I wish Mr Henry the academic lives in the real world, instead of a funny farm.
Article in The Australian by journalist David Uren Economics correspondent THE central problem with the proposed resource rent tax is that it assumes that capital is available to develop all profitable projects.
Treasury Secretary Ken Henry believes that although individual businesses may face constraints on the availability of capital from time to time, the business world as a whole does not.
If existing mining businesses are not prepared to develop projects under the resource tax regime, then new entrants -- all the other Twiggy Forrests out there with a metallic glint in their eye -- will take them on.
In the commercial world of the banks and businesses that are trying to come to grips with the tax proposal, this notion is dismissed as academic bunkum.
Rio Tinto chief executive Tom Albanese set out the industry's view of life under the new tax in an interview with Lateline last week.
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"Day one, pretty much, you would see life would go on -- the trucks would keep running, everything else. Year one capital's getting harder, year two capital's getting even harder than that.
"Ten years down the road people would start saying: 'What happened to our industry? This was the best mining industry in the world bar none. This kept us out of the great recession in 2009. Where did it go?' "
The daily experience of business is that capital is hard to obtain. Banks demand security, an equity buffer and a premium for any residual risk.
Shareholders are prepared to take more risk than the banks, but want a lot more return and are prepared to turf the board and management which fails to deliver.
In a world where the supply of capital is limited, companies make choices about which projects they develop, advancing those with the greatest after-tax returns.
The pure form of a resource rent tax invented by US academic Cary Brown in 1948 requires the government to stump up cash for its share of the development costs, which under Canberra's plan would be 40 per cent.
It is argued that this would be completely neutral for the mining company, as its share of the returns would match its share of the costs, with the government equally exposed to any downside risk.
In the real world, this would still have some disadvantage for miners -- offered a choice of 100 per cent of a project in Chile or 60 per cent of a project in Australia, a mining company thinking of spreading its administrative costs might still opt for the one in Chile.
However, the real problems arise with the shift away from the pure Brown tax. Essentially, the model recommended by Henry requires the mining company to lend the government the money to fund its 40 per cent stake in the project.
The government repays the loan by giving the project tax concessions, which carry an implied interest rate based on the long-term bond (notionally 6 per cent).
If the project collapses before the tax concessions have been drawn, the government guarantees to pay out the remaining share of its 40 per cent stake in cash.
It is the demand that companies fund the government's share at the bond rate that is the show-stopper.
A company's own cost of capital is much higher than the bond rate.
A major mining company might be able to raise funds at around 2 percentage points above the bond rate.
A second-tier company, like Fortescue, might have to pay as much as 7 or 8 percentage points above the bond rate.
The position is even worse than this. Companies require more than their weighted cost of capital to fund a project. They have their own view of the required return on risk.
Henry's view that there is no constraint on capital was the economics textbook standard until the 1970s.
However, this was challenged in the 1980s, most notably by a study by the man who is now President Barack Obama's chief economics adviser, Larry Summers. This looked at investment decisions by a large number of US firms and found that their hurdle rates for assessing projects were far higher than their weighted cost of capital -- often twice as high.
Economist Henry Ergas says the reason is that people have different information. Banks cannot be certain that companies tell them the truth, so charge more, and senior managers may similarly doubt the judgments of junior managers, so require bigger safety margins before risking money.
Treasury's view of an unconstrained capital world ignores the advances in the economics of information of the past three decades.
Ergas says a new body of economic theory has also been developed from the mining industry, looking at investment decisions as the exercise of options, which sets a value on developing a project now, rather than later.
Driven to reach hurdle rates of return, mining companies will abandon projects that would previously have been developed.
The argument that new entrants will pick them up assumes that mining is a low-tech industry.
Although mining is increasingly conducted by contractors, the really substantial projects only occur because of the expertise that the majors, like BHP Billiton, Rio Tinto and Xstrata, have developed as project integrators.
It needs that expertise to develop something like the Olympic Dam project. It is not an off-the-shelf skill that anyone can buy.
Treasury's assumption is that banks will come to the party and develop loan products that enable companies to fund the government's tax concessions for little more than the risk-free rate.
Henry declared in last week's hearing that he was surprised by comments that the government's commitment to deliver tax concessions and refund losses might not be bankable, acknowledging, "I've seen it written, including by people whose judgment I respect".
However, in his post-budget address to business economists he urged patience.
"Over the last 25 years, I don't know how many times I've been told that it's all very well in theory, but that's not how the real world works, only to find years down the track that the people we call financial engineers . . . have reacted so quickly that governments have had to respond.
"People who think these propositions are too theoretical should suspend judgment for a while."
It is the biggest gamble ever seen in this country. At stake is much more than the survival of the government. At risk is an industry which Access Economics reports has investment projects of $105 billion under way and a further $185bn of projects on the drawing boards.
