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PAPUA NEW GUINEA RAINFOREST & SUSTAINABLE DEVELOPMENT CAMPAIGN NEWS

Keep the Current Forest Revenue System in Place

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Forest Networking a Project of Forests.org

http://forests.org/ -- Forest Conservation Archives

http://forests.org/web/ -- Discuss Forest Conservation

09/02/00

OVERVIEW & COMMENTARY

There have been recent suggestions that Papua New Guinea's timber

industry deserves tax breaks. It is critically important to the

future of Papua New Guinea's rainforests that the current forest

revenue system remains in place. The revenue system's relatively

high tax rates control the size of the industry--with real impacts

upon regional forest sustainability--by ensuring that it is limited

to relatively efficient operators; it captures high rents for a

valuable resource whose harvest has real, significant and widespread

environmental and social costs; it is a means of controlling an

industry that has otherwise run roughshod over institutions and

regulations; and in so doing it allows other types of forest

management such as community eco-forestry to compete. The PNG

government is correct in maintaining the current forest revenue

system. Doing so will require following through on commitments to

end the forest industry's dominance of the PNG Forest Board.

g.b.

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RELAYED TEXT STARTS HERE:

Title: Why the current forest industry revenue system should not be

reviewed/reformed

Source: The Independent (PNG), Copyright 2000

Date: August 24, 2000

By: ELIM KIANG

Introduction

THIS article presents an independent research material conducted over

the last seven years on the forest industry in Papua New Guinea and

argues why the current forestry revenue regime should not be reviewed

(or changed). It addresses the international and domestic commercial

(corporate) and economic issues that have not been addressed by

current research calling for reforming the existing forestry revenue

regime dated February 12, 2000 by Dr Colin Hunt of the National

Research Institute (NRI). The NRI research document only addresses

the issue of downward price movement and its consequences on the

logging industry. I discuss these issues in detail below.

The rationale underlying the current regime or its predecessor

introduced under the World Bank and International Monetary Fund

(IMF) sponsored reform program of the 1990s was to rationalise the

forest industry first, and then undertake reform of the industry. The

only way forward was to introduce a high rental tax (export tax) on

an industry that has developed out of control and beyond the ability

of the PNG government and its resources and technical capability to

properly monitor and develop the industry on sound economic and

commercial footing. The high export tax was meant to discipline the

industry by weeding out inefficient logging operations and the

reforms, when introduced, would be more successful with a reduced and

manageable number of loggers in the industry. Therefore, the issue of

high export tax and subsidisation of domestic processing industry is

international economics (trade) theoretically correct but empirically

wrong. I discuss below why this argument could not be supported.

Subsidisation of Domestic Processing

Taxation of log exports would lead to a fall in international price

paid on log export from PNG. The international trade assumption

underlying this argument is that, the tax imposing country is large,

has the ability to influence world market prices, and has a large

domestic processing capacity (or market). This argument does not

hold, as PNG does not have a significant domestic processing capacity

and market nor the ability to influence world market prices. In fact

PNG and resource owners ("landowners") subsidise consuming countries

of Asia and elsewhere. This is because since the (late) 1980s,

governments of the Philippines, Thailand, Malaysia and Indonesia have

imposed trade controls in favour of domestic processing. This has

caused a reduction in the supply of logs to Japan and other Asian

markets. Consequently, Japan being the dominant buyer has been able

to use "market power" ("dominant effect") with an intricate network

of trading houses and agents and obtains logs at much lower prices

than would normally be under competitive conditions.

International outsourcing of production and subsidization

The conclusion of the Plaza Accord in New York in 1985, and

subsequent weakening of the US dollar and the strengthening of Yen,

together with rising domestic production cost, had forced Japanese

companies to relocate in other Asian countries as Japanese exports

became uncompetitive. Japanese log processing companies have also

relocated in countries such as Thailand, Philippines, Malaysia and

Indonesia. These are in-transit production countries, and PNG's log

exports to these countries reflect a combination of outsourcing of

Japanese production, trade controls discussed above, and supply

reduction discussed below. Therefore, this indirect log exports to

Japan through third countries is unaccounted for in PNG's log exports

to Japan. As Japanese importers largely set pricing, these third

countries can import PNG logs at even lower prices. The National

Forest Authority annual price statistics show this. This is another

way through which PNG is subsidising consuming countries.

Mismatch between natural tropical log prices and supply reduction

Asia-Pacific region is the major producer and supplier of tropical

logs. With dwindling "natural" forest in the Philippines, Thailand,

Malaysia and Indonesia, combined with environmental concerns, one

would expect the price of natural logs to increase over time. While

the substitution effect of softwood imports into consuming countries

may check on natural tropical log prices, they are not "perfect"

substitutes of tropical logs. Therefore, the relatively stable prices

especially over the 1980s and 1990s (except 1992-93 period) represent

a market anomaly between the reduction in the supply of natural logs

and the corresponding international prices paid for PNG's log exports

(see figure 1 below). This in itself encourages rapid exploitation of

PNG's natural logs at the expense of resource and environmental

sustainability.

Profitability and Investment

The NRI research document by Dr Hunt does not make a distinction

between economic profit and accounting profit. Economic profit is

revenue less cost plus opportunity cost. Accounting profit is revenue

less financial cost. It is unclear which measure of profit was

discussed in the document. If accounting profit as an indicator of

corporate performance is implied in the document, then it does not

account for widespread corporate accounting irregularities in the PNG

forest industry. Inflationary corporate accounting understates

profits (or generates losses). In addition, widespread inefficiencies

in the industry add to operating costs. These distort production

costs of the forest industry while the state loses out on potential

corporate tax revenues. If inefficiencies could be reduced through

better cost controls and management practices in the industry, the

logging companies could increase investments through generation of

retained earnings.

However, the issue of profitability and investment in the PNG forest

industry becomes trickier when a combination of accounting

irregularities and inefficiency affect industry profitability.

Accounting irregularities artificially reduce profits or generate

fictitious (book) losses by inflating operating costs whereas

inefficiency generates higher operating cost. The accounting and

auditing profession in PNG is also involved by endorsing corporate

accounting irregularities, and more particularly for the forest

industry. The fact that almost all logging companies have been

declaring losses for many years is a reflection of these factors, and

transfer pricing in the forest industry. Transfer pricing results in

the shift in income being the difference between the world market

price and PNG log export price offshore (see figure 1 below). Table 1

below show the minimum potential tax revenue losses (GTAX & AGTAX) by

the state due to these problems. Therefore, as these issues have not

been addressed by the NRI document I do not see any reason why

current forest revenue regime should be reviewed. The cost assumption

used in the NRI research document, is an oversimplification without

adjustments for questionable accounting practices in the industry.

Equity and resource ownership

The equity issue discussed in the NRI research document leaves a lot

to be desired. The fact is natural resources in PNG are owned by the

resource owners (the "landowners"), and not the state of PNG (a

fictitious institution). The overriding objective of the document is

to maximise tax revenues to the state, while holding landowner

royalty constant at ten US Dollars. Equity in this context should be

maximisation of returns to the landowners who are the legitimate

resource owners while, still ensuring that some revenue flows to the

state. The purchasing power of the ten-dollar fixed royalty collapses

in times of very high inflation as has happened in the 1990s, through

the depreciation of the Kina. Therefore, equity discussion in the

document centred on the state and logging companies also collapses.

Income and capital shifting and taxation

Transfer pricing, the lack of monitoring and surveillance of export

proceeds of logging companies, and manipulation of the terms of

foreign currency loans contracted by the logging companies is

resulting in income being shifted offshore. The lack of comprehensive

export proceeds monitoring system in PNG combined with transfer

pricing leads to shifting of income offshore by the logging

companies, to avoid taxation or for other peculiar commercial

motives. The manipulation of the terms of foreign currency loans

results in a series of principal and interest payments which, in

principal, constitute capital shifting offshore from export proceeds

of PNG logs. My own research shows that logging companies are

undertaking income and capital shifting practices. The result is lost

potential tax revenues (see GTAX & AGTAX, table 1 below), which

limits the ability of the government to fund public programs

contributing to the deteriorating public services in PNG.

The Forestry Act (1991) and regulatory capture, and government

Credibility

The regulated could influence policies and regulations to its own

benefit and significantly erode the "credibility" of the government

or its implementing agency. This results in outcomes (good/bad) that

deviate from those originally intended. Currently, the Forest

Industry Association (FIA) has effectively used this strategy

("regulatory capture") to its advantage by ensuring that the Forestry

Act 1991 automatically admits the president of the FIA to the

National Forest Board (NFB). The president of the FIA now has

considerable influence over the Ministry of Forest and the government

through his/her representation on the NFB and stalling effective

reform of the forest industry by the government.

What should be done to reform the forest industry in PNG?

The NRI research document only addresses the revenue side of the

equation and does not address the industry-wide commercial and

economic reform issues, discussed above. Therefore, the following

options are worth exploring. First, the current forestry revenue

regime adequately addresses the objective of market discipline and

forest industry rationalisation for further industry reforms, and

should be left intact. Second, transfer pricing monitoring and

surveillance capability of the tax office needs to be enhanced

through staff training and education. Third, an export proceeds

monitoring database should be developed by key government agencies to

monitor and ensure that all log export proceeds are brought onshore

and converted to Kina. Fourth, a licensing system should be

introduced into the accounting profession by licensing practicing

accountants and accounting firms in PNG. A practicing accountant or

an accounting firm should be de-licenced and banned from accounting

and auditing profession in PNG by the courts, if found guilty

endorsing accounting irregularities. This should ensure strict

compliance to standard accounting and audit practices, than the

current weak self-regulation within the profession. Contracting

foreign professional accounting firms that do not operate

representative offices in PNG could audit accounting professionals

(or firms) and the forest industry. The same should apply to

practicing (commercial) lawyers. Fifth, detailed research into the

forest resources is needed to determine economies of scale timber

volumes for allocation of natural timber concessions. The absence of

this leads to inefficient allocation of time volumes for allocation

of timber concessions and with the resultant environmental

destruction and high operating costs of many low volume concessions.

Sixth, the Forestry Act 1991 should be amended and FIA representation

to the NFB be eliminated in its entirety. Seventh, a cost database

should be developed to monitor production costs in the forest

industry for policy and regulatory purposes. The absence of this

often leads to forest industry policy prescriptions and

recommendations based on assumptions, as is the case at present,

rather than on sound and detailed cost analysis. Eighth, the current

forestry revenue sharing system be revised so that a larger share of

the state's forest tax revenues be shifted to the landowners in

addition to the ten dollar fixed royalty, to address equity concerns

and reduction of purchasing power of the fixed landowner royalty in

times of high inflation. This would enable landowners to afford the

necessary and essential public services that the government has

failed to deliver due to the public sector inefficiencies draining

and stretching limited government resources.

The author of this article is an economist by profession and is

currently employed by the Bank of PNG. Formerly employed as a

researcher, he is now a regulator. The article is based on his

independent research on the forest industry in PNG spanning over

seven years. Some of his research material had been published at

post-graduate studies while some of it had been presented at overseas

seminars. He has a first degree in economics from the University of

PNG; masters degree in economics from the University of Hawaii; and a

masters in business administration from the University of Waikato in

New Zealand.

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