(ZAMBIAN ECONOMIST, DR KAELA MULENGA) WINDFALL TAX CONTROVERSY – A CRITICAL ANALYSIS

Friday, June 15, 2012

(ZAMBIAN ECONOMIST, DR KAELA MULENGA) WINDFALL TAX CONTROVERSY – A CRITICAL ANALYSIS

ZAMBIAN ECONOMIST
Ideas for a better Zambia
WINDFALL TAX CONTROVERSY – A CRITICAL ANALYSIS
by dr. Kaela Mulenga

The Concerns

It is nice to feel that one comes from a country like Zambia which is blessed with abundant natural resources and minerals like copper (cu), cobalt, uranium and others. But the celebratory mood soon dissipates when especially one looks at the situation in the long run –for these resources can get exhausted.Take copper for instance, this is not only a waste resource, but since it is finite, at some point later, it will therefore be exhausted. What happens then? As one politician lamented,once all the profitable minerals are taken out all we’ll have left with will be “big holes” in the ground.

Some estimates put our love affair with copper to end in 50 years. That means my 7 year old granddaughter will only be 57 years old then. What will she live on there after?This situation is compounded because while copper life is going good, currently hardly any savings are being made for neither a rainy day nor any substantial investments; are being undertaken to diversify our economic activities away from copper. When debating on windfall taxes– Hon Yamfwa Mukanga (Kantanshi Constituency MP ) said, “We need something to show to our children when copper is gone that – this is what we built from the copper taxes”1.

Today, probably more than 90% of our GDP is generated from copper proceeds. In short, no copper no economic growth and no growth, no reduction in poverty. Itis that simple. And we should not forget about the reprehensible damage caused by mining activities. Environmental degradation always occurs. So while we mine other ills and hazards are also being created. We have heard stories of poisonous gas fumes in Mufulira, contaminated Kafue river, and not to ignore the huge copper waste dump in Nkana. All the bad by-products produce a social cost. But who is going to pay for these costs? These costs are externalities to the producer and are never taken into consideration. Corporate social responsibility is not on the agenda of many companies. When air is polluted and drinking water is full of toxic effluents and chemicals – our health is compromised.

So, even if all the profits from minerals were to be surrendered to us, it would be too late – for everybody would be dead by then.If the long-term prospects are bleak because of depletion – in the medium to long-term, we’llalso be faced with problems of substitution effects. That is, as the price of copper soars,consumption of this commodity is bound to plateau. Why? In due course, persistently high price would force copper consumer industries in China, India, Japan and elsewhere to look for other cheaper substitutes.

All profit making organizations in free enterprise, behave that way. They aim for cutting costs to boost their profits. As we speak, already copper has lost some market to alternative materials like aluminum and plastics. When the price of expensive nickel fell from $50,000 per tone to below 50percent more of it got used instead of copper. Hence, the higher the copper price, could eventually outstrip its viability for use in say construction piping. In addition, architecture, plumbing and other energy efficient methods have impacted copper demand somehow. In China perhaps the largest consumer of copper, they have started using simpler fabricated products for roofing. Plumbers have switched to PVC tubing instead of copper.

http://www.zambian-economist.com/2010/11/coalition-for-windfall-tax.html 1

Simply put, due to inventions and/or new technology, we could one day wake up and find our copper completelyobsoleteor 100% replaceable. We should also not ignore the fact that economic growth even in China has began to slow down. Mind you, we don’t even know how much stockpiling Chinese have been doing. We can’t bank our hopes only on the fact that China continues to consume some 65% of all world produced copper to feed its modernization program for electricity and infrastructure expansion. From experience, we should also know that eventually, the total world demand is bound to fall – along with the price.

We can recall that copper prices fell drastically in late 70s/ early 80s under Kenneth Kaunda’s rule. Also if we were to take into account the impact of excessive supply on the price from other producers (whose decisions are beyond our control) like: Chile, Mexico, Peru, Russia, DR Congo, and China itself – [if it so wished to influence prices], we can’t be banking on perpetually good copper prices.

In summary – these are some of the issues we should keep in the background I think, when we discuss this sensitive but import matter of windfall taxes. The Big Debate In our local media – newspapers, TV, Radios and discussion forums on the internet –especially the social websites: a heated debate is raging on regarding different forms of mineral taxes: royalties, operating profits taxes, and in particular –WINDFALL TAX a form of taxing the revenues. Revenues in this case concerns copper earnings. And the question is: should Zambia levy these revenues, and if so, by how much? Should our concern only be limited to profits? This serious debate has developed into two distinct camps – one pro and the other against, basically there-introduction of windfall tax(WT).

Unlike LAZ who offer their opinion on important national issues, our EAZ stays silent. I have taken liberty to offer my own opinion.The sharpest salvo on WT came from the current PF Minister of Finance –Hon Alexander Bwalya Chikwanda(ABC or Alex), who has labeled those seeking the re-introduction of the25% windfall tax as “lunatics”. [The Post, March 22, 2012 ].

Alex thinks that production costs – including sea and inland costs are already enough burdens on producers. As such, then we shouldn’t levy them more – apart from the merger 6 per cent royalties he proposed in the budget.This position is probably not shared by some of the PF “back bench” or “freshmen ones”,especially those who faced the youth and miners in the campaign like Hon Wylbur Simuusa (Nchanga Constituency MP). As one might expect, the sharpest response to counter this, comes from none other than the former Minister of Finance under Pres. Patrick Levy Mwanawasa (Levy) –Ng’andu Magande. Curiously both men happen to be economists. Magande who by the way first proposed windfall taxes sharply argues that: Windfall Taxes are a must if Zambia is to raise sufficient revenue – while the going is good with copper prices for investments and the diversification program. He adds that – “moreover PF was propped into power on thepromise of re-introducing the very WTax”. [The Post, March 23, 2012 ]. So why chicken outnow, he asks?2

In addition Magande strongly feels that, re-introducing WTax now would be agood policy direction– without which otherwise the investors’ confidence would be affected. He further feels that, flip flopping on WT question puts pressure on the Zambian Kwacha. A third force in this discussion comes from the previous MMD government people – best represented by ex Minister of Finance– Hon.Dr Situmbeko Musokotwane. Without explicitly saying whether he is for windfall tax or not, Musokotwane however charges that –so long as PF government fails to immediately re-instate the WT as they promised during the September campaign, getting to power would be seen as by “false pretences”. [The Post,December 7, 2011].

Under Pres Rupiah Banda (RB), Musokotwane was the strongest voice fighting against there-introduction of windfall tax, even if many people still remained skeptical. In fact, there are many Zambians who accused both Musokotwane and RB as being unpatriotic sons for opposing the windfall tax. The inspiration for what I call “RB/Musokotwane doctrine” was based on the premise that – China would continue propping up Zambia financially, hence,sources of budget money was secure.

Along these lines – i.e. being either in favor of or against WT, let me now discuss somemain themes I see pertain to either side. For those seeking more details, there is a robust debate on this topic onZambian Economist. [see www. zambian-economist.com]. About ayear or two ago, Chola Mukanga (Cho) – founder of Zambian Economist, presented an excellent discussion on WT in an essay form headed: Eight Reasons for Rejecting Higher Mineral Taxes. Cho discussed in detail pros and cons for each reason. My attempt here is therefore not to repeat that discussion but just to draw distinct boundaries between those who support the re-introduction of WT and those who don’t. A foundation weshall fall back on later when I go through the economic analysis. Among the arguments raised by those who are against higher taxes (the Musokotwane group) – increasing windfall taxes, include:-?

This camp contends that there is no investor who could risk their capital if at all they cannot expect good returns. By extension, this group therefore sees low taxation as a strong incentive for attracting more investments.?They argue that unless you have favorable tax holidays, concessions, and exemption or low both royalties and windfall taxes, you cannot expect to attract foreign direct investments (FDI). [The assumption here being that the bulk of investments would have to come from outside].?Regarding the viability of taxes, Prof Clive Chirwa, a presidential aspirant (Bolton University ) – [see Zambian Economist, Nov, 2010 ], observed that: “good investors with a heart will accept tax of eight per cent on royalty and 25 percent on windfall tax”.? But this group believes that if the PF government re-introduces a 25% windfall tax that would be scaring away new investors. In cases where agreements and other concessions have been signed between the Zambian government and the mining investors – those should not be broken, terminated or tampered with. Doing so would not only be regarded as violation of ‘Rule of Law’ , but would be sending a bad signal to the investors. According to this view, the rule of law means respecting international agreements, which are legal contacts. These must remain binding no matter what.3

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Labels: MINING, POLLUTION, WINDFALL TAX