Distortions Created by Taxes Which are Options on Value Creation: The Australian Resources Rent Tax Proposal

The proposed tax on economic rents earned from Australian resources investments is examined from the viewpoint of the economist's neutrality criterion. Proposed by Garnaut and Clunies-Ross (1975, 1977), the Resources Rent Tax is alleged to be neutral in that it is alleged not to inhibit or distort investment behaviour. We show that the proposed tax effectively is a call option on the value created by every individual resources project. By adapting the Black-Scholes (1973) call option valuation formula, we then demonstrate that the effective incidence of the tax depends upon each project's risks, life and viability. Hence, under conditions of risk, the Resources Rent Tax fails the neutrality criterion.