Drilling Down on Royalties: How Canadian Provinces Can Improve Non-Renewable Resource Taxes

From coast to coast, non-renewable-resource taxation is a key source of provincial government revenue – and political rancour. Alberta has recently started a comprehensive review of its oil and natural gas extraction tax system. Newfoundland and Labrador is looking at a redesign of its royalty system. And British Columbia has set up a new tax on liquefied natural gas production. These provinces can all improve their current resource tax systems to raise more money without jeopardizing investment. The key problem with current resource taxes in Canada is not the tax rates, but the design of the taxes. Canadian policymakers should be looking at international best practices in resource tax design. Australia and Norway have best-in-class resource taxes that are based on the cash flows of resource production. That better design means that resource companies in those countries pay a high tax rate on cash flows but still have a strong incentive to invest. Western Canadian provinces instead rely on economically distorting gross-revenue royalties for most onshore oil and gas taxation. These provinces should change their gross-revenue royalties to more efficient cash-flow taxes. Cash-flow taxes are a better way of reflecting the cumulative costs that resource companies face to extract energy than are gross revenue royalties. Although Alberta’s oil sands cash-flow tax and Newfoundland and Labrador’s offshore royalty follow many international best practices, both have room for improvement. Those provinces should rethink the rules around how companies pre-pay gross revenue royalties, the limits on the kinds of expenses companies can deduct, and having a royalty rate that fluctuates with oil prices. British Columbia’s mining tax hits many of the right notes. However, the province’s tax on liquefied natural gas exports would be unnecessary if it changed its gross-revenue royalties on natural gas extraction to cash-flow taxes. Likewise, the federal government should consider reforms to its own corporate income tax system to tax cash flows, not profits. Canadian provinces have collected about $79 billion in resource-specific tax revenues from 2009 to 2013. But the provinces can collect more while not harming investment in mining and oil and natural gas extraction if they change their distortive gross-revenue royalties into better designed cash-flow taxes.