Progressive Taxation of Extractive Resources as Second-Best Optimal Policy

Abstract

The paper provides a critical review of the literature on the concept of progressivity in thetaxation of petroleum and mineral resources and offers a fresh perspective on its purpose andmeasurement. Regressive taxes, such as royalties, exist to satisfy policy objectives other thanrevenue maximization, such as achieving early revenues, while rent-based or profit-sensitivefiscal instruments must be designed with progressive marginal rates to maximize governmentrevenues. Hence, the emphasis should be placed on tax rate progression of the direct taxationof profit or rent, rather than progressivity in the overall government take. However, asregressive taxes, by their very nature, tend to be distortionary, the optimal degree ofprogression in the rent- or profit-tax rates must take these distortions into account. The centralideas are illustrated with a simple analytical model in which a second-best optimal tax rateschedule on profit is characterized in the presence of the tax distortions caused by theregressive taxes. Some practical implications of the analysis are discussed.