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This paper was prepared as a background paper for the IMF policy paper, Fiscal Regimes for Extractive Industries: Design and Implementation (http://www.imf.org/external/pp/longres.aspx?id=4701). The author is grateful to Philip Daniel, Ruud de Mooij, Michael Keen, and Alistair Watson for careful reading of a previous draft and many helpful comments. Any errors that remain are the responsibility of the author alone.
See IMF (2012), Appendix 2. An outline of the IMF’s technical assistance program is provided in IMF (2010a).
As Poterba (2010) observes, understanding the taxpayer’s behavioral response is what economic analysis adds to the accounting discussion of tax policy.
Lund (2009) provides an excellent and comprehensive review of the literature on resource rent taxes. Peterson and Fisher (1977) and Cairns (1990) offer broad, if somewhat dated, reviews of the economics of exploration and extractive industries.
The size of each block in a highly refined simulation model can be as small as 1 cubic foot.
With simplifying assumptions regarding the impact of depletion on extraction costs and the rate of production, it should be possible to derive an explicit optimal extraction path. Whether the assumptions necessary to achieve that goal are realistic is another matter, and the literature has not really pursued that issue.
The term “decision rules” is a bit strong. In the abstract context of the neoclassical model, decision rules are but verbal interpretations of the marginal conditions for optimization, such as “equating the immediate cost of capital investment with the discounted value of its rewards in future periods resulting from its direct effect on the profit function and indirect effect through the constraint set.” (Cummings and Burt, 1969, p. 988). While such rules describe the guiding principles of efficient investment, it would be difficult to translate them into practical instructions that a mine operator would find useful.
The incentive to delay stems directly from the option value of deferred development; i.e., postponing the irreversible investment to create production facilities until more information on future prices and costs is available to reinforce that decision. Holding expected prices and costs constant, the option value of a given project is increasing in the volatility (uncertainty) of those variables due to the greater likelihood of adverse price and cost movements that would undermine an immediate decision to develop—but which could be avoided by exercising the option to abort. The favorable impact of volatility is even greater on marginal projects than those that offer more lucrative profit margins. Thus, the value of marginal projects is especially enhanced by uncertainty in underlying factor prices.
Hausman (2011) points out that distortions regarding the size and timing of ongoing investment might arise when assets are transferred between owners if the accounting rules fail to recognize the value of embedded options included in the transfer. But, as Lund (2011) argues, the resource rent tax per se does not distort the exercise of real options.
“Uplift” allows the investor additional tax deductions beyond the original amount of capital expenditure.
As published, Fraser’s (1993) analysis is misleading in another respect: his tax is not based on resource rent. Rather, the threshold for taxable income in his model is based on the absolute profit margin per unit of physical capacity—not the firm’s realized rate of return (cf. his equations 2 and 3). The main qualitative results reported in the paper nonetheless stand even after this error is corrected. The easiest means of correction is to set the parameter “c"(the unit cost of building physical capacity) equal to unity throughout the paper, which then makes the profit margin per unit of physical capacity correspond to the firm’s rate of return.
The modeling error described in the previous footnote recurs in these two papers.