Treating tax incentives like illegitimate debt

I’m at the United Nations tax committee, which yesterday hosted a day’s discussion on taxing the mining, oil and gas sectors.

Quite a bit of the discussion dwelt on the stability clauses that are often built into contracts between the governments of developing countries and extractive industry companies making investments. In general these clauses insulate the company from any changes to the fiscal regime – such as, most simply, higher tax rates – as well as from changes to the specific tax incentives they have received. Some companies may instead have standalone Fiscal Stability Agreements.

One of the delegates here at the UN explained that his country was reconsidering its approach to tax incentives, following a “backlash” against them. But as several speakers pointed out, stability agreements mean that a new government in a developing country has its hands tied if it wants to change the tax treatment of investments negotiated under a previous government. Governments are also unable to change the terms of the contract if the investment turns out to be a lot more profitable than they thought at the time, for example if the price of the commodity being extracted rises dramatically.

A government may be able to renege on a stability clause or agreement, but in doing so it will probably run up big costs to compensate the company, not to mention the risk of discouraging future investment. In writing this post I dug up an interesting post on the Ernst & Young website, summarising a survey of 20 African governments:

“Interestingly, all of the countries surveyed maintained that [Fiscal Stability Agreements] were binding on the government in terms of tax law or domestic contract law and that there would be implications for the State if it breaches a FSA”, [Head of Tax Corlie] Hazell said.

Yet a number of countries, such as Guinea, Burkina Faso, Rwanda, Tanzania and Zambia, have in fact renegotiated or withdrawn FSA’s in the last two years. “It is cause for reflection that while naked breaches may not occur, what can happen is that changes are effected to the legal regime, which are then used to justify the government’s inability to honour the FSA, especially where renegotiation clauses are included in the agreements instead of stability clauses”, said Hazell.

It strikes me that there’s a lot of similarity between the issues with long term contracts that bind future governments for many decades into fiscal stability, and the long term repayment of debts incurred by previous governments. Just like with debt, governments can choose to renege and incur legal or economic penalties. And just like with debt, there’s a strong case that decisions taken by one government shouldn’t be absolutely binding on future generations of governments and citizens, especially in countries where democracy is fragile, and even more so when these decisions are often influenced through corruption.

Here’s what the campaign group Eurodad says about illegitimate debt:

Eurodad believes that impoverished people in developing countries should not be burdened by paying for debts which did not benefit the populations of the recipient countries. Such debts are referred to as illegitimate debts.

A debt may be illegitimate because the loan was contracted by a despotic power which then stole the cash, used it to build-up their military capabilities or to oppress the people, or because the loan was contracted for ill-conceived and corrupt development projects which failed.

Eurodad argues that these debts must be declared null and void and creditors must assume co-responsibility for reckless lending. In many cases, creditors extended loans in the full knowledge that the funds would not be used for effective development purposes.

If you replaced “debts” with “mining contracts”, wouldn’t the argument still hold?