Tax cuts will not save Peru’s mining sector from falling prices
Recently proposed tax cuts demonstrate the Peruvian government’s attempt to deal with slower growth and stagnating foreign investment. Regardless, if mineral prices continue to fall, investment in extractive industries will not maintain the levels of the past decade.
The Peruvian Ministry of Economy and Finance (MEF) has proposed a bill that would significantly reduce income tax, corporate tax, and fuel tax to spark spending and attract foreign investment. If passed, income tax would be reduced to 8% for lower-income households and capped at 30% for the highest income households, while the corporate tax rate will decrease 4 points to 26% by 2019.
Economic growth has slowed visibly in 2014, which has led the government to aggressively seek investment from international partners. This month, President Ollanta Humala traveled to Russia, where the two nations agreed to increase trade and strengthen bilateral ties. A couple of days earlier in the Beijing APEC summit, Humala boasted that Peru would remain one of the fastest growing and most dynamic economies in the world.
After Mr. Humala’s trip to Asia, his government proposed broad business-friendly tax reforms aiming to facilitate foreign investment by decreasing the corporate and income tax rates.
Many claim that this is the current administration’s most ambitious economic reform proposal. The tax cuts are a step in the right direction to attract investment, but they will not prevent decreased revenues for mining companies on their own.
Investment in the mining sector is determined mostly by revenue and production rather than tax rates. Gold and copper prices have already dropped dramatically in 2014, which has significantly slashed revenues for mining companies operating in Peru. As an economy that depends largely on copper and gold extraction, a fall in production and investment in these industries could debilitate the entire Peruvian market.
That said, it is clear that maintaining a strong mining sector is a priority for the Peruvian government as it prepares for 2015. Peru has already been forecasted to grow above 5% in 2015, although many think such a high figure is unlikely. In 2014, Peruvian economic growth was more sluggish than expected, with 1.75% growth in Q3 and 2.68% in September.
The dominant industries all contracted during this time period: overall mining production shrunk by 4.79%, with copper and gold production falling by 12.94% and 2%, respectively. Surely, the government has a reason to be worried about the sustainability of the Peruvian economy with tumbling global prices and production of copper and gold.
There are also doubts about the depth of the potential corporate tax cut, which will drop from 30% to 26% by 2019. Chile, which has a similar export portfolio to Peru, already has a corporate tax bracket of 20%, making its extractive industries and particularly the copper industry more competitive at present.
Even though the Chilean government has proposed increasing its corporate tax rate to 27% in 2017, its bureaucratic effectiveness, low rates of corruption, and political stability makes it a more attractive destination for mining companies in the coming years. Chile can increase the corporate tax rate among falling commodity prices because it enjoys a high level of business confidence.
Peru, however, suffers from a decreasing business confidence. In the past 7 months, Peru’s business confidence index has dropped from 60 to 54. As a highly liberalized market that depends on investment, a volatile business confidence is troubling news.
The Peruvian government has proposed tax reform in a timely manner, when commodity prices are gradually dipping and expected to continue dipping through 2015.
Unfortunately, the government has yet to permanently resolve chronic structural issues creating roadblocks for investment, such as security, the growing number of mining-related protests, or the proliferation of illegal mining operations. Peru’s leading industries face deep problems, and a small corporate tax cut is not the silver bullet.
