1. Political Economy of Resource Taxation in Petroleum-Producing Countries Joris Morbee KULeuven CES and KULeuven Energy Institute joris.morbee@econ.kuleuven.be International Energy Workshop – IEW 2009 Session “Policy Instruments 1” June 17 th 2009, Fondazione Giorgio Cini, Venice

2. 1 Bumper sticker spotted in Berkeley, California An alternative question would be: What are the taxes that oil-rich countries impose on extraction of their oil resources?

3. 2 Why is there such a wide variation in taxation of resource extraction? *Including royalties, government share of oil, corporate income taxes and other taxes Source:Himona, I. (2005); Tordo, S. (2006) "Government take"* of petroleum extraction As % of companies' petroleum revenues Indonesia Brunei Turkmenistan Colombia China Australia Bolivia USA EXAMPLES This paper aims to explain the underlying causes of these differences The paper uses a combination of: –Resource economics –Political economy Practical relevance is for: –Companies deciding on international investment strategy –Governments deciding where to focus diplomatic efforts

4. 3 Literature on resource-abundant countries is focused mostly on the "resource curse", in particular the "Dutch disease" *"Resource curse" is the phenomenon that although natural resources seem desirable at first sight, abundance of natural resources can distort a country’s economy and make the country on balance worse off Dutch disease Resource curse* Topic in literature Political economy theories Description Resource-abundance shifts production factors away from other sectors, leading to vulnerability and lower long-term welfare See: van Wijnbergen (1984), Krugman (1987) Quali- tative Model- based Resource-abundance leads to "petro-state", focused on distribution of rent See: Auty and Gelb (2001) (classify states according to Lal's (1995) typology), Karl (1997) Formal models of rent-seeking and probabilistic voting See: Torvik (2002), Robinson et al. (2006), van der Ploeg (2008) My paper uses a similar formal approach, but adds an empirical test on 46 countries

5. 4 The model in this paper considers government revenues from both existing reserves and undeveloped/undiscovered reserves Resources Billion barrels of oil Revenue $ per barrel Medium termLong term ReservesUndeveloped / undiscovered reserves Oil price p Tax  p Investor profits Billion $ Tax revenues Billion $ TRTR T U1 T U2 Government will try to maximize: T = T R + T U1 + P · T U2 T R, T U1 and T U2 depend on tax rate , while P depends on government type

6. 5 T U1 and T U2 depend on the tax rate  Resources Billion barrels of oil Probability of discovery in medium term ReservesUndeveloped / undiscovered reserves 100% Best exploration blocks Worst exploration blocks With higher tax rate, oil companies will initially only invest in the best blocks, leading to shift of revenues from T U1 to T U2

7. 6 Lal (1995) classifies governments along two dimensions Myanmar Ghana Singapore Brunei "Autonomous" (=Dictatorship) Russia India Malaysia US Autonomy (Notation:  ) "Factional" (=Multi-party) "Predatory""Benevolent" Benevolence (Notation:  ) Source:Auty & Gelb (2001), Lal (1995)  = 0  = 1  = 1  = 0 EXAMPLES

8. 7 The type of government has an impact on the government's maximization problem Predatory government  = 0 All values of  Benevolent government  = 1 Government's maximization problem: choose  to...... maximize T = T R + T U1 + T U2... maximize T = T R + T U1 + P re-election · T U2... maximize T = T R + T U1 + (  + (1 –  ) · (g 0 +  g(T R ))  ) T U2 (g 0 +  g(T R ))  Non-exporting countries (  = 0):  is nearly irrelevant for government budget:* P re-election = g 0 / n = g 0  Exporting countries (  = 1): re-election depends on rent distribution potential of government:** P re-election = (g 0 + g(T R ))  *n = number of competing factions;   1 / n **g' > 0 ; g'' < 0

9. 8 As a result, the tax rate  depends on political and geological characteristics As mentioned before, the maximization problem of the government is the following: Choose  to maximize T = T R + T U1 + (  + (1 –  ) · (g 0 +  g(T R ))  ) T U2 The optimal value  depends in particular on –  (level of "autonomy" of the government, e.g.,  = 1 is a dictatorship) –  ("benevolence" of the government, e.g.,  = 0 is a fully corrupt state) –  (whether the country is a petroleum exporter or not) In addition, the optimal  depends on: – The size of (existing) reserves – The size of undeveloped / undiscovered reserves The mathematical model allows us to analyze how each of these variables impacts the tax rate  Function of 

10. 9 The model results are consistent with empirical findings *OLS on dataset of 46 countries, assembled from BP (2008), USGS (2000), Himona, I. (2005), Tordo, S. (2006), Lal (1995) and the author's own assessment of political regimes in a number of countries based on public sources Government "autonomy" (  ) Government "benevolence" (  ) Size of (existing) reserves Size of undeveloped / undiscovered reserves Country is petroleum- exporter According to the modelAccording to empirical testing* Depends on circumstances Proven under conditions (subject of research) Not significant Significant at p = 0.014 level Significant at p = 0.108 level Significant at p = 0.020 level Significant at p = 0.045 level Proven mathematically Impact on resource tax rate 

11. 10 Results of the paper already explain a substantial part of the differences in tax rates Colombia USA China Indonesia 58.8 0 4.0 10.0 7.9 60.7 Resource tax rate in % Resulting tax rate Undis- covered reserves ReservesAutono- mous govern- ment Ex- porting countryRegression constant Application of regression coefficients Tax rate in reality 65 58.8 10.1 0.4 2.1 0 67.2 70 58.8 0 7.3 20.1 0 46.0 58.8 10.1 1.1 3.1 7.9 74.8 40 87

12. 11 Next steps Improve political economy model: turn it into a full-fledged probabilistic voting model Add instruments to the regression (e.g., settler mortality as an instrument for institutional quality) Use standard datasets as proxies for  and , e.g.: –Heterogeneity indices for  –Corruption indices for  Anchor paper in political economy and resource economics literature

13. 12 Appendix

14. 13 Details about the data sample and the regression results Source:Dataset assembled from BP (2008), USGS (2000), Himona, I. (2005), Tordo, S. (2006), Lal (1995) and the author's own assessment of political regimes in a number of countries based on public sources

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