Introduction
Today’s column offers a wrap-up of the ABCs of hydrocarbons taxation, which I introduced in last week’s column. There I focused on Guyana’s Production Sharing Agreement (PSA) oil and gas fiscal regime, treated as a huge sub-set of Guyana’s larger and more comprehensive tax system. In my concluding observation I last week, I introduced the carefully crafted practical guidance and policy advice provided by the IMF to Member States. [See, Petroleum Fiscal Regimes, IMF e Library]
For economies like Guyana there are clearly important interactions between the hydrocarbon fiscal regime and the nation’s more comprehensive tax system. As a general rule, I would argue that, a PSA regime functions more effectively the more embedded are the following characteristics or features of the national tax system:
MRV Capability [That is, the easy ability to measure and monitor, review and report on, as well as verify and vindicate the operational capability of the hydrocarbon regime, PSA].
Institutional capability [That is, the capacity of the institutions to operate as is anticipated, which depend on supporting rules, regulations and trained personnel]
Governance [That is, the rules, practices, processes and mechanisms, internal and external, that inform and guide outcomes]
Legal Environment [That is, the extent to which a given society is based on the rule of law]
A Proficient Tax System
At this stage it would be useful to round off the discussion by briefly considering what the tax literature typifies as the consensus vision of a proficient tax system. Standard textbooks define this as meeting five basic conditions; namely, equity, adequacy, simplicity, transparency, and administrative ease. [See Investopedia]
1. Equity [all taxpayers pay a fair share] to ensure both: horizontal equity and vertical equity.
● Horizontal equity requires taxpayers in similar financial condition to pay similar taxes.
● Vertical equity requires taxpayers who are better off to pay, minimally, the same proportion of income in taxes as those who are less well off. Vertical equity involves classifying taxes as regressive, proportional, or progressive.
2 Adequacy means that taxes must provide enough revenue to meet the needs of society; while ensuring revenue growth funds the cost of services,
3. Simplicity means that taxpayers can avoid a maze of taxes, forms and filing requirements. A simpler tax system helps taxpayers better understand the system and reduces the costs of compliance.
4. Transparency means that taxpayers can easily find information about the raising and spending of taxes
5. Administrative ease means that the tax system is not too complicated or costly for either taxpayers or tax collectors.
Summing Up
Examining the modeled driver of the Government Take statistic and its metrics in relation to the affordability of the Buxton Proposal has focused on Guyana’s PSA regime as part of its wider fiscal system. From this perspective, I draw attention to three crucial conclusions
A. First, under its PSA Guyana faces economic trade-offs. That is, choosing one outcome that causes giving up another. In economics, such trade-offs are evaluated based upon their opportunity cost, which is the value of what is lost when choosing one thing over another.
Given the PSAs tendency to be regressive, in that rising Take ratios are accompanied with rising costs the key trade-off is between profits and costs determined 1] by the appropriate timeline flows 2] exploration – development sequences 3] production flow, Daily Rate of Production, DROP 4] ownership and/or control progression, as well as the investment incentivizing efficiency frontier.
Second, I repeat for emphasis from last week’s column the assertion that, there is no single item in any oil contract, which could establish unequivocally if any party got a deal at the expense of the other, including the “Government Take” statistic- the most commonly used benefits measure.
This is the government’s share of economic profits [bonuses, royalties, profit oil, taxes and government working interest.] Typically, it does not include payroll taxes and skills transfers. It has other limitations like unrealistic assumptions and omissions; coverage of risk, flow of payments, oil prices and costs. Variations in these assumptions can affect the anticipated profitability of a field or project. Moreover, Government Take can vary quite dramatically with the profitability of a project. Government Take also does not adequately capture risk.
Third, as the IMF published online policy and practice guidance I cited last week notes, petroleum investors invest in the country where petroleum is found – unlike other industrial sectors where location is fairly mobile; thereby making such other factory closures location flexible. An image of oil production as strongly international in character is therefore somewhat belied. External and Internal features of the industry are decisive in shaping the tax regime and determining outcomes.
Conclusion
From the standpoint of the crude oil energy sector, economic and financial modeling and analysis of public planning, programming and, project evaluating, rely on Government Take as a key performance indicator, KPI. This metric is by no means perfect or complete. As this column has argued the statistic captures the state’s share of the discounted net cash flows of publicly contracted oil operations. It is contingently optimal, given the data and available know-how over the years
Continuous contract improvement is expected by the theorem of incomplete contracts. As this series has revealed several have been raised; for example, 1] the treatment of interest expenses, ring fencing allocation of income and expenditure by field, imposts related to changing profitability and prices on cost recovery [R-factor or DROP] ]2] exogenous revision of the PSA as in the case of the public auctions amended PSA.
Next week I address the fourth and final modeled driver and its metrics; that is, modeled cost ratios for Guyana oil production
