Growing pressures on government budgets and a public sentiment that many corporations are not paying their fair share are forcing governments to look for ways of increasing tax revenues from corporations. In this context, resource based companies are perceived as a relatively easy target, as it’s impossible for them to shift their operations to another jurisdiction, an option open to many corporations that operate in other industries.
The resource industry is challenged by a dramatic decline in commodity prices, which is expected to persist for the next several years. At the same time, the need to comply with new environmental regulations, driven by the commitments made by governments to combat climate change, is expected to increase resource development and production costs. It comes as no surprise, then, to learn that the ability of resource companies to withstand tax increases has been weakened. Governments need to be prudent when dealing with this issue, as they may end up with a short term increase in government revenues, but a long-term negative impact on regional economic development if a mine is no longer economically sustainable.
To learn more about how our economic impact studies can help resource companies to educate governments and other stakeholders about the benefits their projects can bring to regional economies, and about how forward-thinking tax policies can help achieve long term revenue goals, please contact Michael Dobner or Kevin Chan.
In general, when taxes on a resource company are increased, the result is an increase in the marginal cost of production and/or the marginal cost of new resource development. The economics of resource exploitation is typically characterized by relatively high fixed costs and relatively lower variable costs. This means it’s likely that in the short term (which may, in some circumstances, last a few years), resource companies won’t reduce their production in response to increases in tax, as the marginal revenue from production will continue to exceed the relatively low marginal cost of production. However in the longer term, where new fixed costs have to be incurred, resource companies will likely respond by not:
- recovering low grade resources;
- expanding operations; and/or
- developing new projects
Any of these responses will lead to reduced economic activity, employment and long-term tax revenues.
In many jurisdictions around the world, the cost of developing a new resource is relatively high and is expected to further increase because many resources are located in remote areas and in deeper layers of the earth. In addition, new environmental regulations will further increase this cost. In a period of low commodity prices like we’re in now, high cost resources tend to exit the market. As a result, higher cost jurisdictions are expected to shoulder a relatively large portion of the inevitable retraction of the global resource industry. This precarious condition would be exacerbated by further tax increases.
Taxes levied on resource companies in many jurisdictions around the world include:
- Corporate income taxes – the impact of corporate income tax on resource development and production will depend on deduction rules applicable to resource companies and on the stability of the tax regime (i.e. the level of certainty that can be assumed by resource companies, that over the long term no major adverse changes will be applied against them).
- Mining taxes and/or royalties – where they’re tied to revenues or production, they act to increase the marginal cost of extracting the resource and so may discourage the extraction of marginal deposits and lead to an early closure of a mine.
- Indirect taxes - may affect the cost of development where a significant portion of the inputs are imported.
The inherent structure of many democratic political systems around the world causes governments to lean towards short term perspectives. As such, tax increases that have a relatively minor short term economic impact (as indicated above) may be appealing to governments. However, resource projects generally span a large number of years and their economic benefits can be substantial. In this regard, resource companies should consider educating governments and the public about the economic benefits that may be foregone if a government takes a short term view that impedes long term resource development. In addition to the expected benefits of increased economic activity, jobs and tax revenues to governments, resource projects tend to bring unique benefits that are consistent with the objectives of many governments, such as:
- Creating economic activity in rural and remote areas that have generally seen economic decline and net out migration. Resource projects can help maintain the viability of such communities, which is an objective of many governments;
- Providing employment opportunities with high compensation to less educated people who often suffer from higher unemployment and lower earnings. Resource projects tend to reduce inequality;
- Creating lucrative employment opportunities for Aboriginal communities who tend to live in proximity to resources. This is consistent with the objective of many governments to raise the standard of living in Aboriginal communities; and,
- Attracting multinational companies that can bring new knowledge and technology. Canada, for example, has been lagging peer countries in innovation and productivity, and as such is missing out on the economic benefit so critical to maintaining a high standard of living in a globalized and more competitive world.