The effects of income tax, royalty reforms and relative price changes on potential copper-zinc projects in Manitoba

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Bagnall, Robin Gilbert
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The investment climate for copper-zinc projects in Manitoba worsened as a result of four distinct factors during the period from 1969 to 1977. These were: income tax reforms which led to increased federal and provincial tax assessments; a new provincial royalty act which resulted in increased royalty assessments for a profitable project; a jump in the annual rate of increase in capital and operating costs (inflation); and finally, copper and zinc price increases which failed to keep pace with the cost increases reflecting relatively long run changes in factors affecting world supply and demand. This study evaluates the effect of these factors on potential copper-zinc projects in the province. The analysis is undertaken using a computer model designed to calculate the optimum size of a project which would develop a given mineral deposit. The study shows that the private value of potential copper-zinc projects has declined by about 90 percent since 1969. Nearly two-thirds of this decline is attributed to increased tax and royalty assessments with the remainder a consequence of relatively depressed metal prices and inflation. The study also shows that from the province's point of view the income tax and royalty reforms have had some beneficial effects. In particular the new legislation has reduced the optimum private rate of ore extraction for a viable project closer to the socially optimum rate, resulting in an increase in overall benefits. The legislation is deficient where marginal projects are concerned in that a project will be unprofitable for a private firm even though it could generate some social benefits. Changes to the income tax legislation which would help alleviate this problem would be to allow preproduction development costs to be recovered immediately from a firm's income and include social capital costs in the earned depletion bank. The royalty legislation could be improved by changing the fixing processing allowance to an investment allowance based on the undepreciated balance of total assets, increasing the rate at which investment could be recovered, and allowing losses to be carried forward. An unexpected deficiency in the existing royalty legislation in Manitoba is that it is not very effective in adjusting for inflation. Either more adequate indexing is needed or the two royalty rates should be replaced by a single rate. The study concludes that the worst feature of the reforms appears to be their timing. They were introduced when economic conditions were beginning to worsen, making the overall turn-down in the investment climate worse than it needed to be.