There’s a reason that Frank Lowy is the richest man in Australia – he knows how to screw a good deal out of a tenant, without actually killing their business. Arguably if he were less rapacious there’d actually be more business, and probably more shopping centres.
What Kevin Rudd is doing with his RSPT is trying to emulate Lowy, but he needs to pay more attention. Frank wouldn’t have got so rich if he’d structured his rents like Kevin wants to structure his tax.
What we normally call “rent”, and what economists mean by “rent” when they talk about rental taxes, are two different things. To an economist “rent” equals the difference between the profit achieved and a “normal” profit. For most of us, rent is the regular amount of money you pay for the use of someone else’s asset.
But there are lessons for resource rental taxes that can be drawn from the everyday experience of renting, particularly retail renting.
There are two basic types of rental contract. One is a fixed price per square metre of area which is charged irrespective of how profitable or unprofitable a business is. These rental arrangements are generally subject to review clauses which allow for inflation and growth in the economy.
The other rental arrangement, which exclusively operates in the retail industry, ties the rent paid to the profitability of the business by charging a percentage of the turnover as the rent.
The first type of rental puts most of the risk onto the entrepreneur. If their business can’t afford to pay the rent it is their problem, not the landlord’s. It only becomes the landlord’s if the tenant goes out of business and he has a property without a tenant. It also gives the tenant a greater share of the rewards as it allows them to keep any above average profits they earn.
This is similar to the deal that the state governments have done with miners. The miners pay a fixed price for the right to extract the minerals and it is their problem alone if they make a loss, and their benefit alone if they make a super profit.
The second type of rent is similar to the deal that the federal government wants to force on the mining industry.
Most tenants, given the choice, will prefer the first type of rental arrangement. You don’t go into business to make the sort of profits that can’t afford to pay the rent. You always have your eye on an above average return.
Most landlords will also prefer the first type of arrangement. Landlords are experts in owning property, not running businesses. They don’t have the skills to second guess the business owner, nor the time or inclination. The landlord’s business also generally relies on heavy gearing and they need steady and reliable cashflows to support that.
Frank Lowy prefers the second arrangement, but with modifications. His rents, and those of most regional and sub-regional shopping centre owners, are structured in two parts. The first is a “base rent” which is essentially the first type of rent, and a “turnover rent” which is the second type. The turnover rent only comes into play once a particular turnover is achieved.
So Lowy gets the best of both worlds. He has reliable cashflows to support his borrowings and the tenant bears the risk of the business underperforming. If the business makes a better than average profit and triggers the turnover rent, Lowy also gets a share of the extra profit.
What are the lessons for the government?
The first lesson is that you need a unique set of circumstances to levy a turnover rental. Lowy only gets away with it because regional and sub-regional shopping centre owners operate a cartel. The rents are essentially rigged, although not in such a way that the ACCC can act. They are able to rig the market because townplanning laws make it very difficult to build a large shopping centre, and large shopping centres are very efficient and do produce more turnover for stores than main street locations.
These are not conditions that apply to the mining industry. Unlike shopping centre owners countries do not form cartels (apart from OPEC with oil) and are keen to undercut each other to attract more mining investment.
The second lesson is that you get more reliable cashflows if you go for the first type of rent. If you are going to go for the second type of rent, then Frank Lowy would say to only take your cut on the upside. Yet the federal government has decided to share in the downside as well.
This may well be to justify a higher tax take, but what it means is that the federal government is making long-term spending commitments on the basis of volatile cashflows relying on the health of an industry of which it has limited knowledge and expertise.
Another lesson from Lowy is all things in moderation. It’s OK to be greedy, but not too greedy. Turnover rents are generally pitched at a percentage of turnover which would represent a reasonable rent for an average business. 10% of turnover is not an unreasonable rent for an average retail business to pay, and that is a figure that you will find many turnover rents are pitched at.
Even so high rents inside large shopping centres have led to the development of alternative shopping centres like bulky goods warehouses and discount factory outlets.
A 40% turnover rent, the equivalent of the government’s RSPT, is well over the odds of what any retailer would be prepared to pay. Just like the miners, they would be reviewing their operations and working out which stores to close, and where to move to find more realistic rents.
While he’s running around Australia consulting with miners, perhaps the Prime Mininster could take some time out to consult with large shopping centre owners as well. One consultation might inform the other, to the benefit of both the PM and the mining industry.
(Note: Bryan below points out that the government is taxing profits, not turnover. He’s quite correct. I was using the turnover rent for comparison. The error has two consequences that I can see. One is that taxes on profits tend to be more punitive than taxes on turnover. That is because profits tend to increase faster than turnover, once a company is into profit. The second is my second last paragraph is wrong in detail, but not in general. No retailer would accept that they should pay 40% of their profit to the landlord, even though low profit operations often do, and more. )
An excellent observation Graham.
It is the duty of an entrepreneur to maximise his profits. Other entrepreneurs see what he is doing and compete with him. As you said, not necessarily in the same manner of delivering the goods.Thus in the long term, consumers get a better deal.
It may not happen overnight, but happen it must.
On the other hand robbery by violence or threat of violence, (which is what Rudd is peddling), in recent times past, and in some countries still, is punishable by the death sentence.
If Rudd was hanged, it would be a message to the bureaucracy and politicians not to be so rapacious.
Similar messages have been sent to the ruling class time and time again over the centuries.
Comment by Ronald Kitching — June 9, 2010 @ 12:57 am
I am most bemused that responsibility for the RSPT is sheeted home to Rudd. It’s Ken Henry’s idea, complete with beautiful economics. The ALP is incapable of such design.
Mining is a special case, economically. Check my blog post: http://www.prosper.org.au/2010/06/08/aussie-miners-no-one-likes-a-whiney-child/
Comment by David Collyer — June 9, 2010 @ 1:35 am
It’s Rudd’s tax because while Ken Henry can propose (and he made 138 proposals) Rudd disposes, and he chose to dispose of all but a few of Ken’s recommendations. The ones he takes up are undoubtedly his by adoption.
Checked out your piece. Can’t see any case being made for mining being a special case.
Comment by Graham — June 9, 2010 @ 5:23 am
Whrong, Graham, he RSPT is NOT a tax on turnover, it’s a tax on net profit AFTER all costs, so it’s completely different.
Why not use the correct commercial equivalent: A hotel leased as a going concern will split the net profit 50%:50% as rent and business profit. The RSPT is only 40%
Comment by Bryan Kavanagh — June 9, 2010 @ 6:14 am
Yes Bryan, it’s a tax on profit. I used the wrong term. But it is not completely different at all. A tax on profit is slightly more punitive than a turnover tax, but behaves pretty similarly. You’d be safer with a turnover rent because profits are able to be manipulated whereas turnover can’t.
A hotel leased as a going concern is not the commercial equivalent of the RSPT. The operator, which is equivalent to the miner in this case, doESn’t put in any major capital, so their return is on their labour and some of the non-property inputs. The owners, which is equivalent to the government in this case, have built and developed the property and put most of the capital in.
Your hotel lease example is the equivalent of the government paying 100% of the cost of developing a mine, allowing the miner to operate it and then sharing the profit 50/50. That’s a deal that would probably be attractive to some miners, but it would be a very bad one for the taxpayer as governments have no demonstrated ability to find and develop mines.
Comment by Graham — June 9, 2010 @ 6:43 am
On 12 March 1891 Mr Abbott Delegate to the constitution convention made clear Crown land remains under the States; “that it is not intended that the Crown land of anyone of the colonies shall be interfered with by the federal parliament”. As such any taxation interfering with royalties would be unconstitutional. Also, taxation must be equal throughout the Commonwealth, meaning that the super tax must be applied not just to mining but all companies, including small businesses or none at all as then it is a general taxation and not one interfering with State royalties rights.
.
As for Graham’s argument about the profit rent, this relates to a shopping centre regarding its tenants and would not be applicable if say I were to charge a profit rent on businesses not renting from me but from Frank Lowy business space.
Likewise, the Miners are doing their business with the State government and the Commonwealth then has no profit rent rights as such.
Comment by Mr G. H. Schorel-Hlavka — June 9, 2010 @ 9:48 am
I don’t think that any debate or venturesome claim on higher moral ground will be enough to stop Rudd. It’d be interesting to see what would happen should he do so and then be unseated by the coalition. Is the coalition really going to hand back $5 billion – $10 billion to private interests if they’re presented with a fait accompli?
Comment by murray — June 16, 2010 @ 8:33 am