Economic Incentives for Investments Downstream

• Export taxes on unprocessed products.
• Favorable tax treatment and investment incentives for downstream processing.
• Subsidies supporting the provision of cheap inputs into downstream production.

Export taxes on unprocessed products

In many developing countries, a significant share of government revenue is derived from export taxes.^[1] Export taxes tend to reduce exports. Governments should be aware that, as a result, tax revenues may be less than expected. Profit taxes or royalties are other normal methods of taxation on extractive industry production but require more sophisticated government competencies and institutions.^[2]  

At least 18 African countries levy export taxes on the export of scrap metals or minerals. However, in many cases, the export taxes are limited and are designed to collect revenue, not promote downstream production. But in both China and India, export taxes seek to enhance local processing and downstream activity. China imposes export duties on a wide range of mineral products—bauxite, coke, fluorspar, magnesium, manganese, silicon metal, yellow phosphorus, and zinc. In addition, India imposes export taxes on iron ore.

Policy makers contemplating export taxes and/or other restrictions on exports of raw materials in order to encourage downstream production will need to take into account World Trade Organization (WTO) regulations. While export taxes per se are not forbidden by WTO rules, other restrictions, including conditions surrounding the taxes, may be prohibited. In most cases, especially when applied in smaller countries, export taxes and other export restrictions do not exert appreciable damage on other countries and so generally remain unchallenged.

But if large countries use export taxes and restrictions to encourage local processing on a large scale, damage may be significant and may result in countries taking action at the WTO. As a leading global producer of a number of raw materials, China’s export restraint measures give it the ability to affect global supply and pricing. These restrictive measures can provide significant advantages to Chinese firms that use important raw materials, to the detriment of other countries. (The raw materials in question are key inputs into a wide range of high-value products in critical industrial sectors, including steel, automotive, aerospace, construction, and electronics.) These measures can also create substantial pressure on foreign producers to move their operations, jobs, and technologies to China.

China’s policies were challenged at the WTO and ultimately, the challenge was successful:

WTO Dispute concerning Chinese export taxes on minerals: In June 2009, the EU and the United States both filed requests for consultations with China. In August, they were joined by Mexico (DS394, 395, and 398). According to the requests, China imposed quantitative restrictions on the export of bauxite, coke,      fluorspar, silicon carbide, and zinc, and it also imposed export duties on bauxite, coke, fluorspar, magnesium, manganese, silicon metal, yellow phosphorus, and zinc. These measures were considered to be in contradiction to Articles VIII:1(a), X:1, X:3(a), and XI:1 of the GATT 1994. On 5 July 2011, a dispute panel found in the complainants’ favour. Both sides appealed, and the Appellate Body upheld most of the dispute panel’s findings. In particular, China had argued in its defence that some of its export duties and quotas were justified because they related to the conservation of exhaustible natural resources for some of the raw materials. But China was not able to demonstrate that it imposed these restrictions in conjunction with restrictions on domestic production or consumption of the raw materials so as to conserve the raw materials. On 28 January 2013 China notified that it had implemented the dispute panel’s           recommendations. A similar case brought by the United States, the EU, and Japan in 2012 concerning restrictions on Chinese exports of rare earths, tungsten, and molybdenum also resulted in victory for the complainants in 2015.^[3][4]

If contemplating the introduction of an export tax to encourage downstream production, governments should determine whether such an incentive is indeed required. In some instances, governments have instituted an export tax in order to encourage further processing where no incentives are necessary. As an example, Zambia levies an export tax on copper concentrate of 10 percent of the sales value. The tax is intended to promote the smelting and refining of copper concentrate from mines in the country. The cost of transporting copper in its raw state (concentrate), is almost three times the cost of transporting refined copper. As a consequence, a mining company is better off refining its copper even in the absence of the export tax. The export tax is therefore redundant as a means of encouraging refining.^[5]

Export taxes can also be detrimental to the production of raw materials in some cases. Where a mine is too small to produce the volumes required for a smelter and where smelting capacity is not available nearby or where there are impurities that are not easily managed by existing smelters, an export tax may render such mining projects unprofitable and thus have the effect of curtailing mining output and investment.^[6]

Export taxes have a negative impact on the profitability of the producers of raw materials. Governments seeking to promote downstream production will accordingly need to balance the interests of downstream producers with the interests of the producers of raw materials. This is a complex task, particularly where the profits of the producers are very low and their capacity to absorb the tax is thus very limited. For example, India has favored steel production through a number of measures. Export taxes were imposed first on iron fines and later, on iron lumps. In March 2011, both fines and lumps attracted a 15 percent tax, which was raised to 20 percent later that year. The impact on the iron ore industry was detrimental. Iron ore exports declined to effectively zero. From being the world’s third-largest iron ore exporter, India had become, just two years after the imposition of the export taxes, a net importer of iron ore.^[7]

When a processing facility is not itself profitable but is dependent on taxes levied on the export of the raw material, it becomes vulnerable to a drop in either the price of the refined product or the raw material. There are many examples of marginal or unprofitable processing facilities that relied on export taxes to survive, only to cease operations when prices declined. For example, small copper smelters set up in Katanga in the Democratic Republic of Congo could exist only because of the government’s export tax on copper concentrates and the high transport costs. Most of these smelters closed rapidly when copper prices fell in late 2008.

Favorable tax treatment and investment incentives

Positive incentives, for instance, in the form of tax credits for downstream processing, have been discussed by analysts but there are few if any real-world examples. However, downstream processing can be favored by provisions in tax codes that do not obviously aim at providing incentives for downstream processing. For example, Kazakhstan imposes an excess profit tax on mining profits. Investments in downstream processing are deductible costs, thus reducing the excess profit tax to be paid by mining companies that invest downstream.^[8]

Government incentives for investment in downstream production are more widespread. These incentives can take a variety of forms, including tax holidays, reimbursement of some share of the investment costs, and accelerated depreciation.

Downstream investments tend to be very capital intensive. And in many instances, the potential recipients of incentives are foreign companies. Governments will therefore need to carefully evaluate whether spending scarce resources to share the burden of downstream investments is the best use of their limited resources.

A major problem for government is calculating whether support is necessary and if so, how much support is required to secure downstream processing. Providing support where none or less is necessary is clearly wasteful of government resources. It is very difficult for government to ascertain the precise level of support required to attract the desired downstream investment.

A major challenge for governments is calculating whether support is necessary and if so, how much is required to secure downstream processing. For example, the Mozal smelting facility in Mozambique has received extensive investment incentives, as well as several other support measures. In addition to exemptions from the value added tax, excise duty, customs duty, stamp tax, property tax, and municipal tax on rental income, Mozal is also exempt from corporate income tax payments and instead pays a 1 percent turnover tax. In 2006, these incentives, had have been granted for 50 years, amounted to foregone public revenues equivalent to 11.9 percent of total government revenues. Moreover, there is a strong case that the internal rate of return on the investment in Mozal would have been adequate to secure investment.^[9]

Provision of cheap inputs to downstream production via subsidies

Governments frequently subsidize the costs of inputs into downstream processes. The two most commonly supported are transport and energy. For example, governments often subsidize the provision of electrical power to aluminum smelters via long-term contracts. Since electricity generally constitutes the single-most expensive input, and investment in aluminum smelters is very capital intensive and long term, this provides a significant incentive to investors.

In addition to being the recipient of significant investment incentives and tax concessions (see above), Mozal in Mozambique has benefited from a long-term, low-cost electricity agreement. Mozambique’s demand for electricity in 2007 was less than half of Mozal’s peak demand. Other consumers, residential and industrial, are prepared to pay a far higher price for electricity, but the government must first satisfy Mozal. This illustrates the opportunity cost that this electricity agreement may entail for Mozambique, especially as residential and industrial demand for electricity increases.^[10]