Sunday, May 07, 2006

Is a new oil tax the way to go? 

Today Chavez announced that Venezuela is considering levying a new tax on oil companies called an "extraction" tax. This new tax would be 33% and at the same time it was announced that the existing income tax on oil companies would go from 34% to 50%.

No details were given on how this tax would work. Calling it an "extraction" tax almost makse it souns like its a royalty - ie a set fee on every barrel of oil extracted from the ground. But a tax per se is generally very different. For example a the current income tax is charged on the profits that the oil companies earn.

Given that it is unclear if this tax is more like a royalty or like an income tax because details haven't been given I'll take a minute to discuss why Venezuela would do much better to focus on getting royalties right and not worrying about taxes.

When it comes to collecting oil revenues royalties are vastly superior to taxes. The main reason is they are much easier to collect. A royalty is a fixed dollar amount or percentage of each barrel of oil extracted so calculating what it should be is much easier. If the royalty is $40 per barrel all you have to do is know how many barrels were extracted which can be easily done with meters on the well heads and then multiply that by $40 and you have the exact amount due the government.

Compare that to collecting an income tax on the oil companies. To collect that one has to know how much profit the company made and that is no easy matter. A company can easily hide profits through inflating expenses, using shell companies, or simply keeping its finances as complex and opaque as possible. So to collect taxes it takes teams of accountants and even with them there is no guarentee that the full amount of taxes owed will be collected.

For these reasons governments like Venezuela's interested in maximizing oil revenues should prioritize royalties and de-emphasize taxes. Hence, I had mixed reactions to this new tax. If they wanted to increase their take and make sure the oil companies weren't getting a windfall profit at their expense they should increase the royalties charged. Not only would it increase revenues but it would make the process of collecting those revenues much more transparent. And increasing revenues and transparency is a win-win proposition for all Venezuelans


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