I had planned on writing about tax rates. Instead, I want to discuss how the National Oil Sands Task Force (NOSTF) arrived at its recommendations. Next, I will return to my previously planned article on tax rates.
As a goal, the NOSTF wanted an efficient fiscal regime. Efficiency in this situation means an improvement to the developer's net present with the least costs tot the governments' net present value. Is not a gain by the developer equal to the loss by the governments? No. The reason why there is a difference is that the developer and governments use a different discount rate. They use different discount rates because of different risk profiles.
How are their risk profiles different? A developer is extremely dependent upon oil price. Prices are high, life is good. If prices are low for a developer, life is more challenging. For the governments, if prices are high, that is good for the royalty and taxes from the oil industry but bad for manufacturing, transportation, tourism, and other many other industries. If prices are low, that is poor for royalty and taxes from the oil industry, but good for manufacturing, transportation, tourism, and many other industries. The government is much less exposed to oil prices than is the oil industry, and thus it has a much lower risk profile. With a lower risk profile, it has a lower discount rate, as we discussed in an earlier article.
The NOSTF examined several different fiscal regimes. We tried various manufacturing and resource regimes in North America. We tried various resource regimes throughout the world. We experiment with investment tax credits and other mechanisms that have been used in Canada and elsewhere. In the end, we found the adopted NOSTF recommendations were among the most efficient of the options examined. Actually, I believe the NOSTF terms were the most efficient, though I am not completely positive. For those looking for more of a theoretical background on the NOSTF recommendations, I recommend you read Garnaut and Clunies Ross, Uncertainty, Risk Aversion and the Taxing of Natural Resource Projects.
Because of the different rates, we learned that that most efficient set of terms allowed the developer to recover quickly its investment capital quickly and then allowed the governments to receive their fair share of the economic pie. The NOSTF terms are very aggressive in returning the investment capital to the developer. This happens because of the low 1% royalty rate until payout and the immediate capital write-off that was available under capital class 41A.
Marginal effective tax rates are often a flawed methodology for setting fiscal policy because they do not account for a skewed cash flow profile where the developer has the costs of investment returned quickly. In other words, the marginal effective tax rate can be misleading. The panel for the Alberta Royalty Review discusses the marginal effective tax rate at length. Instead, it should have focused on the value returned to the developer, Alberta government, and federal government.
The purpose in bringing this information to your attention is to inform you that the NOSTF did not choose its terms arbitrarily. There was an effort to promote activity in the oil sands industry using the most efficient fiscal means.
Calgary model Judith Aldama is featured in the photograph, which is hosted at Flickr. If you click on the picture of Judith, you will be taken to where you can view a larger version and see even more pictures of her.
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