Zambia’s finance minister, Honourable Margaret Mwanakatwe, opened her maiden budget speech on 28 September 2018 by recognising that Zambia has a major poverty challenge. While economic growth has been rapid in recent years, it has not been inclusive enough to diversify the economy and provide jobs for the millions of Zambians that are unemployed.
The Minister stated that the answer to this challenge was to encourage the private sector to ‘invest, innovate and create jobs.’
Mrs Mwanakatwe recognised that this meant that the government would have to address its economic challenges, and stop spending too much. This assurance was necessary, as the government has spent 18 percent more in the first half of 2018 than what it had budgeted. According to government, the debt stock – the total amount that the country owes to its external debtors –stands at $9.4 billion, a significant amount in an economy worth only $25 billion. Private sector consumption is set to grow by just 1 percent this year, and the economy remains heavily reliant on mining as its only serious source of foreign exchange revenue, with copper exports accounting for 80 percent of all Zambia’s merchandise exports.
Specific revenue-raising measures
But the specific measures proposed in the budget speech that are intended to earn the government more revenue from the mining industry are flagrantly counter-productive.
“The specific measures proposed in the budget speech that are intended to earn the government more revenue are flagrantly counter-productive.”
It has become all too easy to blame mining companies for ‘profit-shifting’ and ‘base erosion’, instead of just focusing on building bureaucratic capacity and efficiency. If there is evidence of specific wrongdoing in this regard – and there have been enough forensic and general audits of mining companies in recent years – then these should lead to sanctions or prosecutions, conducted in a transparent fashion. But it is unjustifiable for a government to base its minerals taxation regime merely on the suspicion of tax evasion, just as it did in 2014/15, because if those suspicions are wrong – and there is no evidence presently that they are right – the outcome is a distorted regime not based on reality.
Whilst many Zambians will celebrate these changes, based on the unfortunate perception that ‘foreign mining investors’ are intrinsically predatory, a dispassionate analysis will reveal the harmful long-term effects of the Budget’s measures.
The proposal to radically increase mineral royalty rates, for instance, is nothing short of disastrous for Zambia’s development prospects. It will discourage investment away from the very private sector whose job-creating ability the government acknowledges. The Zambia Chamber of Mines, after an emergency meeting of mining companies on Wednesday 3rd October, declared that Zambia was now “uninvestable”. Given that the mining industry is in constant need of investment, and Zambia’s economy depends upon a thriving mining industry, this should be a major concern for policy makers and citizens alike.
Implications for the mining industry of a blanket increase in mineral royalty taxes
At the moment, the minerals royalty tax (MRT) operates on a sliding scale according to the copper price on the London Metal Exchange. This system came into force in 2016 and has been stable until now – a welcome reprieve, according to industry, in a tumultuous mining policy environment that has seen 9 changes to the MRT regime in 15 years.
At present, when the copper price is below $4,500/tonne, the royalty rate is four percent. Between $4,500 and $6,000/tonne, the rate slides up to five percent. Above $6,000 – a current threshold – the rate moves to six percent.
However, in the 2019 national budget, the government is proposing a 1.5% headline increase to all bands, and has now also introduced a fourth tier at a rate of 10 percent when copper prices move above $7,500/tonne.
An increase of 1.5 percentage points on a 6 percent tax rate is effectively a 25 percent increase in the rate. Not only is this substantial in its own right, the government has further proposed that MRT be ‘non-deductible for income tax purposes.’ In other words, mining companies will no longer pay income tax after MRT deductions; it will pay MRT according to production, and corporate income tax(CIT) on gross revenue regardless of how much it contributes in MRT.
No other major mining jurisdiction in the world excludes MRT from being tax-deductible. To the contrary, leading tax experts like Deloitte have strongly promoted tax incentives in light of the increasing mobility of mining investments.
There will be plenty of support in Zambia for these extreme measures. The government is indeed wielding a big stick. So, why is this not a good outcome for Zambia?
The vast majority of Zambia’s mines operate at the upper end of the global cost curve. For instance, Mopani’s operations are presently loss-making, and that’s before the present changes are implemented. It’s difficult to see how or why, in the current operational and legislative environment, parent company Glencore would continue to invest hundreds of millions of dollars to continue the turnaround, when they have so many options elsewhere.
Over in North Western Province, Kanshansi is presently in a more fortunate position. It produces a large portion of Zambia’s total output and its production costs now are still relatively low, although mining becomes more expensive over time. However, it is widely-known that due to the instability and falling competitiveness of the Zambian mining tax regime, Kansanshi’s owners, First Quantum Minerals (FQM), have declared that the next phase of investment – which would have extended Kansanshi’s life span by another 10 years – will not now take place. The effect of this will be that Kansanshi will see declining production in 3-5 years’ time – which means less royalties, and no profit taxes.
With increasingly higher cost burdens, and huge effective tax rate hikes on the horizon, the mining industry across Zambia will be forced to scale back production. Investment in exploration – already a minute fraction of what it was 10 years ago – and new production capacity, that would otherwise have widened the tax base, will now be foregone.
In summary, the new proposals will have the direct effect of shrinking the only significant economic sector with its attendant multiplier effects. The repercussions will undermine Zambia’s ability to raise investment finance more generally, which it needs to tackle its economic challenges.
Mining is a potential flywheel for diversifying the Zambian economy, in addition to having significant multiplier effects (spinning off job opportunities in other connected sectors). Not only did the budget speech propose unviable measures against the industry, it also proposed an import duty of five percent on copper and cobalt concentrates. Instead of incentivising those imports to expand manufacturing that would grow the economy beyond the life of finite mining, the proposal simply kills investment potential in manufacturing opportunities connected to mining.
“The next phase of investment – which would have extended Kansanshi’s life span by another 10years – will not now take place.”
Beyond these concerns, the government has proposed a reversion to a non-refundable sales tax and an abolition of VAT (currently refundable on certain items). No specific rates were offered, but this only generates further policy uncertainty in a country that can do without it. As it is, businesses are facing serious cashflow problems because the revenue authority has been withholding VAT rebates.
The right road to take?
While the budget speech began on the right note, acknowledging private sector dynamism as the answer to poverty alleviation, the proposals on the table to raise revenue and tackle debt will shrinkthe tax base and exacerbate the debt spiral.
The American poet Robert Frost famously wrote in ‘The Road Not Taken’:
‘Two roads diverged in a wood, and I –
I took the one less travelled by,
And that has made all the difference.’
It’s an easy road to tax one’s way out of short-term fiscal pain, but it is a well-travelled road that will lead to permanent injury.