The PRRT & the ineptitude test

Frank Stilwell and Michael Vaughan

In 2013, Opposition Leader Tony Abbott said of Labor’s mining tax: ‘What an extraordinary exercise in ineptitude: the first tax in the history of the Commonwealth that actually does not raise any money.’ If the success of a tax is measured by the revenue it raises, then the Petroleum Resource Rent Tax—the PRRT—is fast becoming a yet more glaring example of failure.

What’s the problem?

Hundreds of billions of dollars are being invested in new Australian gas projects. The Tax Justice Network estimates that, by 2021, Australia will overtake Qatar as the biggest exporter of liquefied natural gas (LNG) in the world—yet Qatar will raise more than 30 times the revenue from their gas industry.

A recent Senate inquiry heard some of the overly generous tax deductions which have led to this point. The massive Gorgon project, for example, is unlikely to pay significant tax through the PRRT for at least two decades. Then there’s the perverse situation wherein a multinational company can cause an oil spill, deduct the expenses for cleaning it up against future profits (at an uplift rate of 15 percentage points above the long-term bond rate), transfer those losses to a different project altogether, and then actually be paid money through the PRRT for decommissioning the project that caused the oil spill in the first case. 

Meanwhile the federal government is struggling with a large and growing annual budget deficit, with hoped-for economic growth arising from the politically toxic corporate tax cuts as the only strategy for getting the budget back towards balance. The failure of the PRRT to generate much revenue at a time when it is so sorely needed makes a political economic solution patently necessary.

The fork in the path

The question now is: what can the government do to redress the currently dismal situation?

The weak response would be to tinker with expense deductions for firms in the industry or to change the regime just for new projects. That would leave the companies safely insulated from paying tax because of the $190 billion in credits they have already amassed against future profits.

A more effective response would need to do two things. First, the 15 per cent uplift rate for the deduction of exploration costs must be significantly decreased. Second, a royalty payment must be applied to offshore gas projects that are currently only subject to the PRRT. These measures have been proposed by the Tax Justice Network and are estimated to raise $4-6 billion extra revenue for the government over the next four years.

The extra revenues could be invested in policy areas where the government is already under pressure, like funding the full Gonski school reforms. Alternatively, they could reduce the annual budget deficits that the government has been backing away from dealing with ever since the abortive 2014 Abbott/Hockey budget.

Will the Turnbull government take this sort of decisive action? That seems improbable. The consultation paper released by the government a few weeks ago has already ruled out major policy changes to the PRRT. The existing projects that are siphoning off a large proportion of our national wealth will not be touched. Discussion of royalty payments has also been designated off-limits.

The bigger picture

The basic fact is that the PRRT isn’t working as a revenue raising measure, failing Tony Abbott’s ‘ineptitude test’ from 2013. On the other hand, it is working to encourage investment in projects likely to be only slightly profitable, which would be too risky to take a chance on if a royalty scheme were in place. That raises the underlying question: what is the point of haaving more, less profitable gas extraction projects, if we don’t get even get any revenue from the big profitable ones?

The other outcome that the current PRRT ensures is that the mining industry will maximise the extraction of emissions-intensive fossil fuels through government subsidies we have already committed to phasing out.

In addition to the environmental impacts of yet more mining, we also need to consider the distribution of the winners and losers. If we are concerned that Australia is becoming a more unequal country, we must look beyond macroeconomic indicators like GDP growth or total revenue. The Evatt Foundation’s Wealth of the Nation report, published last year, found that wealth is increasingly concentrated in the richest households, leaving the poorest 40 per cent with virtually no share in the nation’s growing wealth. The willingness and capacity of the government to use its policy levers, like welfare and education, to redress growing economic inequalities is a big issue. In short, inequality is partly a revenue problem.

Charting a different direction takes courage and commitment. It is probable that the Turnbull government will judge that the price tag—in terms of political capital—more than it can afford. Taking on the mining companies over any policy that raises more revenue from them would precipitate a predictable backlash. In light of the new bank tax announced in the 2017 budget, perhaps Malcolm Turnbull and his Treasurer have already made the judgment that a theatrical stoush with the big four banks has already fixed their ‘optics’ problem with big business.

But of course there’s always the next year’s budget. Without hard reform, the government leaders’ political economic choices in 2018 will narrow to severe austerity or a skyrocketing structural deficit. If that happens, the political cost of failing to reform the PRRT could become a missed opportunity to save themselves.

Meeting the test

In summary, action is required along four lines, as follows.

Firstly, we support reduced uplift rates relative to the current scheme. We agree that the purpose of uplift rates is to maintain the value of deductible expenditure rather than to compensate for the risk borne by corporations in weighing their investment decisions. Assuming this purpose of uplift rates, it is clear that a LTBR plus 15 percentage points goes well beyond preserving deductible expenditure, instead acting to incentivise some investment costs like exploration. Any reform to uplift rates should reduce the overall rates and require that existing credits with high uplift rates are used first in order to prevent them compounding over a number of years.

Secondly, we note that the government has diagnosed the problem under consideration as the failure of the PRRT to collect public revenue from the extraction of such a large quantity of our natural resource wealth. For the government to have any prospect of actually addressing that problem, given that Australia is already in a position to become the world’s largest exporter of natural gas, it is essential to consider the different revenue impacts of reforms which apply equally to new and existing projects. Without full consideration of these options, it is impossible to understand the scale of public revenue that is being foregone through policy inaction. Policies relating to existing projects should be brought under consideration.

Thirdly, attention must also be given to the question of whether the PRRT is sufficient in itself to guarantee a baseline of revenue across a range of market environments. The current policy framework was agreed partly on the basis of optimistic forecasts of PRRT revenue collection by the industry, predicated on market prices higher than at present. Given the difficulties of accurately predicting prices in markets which have undergone—and will continue to undergo—significant changes, especially as renewables play a larger role, reform of the PRRT needs also to plan for a scenario where prices remain low for a significant period of time.

In the latter scenario, the most effective policy framework to guarantee some public revenue would be the use of a 10 per cent royalty, as exists for other extractives projects outside the offshore gas sector. Given that royalty payments are deductible expenses under the PRRT, the industry interests are not being penalised except in the scenario where they expect to pay nothing under the PRRT over the life of entire projects—which would represent such a significant policy failure that intervention now would be more than justified.

Finally, there have been revelations [through Publish What You Pay’s participation in the inquiry process] that Australia’s transparency, as measured by the resource governance index, is lower than for many other countries, including ones to which we provide aid in order to improve their sector governance. It is in the public interest for transparent information about production levels to be widely available and interpretable, particularly when there is simultaneous policy challenges of gas shortages and wholesale export without sufficient taxation. We therefore support calls by the Tax Justice Network to mandate public disclosure of production levels by project, as well as estimates of known reserves.

Overall, the PRRT review exposes the limitations of a policy framework focused purely on maximising the development and extraction of natural resources. While the existing framework may achieve that narrow goal, there is nothing inherently meritorious in that. Much more important are policy arrangements that provide a fair return to the Australian public for the extraction of its shared natural wealth. The current policy clearly fails that test, and the government should be urged to consider major reforms of the PRRT, including a comprehensive royalty scheme applying to existing projects as well as winding back the over-generous uplift rates and committing to greater transparency of production levels.

Frank Stilwell and Michael Vaughan are both members of the Evatt Foundation Executive, in addition to which Frank is Professor Emeritus in Political Economy and Michael is a doctoral student, both at the University of Sydney. Image courtesy of the Tax Justice Network, of which the Evatt Foundation is a member.

See elsewhere:

Suggested citation
Stilwell, Frank and Vaughan, Michael, 'The PRRT & the ineptitude test', Evatt Journal, Vol. 16, No. 3, July 2017<>