Britain’s fracking tax incentives: do they pass the test?

It’s funny, if you’ve only ever thought about an issue in terms of other places, when it suddenly it pops up in you back yard. Gives you a different perspective. So the announcement today that the Britain is going to create the “world’s most generous shale tax regime” [£] to encourage ‘fracking’ is a chance to think about all the pontificating I’ve done about tax incentives.

As far as I can tell, we don’t yet know the details of what is being proposed, only the headline. If there’s more today I’ll update this post. But the key message is a slashing of the corporation tax rate from 62% to 30%, and compensation for local communities hosting a well of £100,000 plus 1% of revenues.

Below I have posted two sets of recommendations on tax incentives, one from the OECD, and one from ActionAid’s new campaign. Looking through them, it seems most are unlikely to create any trouble, since these are statutory incentives that will be passed through legislation. But two thoughts emerge initially.

First, will there be a published, transparent analysis of the revenue expected to be foregone, and predicted benefits? This is usually done in the UK through a “tax information and impact note” attached to proposed legislation, but I wonder how detailed it will be, and whether there will be any way to test the assumptions about how much investment the incentives will bring in. Peter Lilley, a conservative MP with an industry background, said yesterday, “I think tax breaks are unnecessary for fracking, based on my knowledge of the oil and gas industry.”

Second, from the “most competitive in the world” headline, it seems these British incentives are not simply designed to tip the investment past the point at which it has a viable net present value, but quite explicitly to entice investment away from other countries. So it’s tax competition. Why isn’t there a statement that incentives should only be designed to make investments viable, as opposed to making already-viable investments more attractive than those in other countries? Is that too vague?

Furthermore, the recommendations generally talk about regional agreements to limit tax competition, but in this case that doesn’t seem relevant: I think it’s less about regional partners/competitors and more about other countries with shale gas potential. Maybe the recommendations should extend beyond regional proximity to cooperation between countries with similar resource endowments

Here are the ActionAid recommendations:

  • Eliminate all tax holidays.
  • Publicly review all tax incentives, assessing tax expenditure (the amount of tax foregone from incentives), ensuring incentives are well targeted and commensurate with the benefits expected to citizens.
  • Ensure that all phases of new incentives require parliamentary approval, and also that any new incentive offered is grounded in legislation which makes it available to all qualifying investors, foreign or domestic. This would effectively mean an end to discretionary tax incentives.
  • Publish a costing and justification for each incentive offered, followed by monitoring of conditions and a tally of costs and benefits, so the public can see the impact of tax incentives.
  • Grant the Finance Ministry (not solely the Investment Promotion Authority) powers over tax incentive decisions.
  • Refrain from entering into stability clauses (which lock in tax incentives long term) when negotiating new tax incentives and investment agreements.
  • Ensure that tax incentives are audited to check that the investment for which an incentive is offered has actually been carried out.
  • Co-ordinate statutory tax incentives with groups of neighbouring countries, in order to counter tax competition.

Here are the OECD principles [pdf]:

  1. Make public a statement of all tax incentives for investment and their objectives within a governing framework.
  2. Provide tax incentives for investment through tax laws only.
  3. Consolidate all tax incentives for investment under the authority of one government body, where possible.
  4. Ensure tax incentives for investment are ratified through the law making body or parliament.
  5. Administer tax incentives for investment in a transparent manner.
  6. Calculate the amount of revenue forgone attributable to tax incentives for investment and publicly release a statement of tax expenditures.
  7. Carry out periodic review of the continuance of existing tax incentives by assessing the extent to which they meet the stated objectives.
  8. Highlight the largest beneficiaries of tax incentives for investment by specific tax provision in a regular statement of tax expenditures, where possible.
  9. Collect data systematically to underpin the statement of tax expenditures for investment and to monitor the overall effects and effectiveness of individual tax incentives.
  10. Enhance regional cooperation to avoid harmful tax competition.

Tax incentives cost $138 billion…?

#taxpaysfor my PhDCongratulations to ActionAid on the launch of its new Tax Power campaign – an impressively internationalised version of the work ActionAid UK has been doing for five years now. I love the gallery of #taxpaysfor photos.

As part of the campaign launch, ActionAid asked me to help them come up with an estimate for the revenue foregone by governments in developing countries through corporate tax incentives. As the campaign briefing says, there is mounting evidence that such incentives are often ineffective at attracting the kind of investment that leads to sustainable economic growth. (This is distinct from the general rate of corporation tax, which is a whole other debate…) Certainly they are rarely put in place with any kind of cost-benefit analysis, which is why there’s so little reliable data out there.

We decided to come up with a ‘ballpark’ average figure for the revenue foregone as a share of GDP, and apply this to the total GDP of all developing countries. The scaling up part is obviously quite a simple approach, but I was quite pleased with the way we arrived at the average figure to begin with, so I thought I’d share it.

Data on ‘tax expenditures’ – that’s the revenue lost through tax incentives – is quite sparse, and where it does exist it’s plagued with inconsistencies. After quite a lot of hunting around, I managed to find about 20 developing countries where the government had published tax expenditure data, either directly or via a civil society organisation. I took the most recent year I could find in each case. I was particularly proud to have dug up a figure for Bhutan!

Tax expenditure reports can include the cost of everything from VAT exemptions to free trade zones, so it was essential to a) find something consistent and b) focus only on the kinds of expenditures that ActionAid is campaigning on. I’ve seen a few organisations cite massive figures for the cost of tax exemptions in a country where, if you go to the original source, you see that most of these go directly to ordinary people, not multinational companies. An IMF paper [pdf] says that tax expenditures probably amount to a couple of percent of GDP, but that refers to all types of exemption.

Although a few countries give one aggregate figure for direct taxes, which annoyingly makes personal and corporate income tax indistinguishable, there were 16 where I could find, or at least make a good guess at, the share of tax expenditures coming from corporate income tax (sometimes that involved running line-by-line through an itemised expenditure). So that’s the figure I used.

I ignored all other taxes from which companies get exemptions. I also excluded the expenditure on deferrals (i.e. accelerated depreciation) because in theory at least this just creates a timing difference – I presumed that in any given year the government foregoes some revenue in this way, but also receives some extra because of past deferrals. Maybe other tax brains out there can tell me if that was the right thing to do!

The data after all this processing is given in this Google spreadsheet.

I used some whizzy regression software from the LSE to check whether there was any connection between the proportion of revenue foregone and the amount raised, or GDP per capita, or the size of an economy, but I couldn’t find any meaningful relationship. That’s why it seemed like a simple average, 0.60% of GDP, would be the best way to go. Interestingly it’s pretty much the same as the figure for India, which is also by far the biggest economy in the sample.

When you think about it, rough though it is, that’s a huge ‘ballpark’ to be in.

Nicaragua’s new canal: the world’s biggest tax exemption?

Panama Canal with Three Ship

Panama Canal with Three Ship (Photo credit: Wikipedia)

I’ve been reading about the proposed new transoceanic canal in Nicaragua, plans for which were passed by the country’s parliament last week. The Reuters story on it notes that the $40bn cost would be four times Nicaragua’s national income.

According to the Guardian, once running, the canal would double Nicaragua’s GDP and triple employment. So what would it do for the country’s tax revenues? The answer, it seems, is very little.

According to my ham-fisted translation of the draft project agreement [pdf, Spanish], the government has agreed to an exemption from all taxes, including capital gains and value added tax, for the Chinese firm building the project (which happens to be registered in the Cayman Islands). The exemption extends to withholding taxes on dividends, interest payments and royalties, all import taxes, and any taxes on expatriate employees. The only source of tax revenue left out of the exemption is “existing labour taxes”. And all of this seems to be indefinite.

The Cayman Islands company will apparently pay just US$10m a year for the privilege of owning the waterway, although it should be noted that the ownership of the canal will gradually transfer to the government.

Now I can see that this is a very high risk, high cost project, the kind where tax incentives might help tip its net present value above the threshold that makes it interesting for investors. But the sheer size of the project, combined with the sweeping nature of the exemptions, must surely merit a serious cost-benefit analysis. Yet, as often seems to be the case, there’s no suggestion that such an analysis is underway. Here are some opposition voices quoted in the Guardian:

The Sandinista Renovation Movement said it would oppose the bill and “any document that gifts a concession, privileges, exonerations and tax exemptions to an unknown company, for an unknown route, for a period of 100 years.”

“We are going to hand over the country’s sovereignty without knowing where the canal is going to go, how much it is going to cost, its ecological impact or how long its construction is going to last,” Independent Liberal party legislator Eliseo Núñez, told La Prensa.

This might be the first project of its magnitude to be under consideration since tax came to the forefront of international development debates. It should surely be a flagship case, one that will set an example of how governments, businesses and civil society should approach the question of tax incentives.