Extractive industries and development – taxing profits and investing gains

Industries based on natural resources such as oil, gas, and minerals can play a major positive role in the development of low- and middle-income countries, however they can also lead to a very narrow kind of growth which excludes the poor and damages the economy and environment. Good policy is the difference between economic disaster and success. The UNU-WIDER project on extractives for development seeks to contribute to the development of good policies. If managed correctly, extractives could lift more than 500 million people out of poverty over the next 20 years.

One key task for managing the extractive sectors is ensuring that mining companies are effectively and fairly taxed, and that the resulting revenues are wisely invested. In a recent UNU-WIDER interview series on extractives and development Jim Otto, a mineral resources attorney and economist, and Mark Essex, an expert in in the extractives sector, discussed the issues of taxation and investment, and the role they play in the successful management of the extractives sector.

Finding the right balance

For Jim Otto, the taxation of the extractive industries is about finding the right balance between public and private sector interests. When we think about mining we often have pictures of gold or diamonds in our mind, but Jim Otto points out that the margins earnt by mines are often relatively small. If the taxation level is too high projects simply will not go forward. On the other hand if the tax level is set too low the country won’t get its fair share of the revenue, and  its citizens will see little benefit and only costs from increasing mining’s expansion.

Central and local government

Another important balance Jim Otto points to is between central government and local government. Without the support of local communities and provincial governments mines may not go ahead, without mines opening, everyone loses, revenue will not be obtained at national or local level. However if the balance is shifted too far towards the local communities, national revenue will not rise and without rising public revenue inclusive development is very difficult indeed.

Taking a long-term view despite short-term demands

Once the extractives sector is being taxed correctly the next step is to ensure that the resulting revenues are invested wisely. Mark Essex points out that there are more examples of countries that have done this unsuccessfully than countries that have done it well. One of the key reasons for this is that low- and middle-income countries face demands for quick improvements in things such as health, education, and infrastructure which can make it hard to take a longer-term view.

Consequently, Mark Essex suggests that the Norwegian model is not particularly relevant to developing countries, at least in terms of how they manage their revenues, because Norway has the luxury of taking a much longer view. However despite the demands for instant spending, governments must be sure not to liquidate their mining assets too quickly. Without wise investment, Mark Essex suggests, countries will not be able to jump to the next level of development.

Mineral resources provide tremendous challenges for countries, for good and for bad, and their management must be based on good economics and a clear idea of how they can contribute to inclusive development.

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