When I did my economics unit at University I learnt that if you tax goods at a rate higher than other goods, you will discourage consumption of that good. This is the basis of all “Sin” taxes on alcohol and cigarettes. A corollary is that investment in producing that good will similarly be discouraged.

This elementary fact is lost on the Federal Government’s treasury chief, Ken Henry:

The review reportedly tabled by Australia’s Treasury chief, Ken Henry, and leaked to media last week, recommends scrapping individual Australian state royalty taxes on mining projects in favour of a 40% uniform national resource tax.

For the record, the corporate tax rate is 30% of profits. Thus Ken Henry is proposing a 33% tax rate hike (from 30% to 40%) just “because you are a miner.” Apparently this is to help fund the aging population.

Here are just a few unintended consequences:

1. Small to medium sized businesses in the mining sector now find it harder to attract capital, as investors will now be attracted to other companies with a lower tax rate. In other words, the return on investment for miners is now 33% lower.
2. Shareholders in mining companies now get 33% less in dividends, meaning less money to re-invest, save or spend, leading to reduced economic output.
3. Replacing the state royalty taxes, now means that states will find it harder to compete for mining businesses to set up in their states. Competition between states reduces royalty tax rates in the long term.
4. Mining exploration is discouraged, thus leading to lower rates of mining activity, thus leading to lower economic output (including lower exports).
5. Superannuation returns from funds invested in mining companies will be lower, thus actually adding to the problem of funding the aging population that it is purportedly trying to solve!
6. Mining companies will have greater incentive to explore overseas and not in Australia.
7. Discouraging mining activity may actually reduce tax receipts due to the Laffer curve effect.
8. (UPDATE) Companies delay investment decisions due to proposed resource tax, thus dampening economic activity.

UPDATE: Looks like it’s going to happen.

UPDATE: More from Michael Stutchbury from The Australian.

I stumbled across an interesting analysis of a new technological process, horizontal drilling and extraction of shale natural gas. Read the whole thing here but here is the key chart comparing horizontal vs vertical wells:

Comparative production from a vertical and horizontal natural gas well (Chris McGill).

Production Volume

One thing that did strike me is that the horizontal peak production is well above the vertical well but has a shorter life span. Horizontal wells do have significant technical challenges (as seen in the article), but perhaps we can analyse the above chart to give us an idea of the benefits of horizontal drilling. Now to do this is a little tricky, as I do not have the original chart. However, using Photoshop, I was able to extract the area of the chart and the scale to get us total volume (note these are approximations only, but it gives us a “back of the envelope” view):

• Vertical Well (Yellow): 3547 MMFC
• Horizontal Well (Orange): 6097 MMFC
• Horizontal to Vertical Well total production gain: +72%

Judging from the chart the horizontal well extracts and extra 72% more oil in 10 months versus 100 months for vertical wells.

Production Value

Now to estimate the total value of the well let’s assume the price of natural gas is stable (at Henry Hub) at $8.00 per MCF:

• Total value of the horizontal well is 6097*1000*$8.00 = $48,776,000
• Total value of the vertical well is 3547*1000*$8.00 = $28,376,000

Time Value of Money

This is where we get to use some basic financial models to determine the value of horizontal wells compared to vertical wells. The time value of money is the value of money figuring in a given amount of interest earned over a given amount of time. As an example, with an interest rate of 5% per annum, 100 dollars received today is equivalent of receiving 105 dollars in a year’s time.

Note that the horizontal well lifetime is 10 months compared to the vertical well lifetime of 100 months. Thus to be fair we need to compare the value of the horizontal well and the vertical well after 100 months. This is where the Time Value of Money comes in. Let’s pretend we bank the $48,776,000 that the horizontal well extracts, thus after 100 months (assuming 5% interest rates):

• Total value of horizontal well at 100 months: $70,913,392
• Total value of vertical well at 100 months: $28,376,000
• Horizontal to Vertical well gain: +150%

Extraction Costs

I do not know, in detail, the relative difference in extraction costs for these two methods. However, we now have the Horizontal to Vertical Well gain to use in our decision making. If the Horizontal to Vertical well cost is less than Horizontal to Vertical Well gain (+150% in our example), then it becomes economical to use the horizontal well method.

UPDATE: here is some commentary from The Oil Drum on this article regarding the discount rates:

The Former Soviet Republic of Georgia is debating a law to enshrine economic liberty to its citizens and placing constitutional limits to government spending and taxation. This is interesting because we always hear politicians bleat about restraining spending but invariably once they are in a position of power, renege on their promises. By enshrining it in a constitutional form means that it is harder to back away from (although not impossible, if parliamentarians/citizens vote for change). From the Government of Georgia’s press release of the draft :

Fiscal Responsibility

1. Budget expenditure capped at 30% of GDP (FY 2012)
2. Budget deficit capped at 3% of GDP (FY 2012)
3. Public debt capped at 60% of GDP (FY 2012)
4. Extrabudgetary funds are limited
5. Budget earmarks are limited

1. Budget expenditure capped at 30% of GDP (FY 2012): 30% budget expenditure cap is a little high (the US government spending is currently at 40% of GDP!). There is contention as to the optimum level of government expenditure, but below is a chart of reference by a Heritage Foundation report, that shows the optimum level is between 18 and 20% of GDP:

However, having a cap means that it can’t get any worse.

2. Budget deficit capped at 3% of GDP (FY 2012): deficits generally occur when there is a downturn in the economy. Having a cap of 3% of GDP means that politicians will be not be tempted to “bailout” and provide special deals to inefficient industries.

3. Public debt capped at 60% of GDP (FY 2012): This seems high, but Georgia is a newly democratised, fast growing economy in an military unstable region (eg. Russia’s recent invasion). It is understandable that public debt may be higher than OECD countries at this time.

4. Extrabudgetary funds are limited and 5. Budget earmarks are limited: Placing spending limits on special deals for a politicians constituents is a positive measure.

Empowering Citizens by Ensuring Choice in Social Programs
The Liberty Act advances the long-standing policy of delivering targeted social assistance by funding citizens through vouchers and cash benefits (healthcare coverage, education, poverty benefits, etc) rather than funding directly the institutions engaged in the provision of healthcare, education and other services. It provides for the freedom of choice of the beneficiaries to select the service providers

This is an good way to execute government spending programs, but a better way would be to let the free market provide these services. However, vouchers and tax/cash benefits is the least bad way of government providing such services. Citizens having the power to pick and choose their service provider, should mean that service providers must compete for their survival.

Returning the Power to Tax to the People
No new taxes or increase in the tax rates may be imposed other than following an affirmative vote in a nationwide referendum

This is an excellent idea. The public generally hate paying more tax. Politicians running on a campaign of increased taxes, has a very short lived political career.

Will be interesting to monitor its passage into law.

(via Cato)

I have always believed in the Insider Trading laws that protect the market from distortions arising from investors acting on non-public information. Recent articles by Don Boudreaux, discusses Insider Trading, and perhaps it isn’t as bad as I once thought.

One of the problems that was with enforcement of the law. Finding evidence that insider trading actually happened is incredibly difficult. Investors (including employees, directors etc.) buy and sell for many reasons: could it just be coincidence that they sold they shares just as a statement on profitability was about to be announced? Correlation does not prove causation and prosecutors would have to discover a “smoking gun” that proved that a trader acted on non-public information. But just because a law is hard to enforce doesn’t mean it is not worth having. We need another reason.

A company’s share price is a signal to the market about the value of that company’s assets. The goal for a market is for assets to be priced as accurately as possible. So how does a market determine an accurate value? This is from information, ideally disseminated widely, so that thousands of investors can make a judgement call of the value of the company. Information is king.

Let’s now jump to the way directors’ performance incentives. Directors are accountable to shareholders for the value of the company (ie. share price) that they have stewardship over. It is the shareholders interest (and thus the directors’ interest too) to increase the share price. Remember this as I will come back to this later.

So let’s say you are an employee, who gets hold of company information that shows that the company isn’t exactly in good shape. What should you do? Should you go public with that information – no, not if you want to hold onto your job. What you can do it start selling (or shorting) the stock. This would immediately send a signal to the market that the value is not quite what is claimed by the current share price – in other words, the share price falls. So insider trading or acting in your “self interest” actually helps the market determine the value of the company.

Now back to the directors of the company. With Enron, for example, they misled investors and “cooked” the books to artificially inflate the company. If employees/directors who knew this was going on and shorted the stock, this would have sent the share price down. Shareholders will be on the phone calling the CEO to politely enquire what is going on. Given that directors are directly compensated for the share price, they will have the incentive to rectify the problem, before it gets out of hand. While this may not prevent fraud, it will help price a company with greater accuracy, thus giving the market better information to base their investment decisions.

But isn’t this unfair? Why should an insider, in such a privileged position, profit from such internal information? I do not have a entirely cogent argument to this other than: “Life is not fair.” People from all walks of life have advantages over others. The question is, is acting on this insider information better for the market and society in general. If insider trading creates a better indication of a company’s health, then investors can with greater confidence allocate capital to company’s they believe will offer the greatest returns. This increases the productive use of our scarce resources and providing a maximal return to all.

(Thanks to the articles from Don Boudreaux)

Australians will have to pay more for books:

Under current laws, retailers are not allowed to import and sell copies of a book if the local copyright holder has published the book here within 30 days of its overseas release. The Productivity Commission argues this restriction should be removed.

Federal cabinet was split on the push to reform the laws, with Competition Minister Craig Emerson, who was effectively rolled by the backbench, confirming today the government would not act on the Productivity Commission recommendations.

I read earlier about local authors putting pressure the government not to lift the restrictions. I find this puzzling. Authors create content. They (generally) do not actually physically publish the books themselves. It doesn’t matter where their content gets printed. The retort of “what about local jobs?”, well yes certain local book manufacturing jobs may be lost, but on the flipside, if books are cheaper, demand increases, thus creating an incentive for local authors and writers to seek publication.