South Africa: Selected Economic Issues

This Selected Economic Issues paper examines economic development in South Africa during 1995–96. The paper highlights that in 1995, the economy of South Africa grew by 3.3 percent, the third consecutive year of economic growth, and it is expected to grow between 3½ and 4 percent in 1996. Some aspects of the unemployment problem are addressed in this paper. The paper also focuses on the implications for policy of the steps taken in 1994 and 1995 to establish an outward-oriented economy, after many years of effective autarky.

Abstract

This Selected Economic Issues paper examines economic development in South Africa during 1995–96. The paper highlights that in 1995, the economy of South Africa grew by 3.3 percent, the third consecutive year of economic growth, and it is expected to grow between 3½ and 4 percent in 1996. Some aspects of the unemployment problem are addressed in this paper. The paper also focuses on the implications for policy of the steps taken in 1994 and 1995 to establish an outward-oriented economy, after many years of effective autarky.

VII. Mining Taxation

1. Introduction and background

The taxation of the mining industry has been the subject of several reviews over the last decade, notably a comprehensive review by the 1987 Commission of Inquiry into the Tax Structure (the Margo report) and the subsequent report by the Technical Committee on Mining Taxation (the Marais Committee) in 1988. The Minerals Act of 1991 introduced a number of important changes to the structure of the mining industry, particularly with regard to the treatment of mineral rights. A major government review of minerals and mining policy is now refocussing attention on the system of mineral rights and mining taxation, with the aim of establishing a new policy framework for the mining industry.

This review occurs in a context of decline in the gold industry: annual gold production has dropped from around 670-680 tons in the mid-1980s to a current level of just more than 520 tons and employment has fallen by 25-30 percent from a peak of more than 560,000 in 1987 to a current level of around 400,000. A significant part of gold production is marginally viable at current gold prices, investment has declined sharply, and the conditions necessary for investment in an expansion of productive capacity—reportedly a gold price of US$600 per fine ounce—are unlikely to be realized in the near future. In sum, the gold mining industry is considered to have moved into a “mature” phase during the last decade, and despite substantial underground reserves, is facing the prospect of entering into a “declining” phase in the next. Other sectors of the mining industry—notably coal and platinum production—have flourished. However, it is the drop in gold production, which has set the tone for debates concerning mining policy.

This chapter outlines the key features of the mining taxation system, including some of the major changes in recent years, and assesses the main arguments in the ongoing debate over mineral tax policy. In particular it seeks to address two issues: (i) was the decision taken in 1991 to forfeit a charge on the right to mine minerals consistent with the new Government’s strategy of promoting a more outward-oriented economy; and (ii) are there structural features peculiar to mining which justify a separate structure of income taxation. The Chapter argues that there is a strong case for reforming the taxation of the mining sector, to reduce the distortions in the allocation of resources and facilitate the structural change toward nonmineral export production. It leaves open the question of whether the reform of mining taxation should be revenue neutral or result in higher revenue for the Government, but there would generally be a preference for the former given the Government’s commitment to avoid any higher increase in the tax burden.

2. Mineral rights

There are four basic categories of mineral rights: (i) mineral rights with respect to tribal land (owned by the state or the relevant tribes); (ii) mineral rights owned by the state; (iii) mineral rights owned by the mining companies; and (iv) mineral rights owned by the surface owners, in those instances Where mineral rights have not been severed from the ownership of the land. 1/ The Department of Energy and Mineral Affairs estimates that approximately two thirds of the prospecting licenses (by surface area) are for mineral rights held by the private sector.

However, prior to passage of the 1991 Minerals Act, ownership of mineral rights did not confer the right to mine precious stones, precious metals, or oil: those rights were vested in the state. 2/ To mine such minerals a mining company had, in addition to securing the mineral right, to obtain a government lease. The lease in turn specified a profit sharing arrangement which was calculated according to a formula, very similar to that of the current gold tax formula.

In early 1988, the Marais Committee 3/ recommended that future mining projects should not be subject to mine leases and that the existing leases should be phased out. It acknowledged that minerals constituted part of the national patrimony—and that therefore there were grounds for compensation to be paid to the state for extraction—but believed that the “objectives of ensuring continued investment in mining and maintaining the industry’s international competitiveness should enjoy priority over the patrimony argument.” 4/ More specifically, the committee argued that as “the mineral resource base…must be actively maintained through exploration and investment…it is unwise to discourage this process by imposing additional taxes [over-and-above income tax].” 5/

The initial response of the Government of the day to this recommendation was not favorable. The 1989/90 Budget Review makes clear that the Government was “very conscious of the fact that the mines were reducing the country’s mineral wealth” 6/ and should therefore bear an additional taxation burden. The Government was also concerned that the revenue loss resulting would be unacceptably high, 1/ and opposed any proposal whereby this “forfeiture of revenue would be recovered from other sectors.” 2/ The Review did recognize, however, that if the Minerals Bill was enacted unchanged, the state would no longer be entitled to mining leases in those cases where it did not hold the mining rights. Under such circumstances, the Review indicated that it would be necessary to investigate alternative taxes or levies on the mining sector to replace the lease payments and to consider the possibility of extending those levies to include all metals and minerals and not just the precious metals (and stones) covered by the existing lease payment system.

The 1991 Minerals Act did not incorporate the relevant clauses of previous Acts, 3/ which had vested in the state the right to mine precious stones, precious metals and oil, and consequently the legal basis for the lease consideration system was removed. However, in light of concerns about the weakened financial position of the gold mining industry and the need to encourage development of new mines, the Government decided not to introduce a new levy or tax to replace the lease consideration, and the Budgets subsequent to the Marais Committee report sought to alleviate the burden of taxation on the mining sector further along the lines recommended in that report.

The statements of the African National Congress (ANC) on mining policy during the transition period to a Government of National Unity created much controversy. One of the central tenets of the ANC’s mineral policy was that “the mineral wealth beneath the soil is the national heritage of all South Africans, including future generations,” and consequently “users must pay rent to the ‘people’ or state to deplete [them]”. 4/ To this extent, therefore, its position was virtually indistinguishable from that set out in the 1989/90 Budget Review. Where the ANC policy differed markedly from that of the previous Government was on the proposed mechanism for achieving this goal. Rather than seek to reinstate government control over the right to mine, the ANC proposed the “return of mineral rights to the democratic Government.” 5/ In part, this policy reflected a concern that private ownership of mineral rights was causing suboptimal exploration and development of the country’s mineral reserves. The ANC position suggested that the existing system of privately owned mineral rights provided no incentive to mining companies to develop their stock of mineral rights, while denying other interested parties, in particular foreign investors, access to those rights—the so-called “freezing” of mineral rights. 1/

Despite the assurances by the ANC that security and continuity of tenure for mineral exploration and mining would be guaranteed under a system of public ownership of mineral rights, much of the criticism of the ANC proposal has focused on its impact on investor confidence. The Chamber of Mines argued that private ownership of mineral rights provides the necessary security of tenure to encourage investors to commit the substantial resources required to explore and develop mineral bodies, and that government assurances of security of tenure would be inadequate for this purpose.

In the absence of convincing evidence that private ownership of mineral rights results in a socially suboptimal exploration and development of the country’s mineral reserves, the case for private ownership on the grounds of security of tenure seems sound. The central issue of mineral rights, therefore, revolves around the case for imposing a charge on mining companies for the extraction of a nonrenewable resource.

3. Gold and the economy

Removing the charge on mining companies for extracting a nonrenewable resource is equivalent to subsidizing the mining industry, because it represents a transfer to the mining companies, free of charge, of a rent on part of the country’s patrimony, namely its mineral wealth. The majority opinion in the Marais Committee believed that the strategic status of the mining sector, gold mining in particular, justified this subsidy, notwithstanding the consequent switch in the relative tax burden from the mining sector to the nonmining sector and the replacement of a relatively efficient tax instrument 2/—a tax on rent—with less efficient tax instruments. It is clear from the 1989/90 Budget Review that the Government of the day was very concerned about these tax policy implications.

The view that the mining sector holds a special status in the economy was not new and remains influential. 1/ The introduction to the recent discussion document on mining policy states: “the centrality of the mining industry to South Africa’s economy is a common point of departure for all parties… it is widely recognized that, because the industry is a cornerstone of the South African economy… any changes that may take place will have far reaching ramifications.” 2/ The ANC Minerals and Energy Policy Discussion Document reflects a similar perspective. This mode of thought immediately establishes a prima facie case for providing special assistance to the mining sector, especially in the context of a gold mining industry under pressure.

But it is not clear that this implication is well founded. In the past, the mining sector, gold mining in particular, was an engine of growth of the economy. For much of the period since the 1960s, the Government pursued an inward-looking growth strategy. Once the early opportunities for growth from import substitution had been exhausted, the economy, hampered by the weak competitiveness of the nonmining export sector, relied increasingly on the mining sector to maintain the momentum of economic growth, by relieving the balance of payments constraint, and by providing a source of employment.

The mining industry remains an important sector in the economy. Although mining production now accounts for only 9-10 percent of GDP, and makes a negligible contribution to government revenue—less than 2 percent of total revenue—mining exports are still approximately 40-50 percent of total exports. 3/ However, since the early 1980s it has become increasingly clear that the mining sector is unable to maintain the role of the engine of growth, nor can it support the employment generation required to address the unemployment problems of the economy. 4/ The prospects for the future are no more promising: gold mining is confronted with a trend deterioration in production levels and a weak gold price; the prospects for the nongold mining sector are brighter, but the contribution to employment from that sector is expected to be modest as production has become increasingly capital-intensive. Partly in recognition of the waning ability of the mining sector to maintain the momentum of economic growth and employment generation, the Government has begun the process of shifting toward a more outward-oriented economic strategy since the late 1980s.

This change in growth strategy, however, has an important bearing on the policy to forfeit a charge on the extraction of nonrenewable resources. The paramount importance of ensuring “continued investment in mining and maintaining the industry’s international competitiveness” is not synonymous with the development of a dynamic outward-oriented economy, and may even be detrimental to it, particularly if pursued through the tax system. Artificial support of the mining sector delays a shift in the structure of relative prices in favor of the production of nonmining exportables, impedes efforts to reduce the tax burden on other sectors of the economy, and embodies the use of less efficient tax instruments.

In summary, the switch in growth strategy essentially removes the basis for providing a subsidy to the mining sector. Consequently, the rationale for terminating the lease payment system—at least the failure to impose a replacement levy—is considerably diminished and so there may be a strong case for reconsidering the orderly introduction of some form of levy on the right to mine, as proposed by the Government of the day in 1989 and, more recently, by the ANC.

There are a number of issues related to the appropriate form of such a levy and these are discussed in greater detail in Appendix I. However, there are some basic principles that should be taken into account. First, the levy on the right to mine should be considered as a factor payment for the use of a nonrenewable resource. The state must take into consideration the opportunity cost of extracting the mineral resource when setting the levy on the right to mine. Second, the state must ensure that the structure of the levy does not leave it bearing an inappropriate share of the risk in the mining venture and to the extent that the Government wishes introduce a risk-sharing arrangement into the levy structure, it should ensure that an appropriate price is charged for bearing a portion of the risk. Third, the levy structure should aim to minimize sovereign risk borne by the private mine proprietors, that is, the risk that the state will alter the fiscal arrangements after commitments have been made to mineral exploration and development.

For these reasons, it is argued that a severance tax should play an important role in the levy on the right to mine. The severance tax may be supplemented by profit based charges but the latter should not be relied upon as a major part of the levy on the right to mine.

4. Mining taxation

We now consider the merit of arguments suggesting that characteristics inherent in the mining process—notably risk—form a basis for a separate structure of taxation distinct from that for nonmining activities. The arguments presented in favor of a separate tax structure are not based on claims for subsidies, but suggest that were, mining activities taxed on the same basis as nonmining activities—through the standard corporate tax structure—they would be disadvantaged because they are subject to substantially greater risk than nonmining activities.

This issue arises because the mining sector is eligible for a system of accelerated depreciation allowances—the redemption allowance, the capital allowance, and the ring system—which is markedly different from that available to nonmining companies. Furthermore, gold mines are subject to a formula tax, rather than the standard rate of corporate tax. These two features of the mining tax system have generated much debate.

a. Accelerated depreciation allowances

The tax system provides for an extreme form of accelerated depreciation allowance in the mining industry: the redemption allowance allows eligible 1/ capital expenditure to be deducted in full against income in the year of assessment in which such expenditure occurs. The deduction is, however, subject to Sections 36(7E) and 36(7F) of the Income Tax Act—the “ring fencing” provisions. 2/ Section 36 (7E) restricts the deduction of the redemption allowance to taxable income from mining operations, with the balance carried forward to subsequent years. For all new mines developed after 1984, Section 36(7F) further restricts the deduction of capital expenditure on a mine to the taxable income of that mine. In 1990, the Government introduced a partial relaxation of the ring fencing system. Section 36(7G) allows 25 percent of an existing mine’s taxable income to be available for write-off against the development of a new mine.

In addition to the redemption allowance, some mines are eligible for a capital allowance. The capital allowance provides for the redemption allowance to be carried forward with interest. There are three basic categories of mines eligible for capital allowances: (i) post-1973 mines are eligible for a capital allowance of 10 percent; (ii) “other deep level” mines are eligible for a capital allowance of 10 percent; and (iii) post-1990 mines, eligible for a capital allowance of 12 percent.

The mining industry has vigorously defended the redemption allowance. First, it has argued that a system of accelerated depreciation allowances is essential for the mining industry to compensate the mining industry for the high risks associated with its mining activities. These risks come in a number of forms: (i) the geology of South Africa’s mineral reserves, particularly its gold reserves: the reserves are at great depth, which not only greatly enhances the costs associated with mine development but also increases the risk of mine failure post exploration; (ii) the long lead times until a project comes on stream; and (iii) the risks associated with operating in volatile commodity markets. Second, it has been argued that although the immediate redemption of capital expenditure is an extreme form of accelerated depreciation, it has the advantage of simplicity. In particular, it avoids the difficulty of having to distinguish between capital expenditure and current expenditure in a mining operation. 1/

The case against the system of redemption and capital allowances was argued eloquently in a dissenting opinion in the Marais Committee report. 2/ The opinion argued that the retention of a system of accelerated depreciation allowances ran contrary to the trend in international tax reform to move away from such incentives. The move away from accelerated depreciation allowances, the opinion argued, was driven by evidence that tax incentives for capital expenditure tended to promote “the quantity of investment at the expense of its quality” and “biased economic activity toward capital intensity.” The overall impact was not to enhance economic performance but merely to depress effective rates of corporate tax far below the statutory rate.

The Margo Commission focused more closely on the distortions arising from the ring fencing system, and the consequent damage done to the efficient allocation of resources. Nevertheless, despite the costs associated with the ring-fencing system, it was clear to the commission that it was a necessary evil as long as the system of accelerated depreciation remained in place. The commission argued that the most effective way of addressing the distortions created by the accelerated depreciation allowance and ring fencing systems was to abolish the redemption allowance and replace it with ordinary depreciation allowances granted to other branches of the economy. Once the redemption allowance was abolished, the ring fencing system could safely be abolished as well. 1/

Clearly, as recognized by the Marais Committee, the issue of accelerated depreciation allowances turns on whether the mines are subject to special risks and, more importantly, the appropriate policy response to such risks. This issue will be addressed following a discussion of the special tax treatment of the gold sector.

b. The gold tax formula

The tax rate payable by a gold mine on its taxable income—profits—is determined by the following formula:

y=a(1-b/x),

where a and b are fixed parameters and x is the ratio of taxable income to revenue. The parameter b, currently set at 5 percent, defines the tax threshold, below which profits are not taxed (the “tax tunnel”). Parameter a is linked to the standard rate of corporate tax. 2/ As is clear from the above, the gold tax formula is progressive and provides a tax incentive to mine marginal ore bodies (see chart 17). 3/

Advocates of a switch to a flat rate tax, the Margo Commission included, have argued that the gold tax formula is flawed because it breaches the principle of tax neutrality and introduces an undesirable incentive to mine marginal ores.

Chart 17
Chart 17

South Africa: GOLD TAX FORMULA

Citation: IMF Staff Country Reports 1996, 064; 10.5089/9781451840926.002.A007

The Marais Committee, however, rejected recommendations to replace the formula tax with a flat rate tax, arguing as follows:

(i) the inducement to mine marginal ores, far from being undesirable, is an essential feature of the gold tax formula. It argued that the inducement was in the best interest of the country because it increases mine output in the long run and extends the lives of the country’s mines.

(ii) The formula has the benefit of providing a degree of burden sharing, both between mines, with richer mines paying a higher rate of tax, and between the industry and the Government, with the Government receiving a share of the windfall profits during a commodity boom and providing tax relief to the industry when commodity prices weaken. The latter breach of the principle of tax neutrality was considered necessary because of the high risks associated with gold mining.

To the extent that the first argument pertains to the need to subsidize the development of sub-economic projects in the gold mining industry, the argument has been addressed—and rejected—above. And was recognized by the Margo Commission, subsidies to mine marginal ores introduce an undesirable distortion into the extraction profile of a mineral reserve, inhibiting flexibility of mine production. 1/

The case for providing a degree of burden-sharing requires more careful consideration, as some recognition by the tax system that the geology of some mines makes them substantially more profitable than others has some superficial attraction. However, the superior “profitability” of favorably located mines reflects the fact that these mines have access to “high- rent” minerals. The corporate tax is not the appropriate fiscal instrument for addressing the issue of differential mineral rents. Other instruments need to be developed, primarily in the context of the contract negotiated between the state and the mining companies regarding the right to mine.

The prominence of the “ability-to-pay” arguments in the Marais Committee report clearly also reflected pressing concerns that the shift to a flat rate tax would have substantial negative financial effects on low grade, low margin mines. These concerns will, if anything, have intensified in the intervening period. However, the appropriate response to these concerns is not provide support through tax expenditure. Rather, if support is deemed to be warranted it should, as proposed by the Margo Commission, be provided through a system of grants which would enable the Government to target aid to the gold-mining sector accurately and effectively.

There remains the case for providing some degree of burden sharing between the Government and the mining industry, particularly with respect to the risk that some deposits might not live up to expectations. Clearly, the fact that the gold tax formula is restricted to gold mining 1/ carries the implication that gold mining is subject to special risks that do not apply to nongold mining. 2/ However, the fundamental argument is the same as that for the accelerated depreciation allowances: the mining industry is subject to special risks, which should be shared with the Government. It is this case that is considered next.

5. Risk insurance

The risk argument of the mining industry merits closer attention, because it has played a key role in the mining taxation debate. Two sets of risks need to be distinguished. Firstly, the risks pertaining to investment in individual mines. As noted above these are fundamentally risks related to the geology of the mineral reserves. Secondly, there are the risks confronting the industry as a whole. These include not only the risks associated with operating in a volatile commodity market, but also risks related to security of tenure and the stability of the fiscal regime. For both the enterprise and the industry risks, three principal issues need to be considered: (i) what is the appropriate policy response to the risks, and should government bear a portion of the risk, as it does implicitly through the current tax regime? (ii) if so, what price should the government charge investors in the mining industry for providing insurance cover? and (iii) is the corporate tax system—in particular its system of accelerated depreciation allowances—the appropriate instrument for providing such insurance?

With respect to the industry risk, the case is relatively straightforward. There would appear to be fairly general agreement that the problem of volatile commodity markets is not unique to the mining industry and that risks arising from this source do not therefore constitute a strong case for a special mining tax regime to absorb some of the risk. Indeed, there is evidence that the private sector is generally better able to manage this risk than the public sector (See Collier and Gunning, 1996).

The risks associated with security of tenure and the stability of the mining fiscal regime, clearly lie within the domain of government policy, but the appropriate response is not to compensate the mining industry for such risks but rather to seek to minimize them. In this light, there would appear to be a strong case for retaining the current system of mineral rights combined with a mechanism to ensure an adequate return to both the state and the mining company for the depletion of the country’s mineral resource. Historically, the fiscal regime has not performed this function well; it has undergone a number of sizable changes in the past—e.g., the use of mining surcharges and the introduction of the ring fencing system in the early 1980s—as governments attempted ex-post to capture an adequate share of the mineral rents generated by mining activities. Such ex-post adjustments to the fiscal regime are clearly undesirable as they raise the risks associated with investment in the mining industry. To minimize the risk of such upheavals, the fiscal regime should ensure that it provides for adequate compensation across a wide range of contingent states at the outset.

The issues with respect to the appropriate response to mine-specific risk are more difficult, but again it is not clear that it is in the best interest of the economy for the Government to bear a portion of this risk of a mining venture. A number of factors need to be taken into consideration:

  • The risks associated with a mining venture can be diversified by the private sector. While the risks of an individual mining venture may be high, the risks associated with a portfolio of mining investments are likely to be substantially lower, and the risks associated with a portfolio of investments of which mining is but a component will be lower still. Thus, the risk that should be of concern to policy is not the risk at the level of an individual mine, but the residual risk that remains after such mine-specific risks have been as fully diversified as possible (through the financing structures of such mines). Government’s attempts to transfer some of the nonresidual mine-specific risk to itself, may not therefore be an appropriate policy response to such risks. Firstly, the Government may be less well positioned to diversify or adapt flexibly to the risks that it is taking on than the private investors to which it is providing insurance. Secondly, the provision of insurance may induce the private sector to adopt investments that are less well adapted to the conditions confronting the economy. There should therefore generally be a prima facie case against the state providing risk insurance to private investors, particularly if potential investors—both domestic and foreign—in mines have access to a full range of financial instruments through which they can diversify such mine-specific risks.

  • If the Government is persuaded that there is a case for intervening to address the residual—i.e., nondiversifiable—risks associated with investment in a particular sector of the economy, it will need to consider carefully the price that it will charge for providing that insurance. It’s own ability to diversify the risks that it is taking on will be important factors in determining the appropriate price. Given the relative characteristics of the Government and the type of investor attracted to large scale mining ventures, it is highly likely that the price that the Government would have to charge investors in the mining sector to adequately compensate it for providing insurance for mining activities would render that insurance unattractive.

  • As with all policy interventions, the possibility of unintended effects of publicly provided insurance for mining activities must also be considered. For example, even if one could argue that the gold tax formula addressed residual risks in gold mining, this formula clearly has effects additional to this, namely, it subsidizes the exploitation of marginal ores, an effect that, as argued above, is undesirable from an efficiency standpoint. And given that South Africa is still a large producer relative to world markets in a number of mineral markets, one of the unintended effects to which careful consideration should be given is its impact on the world prices of the commodities concerned. 1/

Finally, as noted above, the corporate tax system is not an appropriate instrument for addressing such residual risks. The function of the corporate tax system is to levy a tax on corporate income in the economy in a manner that minimizes, to the extent possible, distortions in the inter-sectoral allocation of resources. One of the great weaknesses of many systems of mineral taxation—including that in South Africa—is that a multiplicity of objectives have been loaded onto a single instrument, the corporate tax. 2/ As a result, it is difficult to identify the effective tax rate on corporate income in the mining sector, especially the gold mining sector, because the rate of corporate tax includes: (i) the implicit charge that the Government is levying on the mining sector for the extraction of a nonrenewable resource; (ii) the adjustment to that levy for the implicit price the government is charging for providing risk insurance; and (iii) a tax on corporate income which should adhere to the principle of tax neutrality. In general, the corporate tax should be relieved of the burden of providing a levy on the extraction of a nonrenewable resource and the associated risk insurance (if any), and that other fiscal instruments should be developed to address these issues.

6. Summary and conclusion

The evolution of the debate on the system of mining taxation can be summarized as follows:

a. The state’s claim on the right to mine was forfeited in the early 1990s, despite a general agreement that the mineral resources formed part of the patrimony of the country. It was forfeited because it was believed that this claim should be subordinated to the need to encourage the development of the gold mining industry. These arguments were given an added urgency by the difficulties that the gold mining industry had confronted since the mid-1980s.

But the arguments in favor of forfeiting the patrimony over mineral resources are rooted in a view of the economy that is now out of date and inconsistent with the government’s strategy to develop an outward-oriented economy. The Government should reconsider the orderly introduction of some form of levy on the right to mine. Issues that the Government will have to consider with respect to the appropriate form of such a levy are discussed in Annex I.

b. The retention of the gold formula tax rested on two arguments: (i) that it was appropriate to provide an inducement to mine marginal ores; and (ii) that the formula allowed the Government to both take into account the ability to pay of different mines and share some of the risks of gold mining more generally. Underlying the decision to retain the formula tax was a concern about the impact of a move to a flat rate tax on the financial position of existing marginal mines.

Neither of the two arguments is particularly convincing and if support to marginal mines is merited, it should not be provided through the tax system, but rather through a system of grants, which would enable the Government to target the aid accurately and transparently. The Government should consider abolishing the current gold formula tax and applies the standard rate of corporate tax to the gold-mining sector.

c. The arguments for retaining the system of accelerated depreciation allowances—the redemption allowance, capital allowance, and the ring fencing system—rested on the belief that the Government should bear some of the special risks associated with mining activities.

This chapter has argued that it is not necessarily appropriate for the Government to attempt to modify the risk characteristics of activities in an economy even in the case of nondiversifiable, or residual risks. However, if the Government believes that there is a case for providing some form of insurance to investors in the mining industry to cover this sort of risk, then it should ensure that the insurance it is providing is priced appropriately. Finally, the paper has pointed out that, whatever the case for providing insurance to investors in the mining industry, the corporate tax system is not the appropriate vehicle for doing so. Rather, the appropriate instruments should be developed in the context of the contract between the Government and mining companies governing the right to mine. Therefore, the Government should consider abolishing the system of accelerated depreciation allowances—the redemption allowance, capital allowance, and the ring fencing system—for the mining sector, and replacing them with a system of depreciation allowances, which would ensure intersectoral neutrality.

Given the prominent role that the mining industry has played in the South African economy, the decision to embark on an economic strategy which does not have the mining sector as its focal point clearly represents a significant break with the past. There is clearly the temptation to keep a “foot in both camps.” Such a stance will be unsustainable if it results in continued distortions in the tax system to support and prolong mining activity artificially. Nevertheless, it is also clear that concerns about the transition away from a mining-based economy will be difficult to assuage while the nonmining sector has difficulties competing internationally, hence has a limited capacity to address the unemployment problem. A strategy to promote growth and employment in the nonmining economy would both greatly facilitate, and be reinforced by, the reform of the mining taxation system.

Implementation of a Levy on the Right to Mine

One of the weaknesses of the fiscal regime for the mining sector has been that the distinction between mineral taxation and mineral pricing policies has not been adequately delineated. Mineral tax policy should be separated conceptually from the state’s role as a guardian of a national resource, with decisions about natural resource pricing policy and associated risk sharing arrangements that arise when Government negotiates with a mining company over the right to mine a nonrenewable resource handled through a separate set df fiscal instruments.

The institutional framework for the separation of tax policy and mineral policy was in place with the lease payment system prior to the 1991 Minerals Act and remains substantially intact, because the Government continues to negotiate with mining companies over the right to extract minerals on government-owned mineral rights.

This section reviews briefly some of the basic principles that the Government should take into account when considering appropriate instruments to capture the levy on the right to mine, and reviews some of the pros and cons of profit-based instruments versus production-based severance taxes. The review suggests that the old lease payment formula, which was based on a profit sharing arrangement, may not have been optimal. 1/

The levy on the right to mine must fulfill a number of functions: (i) it must ensure that an appropriate price is paid for the mineral resource; (ii) it must reflect a decision on an appropriate risk-sharing arrangement (if any) that it will enter into with a mining company, and the price that it will charge for bearing a portion of the risk; and (iii) the levy structure should attempt to reduce sovereign risk, i.e., the risk that the Government will alter the fiscal arrangements after the investor has made a commitment to invest in mineral exploration or development. Clearly, sovereign risk is a much broader issue than the structure of the levy on the right to mine. However, an appropriately designed levy, which provides a reasonable prospect of a stable contract between the state and resource owners with respect to the extraction of mineral resources, will make an important contribution to reducing sovereign risk.

Analysis of the opportunity cost of the extraction of a mineral ore body is important to establish the reservation price that the Government would want to place on the mineral resource. 2/ The structure of the levy should also ensure that the government is not left bearing an inappropriate share of the risk involved in mining ventures. This latter point is important, because pure profit-sharing arrangements, such as the lease payment system, run the risk that the natural resource endowment will be extracted without significant positive payments being made to the state for the extraction of a nonrenewable resource.

In practice, it is unlikely that a single fiscal instrument will efficiently capture both the appropriate price for the resource and the risk sharing element. In general multiple fiscal instruments will be needed. Two such instrument warrant attention here:

1. The resource rent tax

The lease payment system—and to a lesser extent the gold formula tax—approximate closely to a resource rent tax (RRT). 2/ Recent literature on mining taxation has identified a number of problems with a RRT: (i) it is a high risk instrument, because it only provides a return to the state if a project yields above normal rates of return; international experience with RRTs suggests that they have not been successful in generating revenue 3/—the experience of the lease payment system would tend to support that contention; (ii) the revenue stream, if any, is back-ended; and (iii) an RRT, used by itself, does not provide a framework for assessing the opportunity cost of proceeding with a project. For these reasons, it is argued that profit-based taxes such as the resource rent tax should not be relied upon as a major part of the levy on the right to mine, although it could be retained as an element of the levy if the Government believes it necessary to provide some form of risk sharing.

2. Royalty payments (“severance taxes”)

A royalty or severance tax is a specific or ad valorem duty levied on the volume or value of resources extracted. Severance taxes have been severely criticized by the mining industry on the grounds that they raise the marginal cost of extraction and may therefore discourage development of marginal projects, by making them submarginal.

Royalty payments have a number of attractive features, in addition to being easy to administer. Firstly, it is important to bear in mind that the levy on the right to mine is a factor payment charged by the Government for the extraction of a nonrenewable resource. As such the levy should serve an important role in determining whether an investment should proceed or not—that is a resource should be left in the ground if mining companies are not prepared to pay the price reflecting the state’s opportunity cost of extraction; there is no rationale for providing the resource for free. A royalty payment performs these functions well. Secondly, the royalty payment ensures that the state receives a minimum payment for the extraction of a mineral resource, and that it receives it relatively early in the development of a mining project (as soon as production commences). Thirdly, a regular stream of payments to the state is likely to enhance the stability of the fiscal regime governing the mining sector, and may therefore be in the interests of the mining companies, who have expressed serious concern about the adverse impact of an unstable fiscal regime. Lastly, as long as the royalty payment is not unduly high, the present value of the efficiency costs associated with severance taxes is likely to be small.

For the above reasons, it is argued that a severance tax should play an important role in the levy on the right to mine. The rates of royalties cannot be prescribed as a general rule, as they will depend, inter alia, on the perceptions of profitability and other fiscal aspects of the levy. However, international experience with royalty rates for gold, as well as the existing practice on leases for state-owned mineral rights, would suggest royalty rates ranging in the region of 3-6 percent of gross revenue. The rates of royalty may vary across leases and could have stepped rates triggered by higher commodity prices. Finally, the price mechanism used to determine the liability under the royalty should be transparent.

South Africa: Tax Summary as of April 1, 1996

(All amounts in South African rand)

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South Africa - Exchange Arrangements

A full description of South Africa’s exchange arrangements as of March 31, 1995 is given in Exchange Arrangements and Exchange Restrictions, Annual Report, 1995. With the abolishment of the financial rand system on March 13, 1995, South Africa eliminated its last restriction subject to approval under Article VIII of the Fund’s Articles of Agreement.

Other changes in the exchange system in 1995 and early 1996 include:

Payments for invisible:

August 23, 1995: Indicative annual limits on allowances for travelers to other than neighboring countries were raised as follows: (i) for tourism, from R 23,00 to R 25,00 for adults and R 11,500 to R 12,500 for children; and (ii) for business travel, from R 34,000 to R 38,000.

December 7, 1995: Limits on other service payments were raised, including on subscriptions to societies, club memberships, and director fees.

A administrative changes affecting purchases of travel allowances and export declaration forms were completed in June 1995 and March 1996.

Nonresident Accounts:

The abolishment of the financial rand system led to the elimination of restrictions on nonresident accounts and on emigrant blocked accounts.

Capital Restrictions on Residents:

On July 13, the Government announced that insurance companies, pension funds, and unit trusts would be permitted to invest abroad by way of swap arrangements providing foreign investors part of their existing asset portfolios in exchange for foreign assets.

On January 23, 1996, the Government announced an extension of the asset swap dispensation, permitting the above-mentioned institutions to acquire up to 10 per cent of the Government’s £100 million Euro-sterling issue launched on the same day.

The South Africa Reserve Banks (SARB) Role in the Forward Market:

On July 13, 1995, the Reserve Bank announced its intention to withdraw from short-term transactions in the forward market for other than financial transactions. It will continue to participate in regular export/import transactions from time to time on its own initiative. The requirement for exporters to obtain forward cover was also abolished.

Table 1.

South Africa: Expenditure on GDP, 1992–95

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Sources: South African Reserve Bank, Quarterly Bulletin.

Contribution to GDP growth.

Table 2.

South Africa: Gross Fixed Investment and Capital Stock, 1992–95

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Sources: South African Reserve Bank, Quarterly Bulletin.

Including transfer costs.

Finance, insurance, real estate, and business services.

End of period.

General Government plus four departmental enterprises (Community Development Fund, Government Motor Transport Trading Government Printing Works, National Housing Fund).

Table 3.

South Africa: Financing of Domestic Investment, 1990–95

(In percent of GDP at market price)

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Sources: South African Reserve Bank
Table 4.

South Africa: Personal Income and Expenditure, 1992–95

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Source: South African Reserve Bank, Quarterly Bulletin.

After provision for depreciation and inventory adjustment.

After adjustment for net renumeration paid to non-residents.

Income from property, current transfers (gross), less direct taxes.

Table 5.

South Africa: Real Gross Domestic Product at Factor Cost, 1992–95

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Source: South African Reserve Bank, Quarterly Bulletin.
Table 6.

South Africa: Indicators of Mining and Quarrying Activity, 1988–95

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Sources: South African Rsssrva Bank, Quarterly Bulletin: Central Statistical Service, Bulletin of Statistics.

In 1990.

Table 7.

South Africa: Indicators of Manufacturing Activity, 1990–95

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Source: South Africa Reserve Bank, Quarterly Bulletin.
Table 8.

South Africa: Nonagricultural Employment, 1988–95

(1990 = 100)

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Source: South African Reserve Bank, Quarterly Bulletin.

Central Government, local authorities, provincial administrations, statutory bodies, and national and independent states (TVBC).

Transnet and the Department of Posts and Telecommunications.

Includes Electricity Supply Commission, Boards of Control, and universities.

Table 9.

South Africa: Remuneration, Labor Productivity, and Unit Labor Costs in tha Nonagricultural Sector, 1991–95

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Source: South African Reserve Bank, Quarterly Bulletin.

Seasonally adjusted.

At 1990 prices; daflated by nonagricultural deflator.

Table 10.

South Africa: Price Developments, 1991–95

(Percentage change over the previous period; period average)

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Source: South African Reserve Bank, Quarterly Bulletin.

The consumer price series uses 1990 weights; the producer price series uses 1985 weights.