on the Julia Gillard Memorial Assembly Hall program. And, if the government had chosen to spend less, and more wisely, the 2010-11 budget would have started off with a materially lower deficit.

So the 2010 budget’s massive deficit of $40 billion next financial year and $57 billion this financial year—the largest in our history—is in large measure a consequence of the panic of 2009. The Rudd government can argue that at the time it believed it was staring into an abyss and that all around it there was gloom and disaster. But, having overspent in 2009, and the subsequent strong performance of our economy demonstrating how ill-judged was last year’s budget, how can the government justify in this budget failing to do anything to reverse the massive increase in public spending it set in train last year?

Niall Ferguson recently reminded us that, while Milton Friedman may have been right in saying inflation was always a monetary phenomenon, blow-outs in public debt, and public debt crises, are always and everywhere a political phenomenon. He wrote:

They are consequences of political weakness. Excessive expenditure and insufficient taxation, failures to make decisions about unsustainable fiscal policies are political; they are not the results of profound economic processes.

So, just as last year’s overspending was the consequence of political panic, this year’s lack of action to remedy that overspending and cut back on expenditure is the consequence of political weakness.

The largest new policy contribution to government revenues over the forward estimates comes from the proposed resource super profits tax, which seeks to replace state royalties for the extraction of natural resources with a new profit based tax which will raise an additional $9 billion in net revenue for the Commonwealth in its full year of operations. Many market analysts have expressed the view that that $9 billion is a low figure and that on a steady state the take from the mining industry will be substantially more. The tax will substantially increase the share of mining companies’ profits taken by government and, in that respect, it can only reduce the attractiveness of investment in the Australian resources sector. The government has argued that, paradoxically, increasing the tax on mining companies will increase investment in the mining sector—yet at the same time it proudly boasts that its increased tobacco excise will reduce smoking. Their claim is barely credible.

The tax is described as a ‘superprofits’ tax and seeks to tax 40 per cent of a mine’s profit after deducting its expenses, including depreciation of capital investment. Before calculating the taxable profit figure the expenses are uplifted by a percentage equal to the 10-year Commonwealth bond rate, currently around 5.7 per cent. Describing a profit which is over 5.7 per cent as a ‘superprofit’ is absurd. It could more fairly be described as a ‘slightly better than thoroughly anaemic profits’ tax. The government argues that this risk-free rate is appropriate because, under the new tax scheme, the Commonwealth is prepared to refund to the taxpayer 40 per cent of any unrecovered losses from the mining project at its closure. The government therefore is proposing to effectively nationalise 40 per cent of every resource project in Australia, seeking 40 per cent of the profits in return for offering, at a long-away date, to pick up 40 per cent of the losses. In other words, the government argues that only 60 per cent of the capital invested in the project is subject to the normal commercial risks of the project failing—the remaining 40 per cent is underpinned by the Commonwealth’s commitment.

Moving out of the Treasury and into the real world, the fact is that this ‘Commonwealth put’, over 40 per cent of the project’s losses, will not reduce the capital costs of mining projects as the Treasury supposes. That proposition, upon which the whole economic argument for the tax depends, is highly theoretical and completely untested. The market’s judgment is that all the tax does is reduce the returns available to investors and therefore it undermines the attractiveness of the sector as a whole.

Most major mining companies operate in many countries. Mining is truly a global industry, and countries compete not just in the quality of the resources on offer but in terms of their taxation. In a study published last week, Goldman Sachs JBWere concluded that the superprofits tax will make the Australian mining sector the highest taxed in the world. They give as an example the case of iron ore. They show that the total tax burden on iron ore projects in Australia will be 56.8 per cent, whereas in Brazil, our most important competitor, it will be 35.8 per cent.

It is natural that, with projects involving massive long-term investments, investors are going to be very sensitive not simply to the tax rates but to the fiscal stability and, indeed, predictability of the countries where the mines are to be located. So any government seeking to make a major change to the way in which mining companies are taxed should ensure that the changes brought about are after thorough and detailed consultation with the industry. Here, of course, there was plenty of potential for that consultation. The mining industries have for years argued that profits are a more appropriate basis for levying royalties than gross revenues or, indeed, volume of production. So the fundamental premise of the change was not in contention. There was therefore every opportunity and every reason to consult widely before finalising the shape of the new tax—the less of a surprise and the better understood the tax was prior to its announcement, the more measured would have been its reception.

But the government chose not to do that. It could have very readily released the Henry tax review when it was presented to the government in December last year and there could have been a fully informed discussion about the recommendations of the Henry tax review, including those that related to resource taxation. Given that this was clearly an essential item in the thinking of the Henry tax review and the government, a paper on this issue could have been produced, such as a green paper, and made the subject of thorough consultation in the course of last year. There was every opportunity to engage the industry which, as I said a moment ago, was prepared to consider reforms to the way royalties were levied. Goldman Sachs concludes that the current resource super profits tax proposal risks altering a long-established perception of Australia as a country with fiscal stability.

The upshot of all of this is that we have the government imposing a great big new tax in conditions of great uncertainty and confusion—all created by the government itself. The inevitable consequence has been a loss of confidence both in the government and in Australia as an investment destination. We have seen politicians from Canada leaping onto the television to make sure that everybody knows they offer a more predictable and more friendly taxation environment for mining companies. Projects in Australia are being put on hold or abandoned. Thousands of jobs are at risk, as are billions of dollars of investment, whether it is in the hands of the mining companies or the Australian households whose super funds have invested in the mining companies and which have been devastated by the destruction of value caused by the government’s handling of this matter.

The Commonwealth bank’s budget summary is headed ‘From China with love’, and that is a fair comment because fundamental to the budget’s optimistic view of our economic future is the assumption that Chinese demand for our resources will continue unabated with our terms of trade rising to a 60-year high next year. This big bet on continued Chinese demand is the assumption that underpins the mining tax. The government assumes that Chinese demand will be so strong, that commodity prices will be so high, that the industry will be able to bear a substantial increase in the government’s share of its profits. And this is the fundamental point that we must not forget. We can debate the design of the tax—profit base versus gross revenues. We can debate the question of whether it should apply only to new projects, as the industry contends, or whether it should apply to all projects. We can argue the toss about whether it should apply differentially to different minerals. But at the end of the day the fundamental economic reality is that this is a substantial increase in the government’s share of the profit pool generated by the business of mining in Australia. That, inevitably, must have the consequence of reducing the attractiveness of investing in that industry, because the pool of profits available to investors has been reduced by the government increase in taxation.

Recent events in Europe have reminded us that the global economy is a long way from being out of the woods. While we sagely observe that Greece’s financial woes and near bankruptcy are the product of unsustainable government borrowing and spending, we should note that the government debt of many other countries is not far enough behind for any comfort. Indeed, there are a number of developed countries where the levels of government debt are well ahead of the levels in Greece. We also need to recognise in this uncertain world that a linear continuation of high levels of economic growth in China is by no means assured, and again debt is at the centre of those concerns. The true level of government debt in China is difficult to discern, because so much debt has been raised by state owned enterprises, local governments and, in particular, local government owned investment companies. China’s RMB4 trillion stimulus package—13 per cent of GDP—announced in 2008 was enormous by any standard, but additional to this investment has been another RMB20 trillion, an additional investment, by local government investment companies.

Much of the investment activity undertaken by these local investment companies owned by local governments has been in real estate development, which has fuelled the growing real estate bubble which the Chinese government has very recently been endeavouring, insofar as it can, to deflate. Professor Victor Shih of Northwestern University has recently estimated that, taking into account the indebtedness of these local government owned investment companies, the real level of government related debt in China would be close to RMB40 trillion in 2011, or 96 per cent of GDP, and 4.6 times total government revenue. This is a high estimate. There are estimates around, including from Goldman Sachs, which are considerably lower than that, but on any view the real level of government related debt in China is dramatically higher than that in the official figures. Professor Shih’s estimate would place China among the countries with the highest debt to GDP ratio; however, it is worth noting that, like Japan, China’s high level of indebtedness is almost entirely funded from domestic sources. Indeed, one of the aspects of the Chinese debt story that may well develop a political dimension is that this has been a very bad deal for thrifty Chinese households who have been depositing their savings in banks at low interest rates, and the money is then lent on to government related corporations. Household thrift has been subsidising government waste.

Of course, as households receive inadequate, negative real returns on deposits, many have naturally sought to buy property as a hedge against inflation and this has also contributed to the housing bubble. The China economist Michael Pettis calculates that at a minimum the subsidy paid by households to banks and their mostly government related borrowers in the form of excessively low rates on their deposits is five per cent of GDP per annum and possibly up to twice that amount. There is a high degree of uncertainty, as I said a moment ago, about these estimations of total government related indebtedness. The question exercising the minds of policy makers and market analysts therefore is: what is the likelihood of Chinese banks suffering a very high non-performing loan ratio leading to the need for a government bailout of banks and government owned investment companies?

And what are the implications of all this for economic activity in China? So far this year there have been mixed signals from the central government with some leaders calling for banks to cut their exposure to local investment companies and real estate investment more generally, with others indicating that a continuation of stimulus fiscal and monetary policies is appropriate. Recognising the risks in making forecasts about a market which is so complex and so lacking in transparency, we must, nonetheless, recognise that there is a substantial risk that the Chinese government may respond to the massive growth in debt by restricting new lending and perhaps by fiscal consolidation—raising taxes, perhaps by taxing property—all of which would certainly put a crimp on growth in construction and hence demand for our commodity exports.

The risks associated with the Chinese boom continuing therefore are plain enough, yet there is very little evidence that they are being taken into account by the government in this budget. A more prudent government considering a new resource tax, for example, may have directed at least a portion of the proceeds of that tax to government saving, perhaps in the form of a sovereign wealth fund, so that there is an ability to fund deficit spending when the boom goes sour and an ability, as and when required, to invest outside of Australia as a means to take upward pressure off our own exchange rate.

Dr Henry in a recent speech rejected this idea largely, it seems, on the basis that the revenue surge was going to be long-lived, in which case he said, ‘The alternative of tax cuts,’ permitting the private sector to make its own savings and investment decisions, ‘should always be considered first.’ Whatever the merits of that argument—a sovereign wealth fund to save for a rainy day versus immediate tax cuts—it is revealing that he regards the surge in revenue from the resources boom as being long-lived. In other words, it appears that the Treasury does not anticipate any material interruption to the high rate of growth in China.

Returning to the theme with which I began this speech, the government’s attitude to China is similar to its approach to the global financial crisis last year. In each case the government is confronted with uncertainty, and the question is how to respond to it with policy. Last year the government concluded that we were staring into a bottomless abyss, so bleak was the future. This year it concludes we are riding a boom which will never end.

A more prudent judgment would say that neither conclusion was likely to be correct. Certainly, a wiser policy response would be one which gives you the flexibility to deal with the possibility that outcomes may not be as bad—or this year, as good—as you imagine. Last year it made sense to spend less, more wisely and, if circumstances required, to then consider spending some more. As I said at the time, the parliament was not closing down; it was always open to the government to come back and spend more if it needed to. Firing off all the ammunition in the first engagement, as the government did, deprived it of any flexibility and it was left spending far more money than it would have done had it known how the economy would actually perform.

Equally, this year the government is not making enough savings and is continuing to spend on the assumption that revenues will remain strong indefinitely. A more prudent approach would be to cut expenditure more, reduce debt and make more savings from the mining boom’s revenue bonanza so that, if things do not go as well as expected, we have the fiscal flexibility to respond.