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(ZAMBIAN ECONOMIST) Eight reasons for rejecting higher mining taxes...

COMMENT - This is an excellent Socratic treatment of the pro's and con's of a re-introduction of the Windfall Tax, and why the Zambian economy is not benefiting from it's main economic activity - copper mining. Please comment on this article at the original page on the Zambian-Economist blog.

Eight reasons for rejecting higher mining taxes..
by Chola Mukanga
Saturday, 22 May 2010

Today, we turn the tables and present the most cogent arguments that could be made, if I was hired as a “spin doctor” for Rupiah Banda and help argue against relatively higher taxation than at present (It is taken for granted in the post below that higher taxation would mostly likely involve restoration of the Mwanawasa mining fiscal regime, with windfall taxation at its heart). I offer eight reasons that can be put forward for rejecting higher mining taxes - offering both the central argument to substantiate the reason and then the counter-argument (response). Effort has been made to be impartial but also succinct. One can write an essay on each of the arguments, but for ease of access I have tried to summarise them. I’ll leave it to the reader to expand on them and decide whether the “argument” is stronger than the “response”. By nature of the "title" and this introduction, I have shifted the burden of proof onto those seeking change.

Reason 1 : High taxes would reduce competitiveness


Argument: Increasing mining taxes when other countries are not changing their tax systems, with the exception of Australia, would make Zambia uncompetitive in this important area. Zambia is a small country and we are not exactly renowed as an attractive place to invest. on It is because of the mining revival that we are now having investment in excess of $3bn annually. We have also seen that countries that have imposed windfall taxes have lived to regret. For example Mongolia once raised its mining taxes only to find itself in a quagmire with investment drying up! We must also remember that low taxation is the bedrock of attracting foreign direct investment (FDI). It is therefore critical that we see mining in the overall context of Zambia’s successful FDI policy. No one doubts that low taxation is critical component to that.

Response: The argument is based false premises for several reasons.

First, Zambia’s taxation threshold has enormous scope for increasing taxes without harming competitiveness. Zambia has one of the lowest tax regimes in the world. Prior to 2008, the effective tax rate stood at around 32%, with the Levy Patrick Mwanawasa (LPM) changes it was intended to rise to 47%. LPM put it best : "with these new measures, the Zambian tax regime still remains competitive and moves Zambia into the media position in international comparisons at 47% effective tax rate. The effective tax will not adversely affect the companies' viability as their returns will remain well within the international norms". In short Zambia was to tax more than Tanzania but less than resource rich nations Botswana, Mozambique and Angola. It is therefore wrong to suggest that reintroducing the windfall tax for example would significant damage it’s competitiveness.

Secondly, there’s no concrete evidence that FDI is driven by lower taxes per se. Although tax competition is used usually to justify the level of tax, it is clear from literature that the key driver of foreign direct investment tends to be political stability, cheap / diverse labour and, most importantly, prevailing global economic forces. Zambia’s mining industry is booming because the prices of commodities are high and will continue to be high for some time, aside from few fluctuations because of the long term global imbalance between demand and supply. Of equal importance is that the investors are confident of the political ambiance in the country.

Third, the argument is structurally predicated on the idea that growth in mining must necessarily be driven by external investment – this need not be the case. Many economists believe that although FDI has a role to play in development, what matter is the structural transformation of the production side of the economy. To do that requires government investment in technologies and other supporting industries, which won’t happen without access to mining revenue. Indeed, without government revenue there can be no tangible and accelerated diversification.

Finally, there’s a broader point also to be made – the current low mining taxes may be attracting “wrong investors”. Many of the investors Zambia has attracted in the mining industry have been nothing short of short term vultures (term used is "infestors"), whose primary interest is to come into the country to siphon resources on the cheap and vacate premises when the going gets tough. Poorly designed incentives coupled with a friendly regulatory structure continues to undermine Zambia. A strong starting point in rectifying these problems is appropriate and fair taxation.

Reason 2 : High windfall tax would harm exploration

Argument: The biggest challenge for Zambia is to discover and exploit the vast minerals we have. To do that we need exploration, this is a costly and uncertain exercise. It is undertaken only if there’s a strong possibility of finding something and being able to earn a return on it. Relatively higher taxes, especially in the form of revenue windfall systems, are a disincentive to exploration. As a country we are in a hurry to develop and achieve middle income status by 2030. We must incentivise investors to undertaken exploration activities because that would guarantee a better future for our children. Allowing foreign mining firms to continue operating under existing conditions would guarantee the opening up of more copper mines, which would in turn create more employment for Zambians. Not only that government would collect more taxes through personal income tax and land tax the councils collect from the mining firms, while the tourism and services sectors would also benefit from wider catalytic impacts.

Response: There are three problems with this argument. First, it treats mining taxation in very general fashion. We must distinguish the principle from the application. It is not true that any mining taxation reform would lead to lower exploration activity. Different incentive or taxation structures can be developed that would allow the people to benefit from current mining activities while incentivising future exploration. Secondly, it predicated on a highly uncertain future. The investments that would be disincentivised, if the argument is to believed, are those taking place from 2020 and beyond. However, given the current configuration of the taxation system, as we have seen in Lumwana’s case, no significant revenue would begin to accrue from any such unknown investment until 2025 and beyond. In short this is an argument about an unknown and distant future. Finally, the argument again presupposes that only foreign firms can do “exploration activities”. There’s a strong case for government to assume a greater role in exploration activies to narrow the information loss between investors and government. This would also help reduce the sort of problems we have seen where Lumwana has huge uranium deposits off the back of a copper investment. More exploratory and geological exploration would put the Zambian people in the driving seat of their resources.

Reason 3 : Higher mining taxes will compromise safety and harm environment

Argument: Increased taxation will not have the desired social effect because it mainly leads to mining companies pushing the costs on workers and local communities. Principally mining safety and environmental damage would get worse as foreign firms seek to maintain their profits. Indeed the service conditions of workers may also be affected. We would be robbing Peter to simply pay Paul! The worker and the local community must come first. Higher taxation would not make things easier for these groups. Quite the contrary it will make it worse!

Response: There’s some truth in that argument. Increasing taxation will always create perverse incentives for mining companies. However, this is not an argument against increasing taxation per se. Rather it is an argument for why taxation must be part of a broader strategy that takes safety and environment into account. Indeed such a strategy much also bring into line how any windfall revenues are managed to empower local people and avoid the “Dutch disease”. Its therefore simply wrong to suggest again that higher taxation per se would be the source of these potential difficulties. We can have both high revenue and a good environment if careful thought was given to these issues.

Reason 4 : The profit variable tax does the same job as windfall tax

Argument: People who argue constantly for the windfall tax have a poor grasp of taxation issues or basic economics. It is quite obvious to everyone that the removal of the windfall tax will not lead to loss of government revenue as the variable tax still captures any windfall gain that may arise in the mining sector. Infact it is better because it ensures that mining companies are not being driven out of business by explicit accounting for cost of investment.

Response: This argument demonstrates complete ignorance of the common wisdom of tax collection. Although many would agree that theoretically the profit variable tax can go some way in capturing the necessary revenue from higher copper prices, a windfall tax is easier to implement. It is also easier for the public to check how much revenue government is getting in its coffers. With a profit variable tax it is an accountant's job! Multi national corporations love profit variable taxes because it is easy for them to hide their profits through inflated costs and so forth. Simply put, the mining companies have smarter accountants than the Government. This is why the mining companies pushed for removal of the windfall tax. They knew they'll pay very little. It is also the reason why all the donor partners have concluded the status quo is not desirable, with some calling it "depressing”. Simpler taxation mechanisms are key to improving collection.

Reason 5: The “certainty principle” favours the status quo

Argument: The long-term outlook for copper mining in Zambia is still very uncertain following the period of government led ownership prior to liberalisation. . Investors don't have sufficient confidence that government is committed towards an open investment policy. Constantly changing the fiscal regime whether for good reasons or not does not inspire investor confidence. What we need is certainty and stability that reduces the risks to long term investment. Having undertake reforms in 2008 and 2009, we need a period of calmness to settle things down. We perhaps can come back to this issue in 2015 or beyond. We must learn from successful countries like Chile, Australia and Canada who don’t arbitrary change their mining taxation regimes.

Response: The point regarding certainty is perfectly valid, but it misses the more fundamental question – what drives certainty? Certainty is derived from ensuring that you have a mining settlement that has the full buy-in of all Zambians. Otherwise, every government that comes along will constantly alter its mining policies. This calls for a Zambian solution, not an MMD or PF or UPND solution. The approach to mining policy must therefore be necessarily consultative and transparent. It is not just about the level of taxation but "how" you get these stable mining policies The mining companies need to realize it’s in their long term interests to push for transparency - deals made under the table are not sustainable. The approach should be consultative and transparent. These are the foundation of “rule of law”. At present there’s no rule of law in this area because government has acted without the people’s consent. It should also be noted that the suggestion that other countries are not changing their taxation regimes is blatantly wrong as can be found here.

Reason 6: ZCCM-IH is doing its job – its about empowerment not revenue

Argument: It is disingenuous to claim that Zambia does not benefit from mining because we are also owners of these mining companies! ZCCM –IH is a state owned venture and it owns 20% plus shares in joint venture with foreign mining corporations e.g. FQM’s Kansanshi and Vendata’s Konkola . Therefore as the transnational companies soar in their mining profits ZCCM-IH gains significant windfall. A "them Vs us" approach does not therefore quite reflect reality on the ground, where ZCCM - IH is a big player with assets over $1bn. When you attack mining companies, just remember you are also an owner of those investments! For example, recently we saw huge dividends of around $18m to the Zambian people by KCM.

Response: It is true that ZCCM-IH does have interests in many of these companies, but it hardly possesses a controlling interest stake in any of the key joint investments. More worryingly it’s been clear for a while that ZCCM –IH has not been receiving meaningful dividends from its jointly owned projects. The $18m hardly qualifies as "huge". A fact which led to rumours last year that government was planning to convert these financial liabilities into equity, thereaby raising substantially its stake in the mines. That the government recognised this possibility is a clear testament that the ZCCM-IH model has not worked. Indeed, what seems to concern many people is that ZCCM - IH is not "empowering" ordinary Zambans. If ZCCM-IH was owned by ordinary Zambians a potential argument can be constructed that some money does filter back to ordinary Zambians via the "theoretical dividends". ZCCM-IH is currently listed in Lusaka (alongside London, and Euronext Stock Exchanges), with the government owning 87.6% shareholding, with the remaining 12.4% held by private equity holders largely abroad. Unfortunately the whole venture is not very transparent! According to foreign private equity holders in ZCCM-IH the company has never published its financial report for nearly 4 years! Its inventories are also not formalised! Remarkable for a listed company! It is hardly the sort of company one wants to appeal to as the reason for not increasing mining taxation. On the contrary, it beggars belief that many Zambians do not even realise that ZCCM-IH is a huge part of the reason Zambia is not benefiting from its vast reserves of copper.

Reason 7 : We are already benefiting through employment

Argument: Investment in Zambia has grown significantly, as much as $5bn has been invested in the mines. Without the current fiscal regime Zambia would never have the sort of investment it has had. Indeed part of the reason why Lumwana was built was due to the favourable regime, For 25 years, Zambia had no new mines opening, now we see plenty of new ventures being proposed under the visionary policies of the MMD led government over the two decades. Significant jobs have been created from new investment opportunities. Zambia may not be benefit as much as we all would like from mining taxes but it is benefiting significantly from new jobs. As His Excellency President Rupiah Banda has helpfully reminded us "we must ensure that we do not kill the goose that lays the golden egg. There is little point in taking in a few million dollars in tax if thousands of jobs are lost as a result”. We have seen that employment has risen from 22,000 jobs in 2000 to 48,000 jobs in the mining sector because of new investments. Any appraisal of Zambia's mining policies must account for the huge benefits we have got from this extraordinary ramp up in job creation. Our approach must be to continue allowing more money to come into the economy to create jobs.

Response: The argument as formulated is misleading for three reasons. First, without doubt Zambia has significantly increased foreign direct investment to the mining sector. But the fundamental question again is what has driven this investment? As the response to Reason 1 suggested its broader issues related to political stability, cheap / diverse labour and, most importantly, prevailing global economic forces. Secondly, the employment argument is easily rejected because the counter-factual is all wrong. The so called jobs created by the MMD led government of the last two decades are essentially the jobs they destroyed through the disastrous privatisation project of the early 1990s. But suppose we can allow the argument that these are new jobs how far does the argument go? Not very far because the real central question of course relate to the “quality of jobs”. The argument regarding job creation treats jobs as homogeneous and an end in themselves. The goal of government is to provide a conducive environment where individuals can create value adding jobs and thereby foster wealth creation. Pointing to jobs built on casualisation is not wealth creation.

Reason 8. We have corporate social responsibility!

Argument: There are many companies doing very good social responsibility projects. For example First Quantum Minerals has done much rehabilitating roads in Ndola. Similar Konkola Copper Mines is working to empower the Luano Community in Chingola through an innovative goat draft project - an interesting alternative to microfinance. Lumwana recently pledged to spend K4bn on the local area, including plans to launch a multi-million Kwacha programme to diversify its local economy in Solwezi away from dependence on mining. These are great initiatives that should be supported through lower taxation.

Response: Corporate Social Responsibility (CSR) is a positive undertaking but it is at best a distortionary second best scenario. The ideal scenario is that government should tax mineral resources sufficiently in a way that profits local people and does not impact negatively on the environment and safety of workers. The government is currently not pursuing the ideal and therefore our efforts should be directed at ensuring it does. The more serious problem with the argument is that it ignores the real manace of CSR. Such initiatives, though spun as “social projects” are essentially "bribes" to keep local people quiet. Firms do not engage in "social responsibility", they practice "shareholder responsibility". The projects mentioned in the argument should therefore be rightly seen as a small price that mining companies have decided to pay local people in Ndola and Solwezi lest they become agitated at the lack of development in the area and demand the Government to do more to tax the mine (which would be bad news for the shareholders).

I have set out the above arguments and responses for three reasons.

First, I wanted to bring all the arguments / counter-arguments together in one place for ease of reference.

Secondly, I believe both sides have reasonable arguments to make and what we need is actually dialogue rather than speaking past each other.

Thirdly, often in economic analysis it’s not black or white – the question is how one weighs up the pros and cons. If this post helps people approach other issues in similar manner, then we would have progressed how debate ought to be had. I trust that readers will find these arguments and responses useful.

More importantly, it is hoped that I have tried to make the best possible "argument" and the best possible "response". Where a "reason" appears to be missing, this should be cited and it can be added provided it is distinct from the above eight reasons. If its not added, I will respond explaining why I don't think that particular reason is distinct.

Labels: CHOLA MUKANGA, NEOLIBERALISM, WINDFALL TAX, ZCCM-IH

posted by MrK @ 8:05 PM