The proposed resources tax may be a hot political issue but how many of us know how it works?

WHO could have guessed that our main political battleground would become a tax on the profits of the mining industry? Especially when, as one analyst says, only 19 people in Australia really understand it?

So many claims and counterclaims are flying around that it is difficult for anyone to know the truth. Let's look at some of the main issues.

Why do we need this tax?

The government says the main reason is that Australians are not getting a fair return from the minerals they own. Booming demand from China and India has sent mineral prices soaring in recent years, but state-based royalties have barely risen, handing the miners huge profits not shared with the owners of the minerals: us.

Second, everyone except the Coalition agrees that a profits-based tax is a better way of taxing mining activity than royalties, which hit hardest on the most marginal mines. That's why the Henry review proposed the tax.

Third, Treasurer Wayne Swan constantly alludes to the dangers of a "two-speed economy" the mining boom pushing the rest of the economy into the slow lane, by driving up the dollar and thus making other industries less competitive, while outbidding them for scarce resources of skilled labour and capital. Yet Swan also denies that the new tax will slow mining, saying it will increase mining output. Hmm.

Deep in the background, one suspects, is an issue neither side has aired publicly: the mining industry led the campaign that derailed the emissions trading scheme. There's a hint of payback here.

How would it work?

It's complicated. But the central feature is that mining companies would be charged a tax of 40 per cent on "super profits" defined as any profit in excess of the return on the safest investment: long-term government bonds. That threshold is normally about 6 per cent.

For the miners, there are three benefits. First, the tax works both ways. Companies losing money on a mine would get 40 per cent of their losses back from taxpayers: either as credits against tax on future earnings from this or other mines, or (if they go out of business) as a cheque from the government.

Second, Canberra would repay all their state royalties (one unresolved issue is how it might stop the states jacking up royalties to profit from this). And third, part of the tax would be ploughed back into mining infrastructure and tax breaks for exploration. In effect, the federal government would become a 40 per cent partner in all mines with no say in management, but sharing the profits and losses.

But if miners support a tax like this in principle, why are they so vehemently against this tax?

Because it would reduce their profits. The miners now pay about 35 per cent of their taxable income in tax and royalties. Under the new scheme, a mine earning a 15 per cent return on investment would pay 45 per cent of that in tax, rising to 50 per cent for a 25 per cent return, and 52.5 per cent for a 40 per cent return.

The Minerals Council says miners pay 41 per cent now, rising to 58 per cent under the new scheme.

The first is poor arithmetic, the second assumes an infinitely high rate of return. But their core claim is right: these would be the world's highest mining taxes.

Second, they question whether the tax is workable. It assumes they can borrow money at the same rate as the government, which seems unlikely. And many doubt that future governments will really pay out billions of dollars in compensation to failed mines or that future taxpayers would accept this.

So do they want the tax scrapped?

No, only the Coalition wants that. The Minerals Council wants four big changes:

Reduce the 40 per cent tax rate.

Lift the threshold for "super profits".

Exempt existing projects.

Apply different tax rates to different commodities.

They contrast the new tax with the old resource rent tax on oil and gas, introduced in the '80s by the Hawke government, and designed by Ross Garnaut and Anthony Clunies-Ross. Its threshold for super profits was set 5 per cent above the bond rate (in effect, taxing only profits above 11 per cent). And it exempted existing projects including the lucrative North-West Shelf gas fields, now facing the new tax.

What's the government's response?

There isn't one, because the two sides are not negotiating on these core issues. The industry was consulted by the Henry review, but not before the tax was decided. And while a government panel is now consulting with the miners, its brief is limited to transitional issues (important, but not the main game).

Rather, the two sides are shouting at each other through the media. Swan says the 40 per cent tax rate is non-negotiable. But one suspects that, in the end, it could be negotiable if a deal is to be done.

There are hints that the government will compromise on the threshold for super profits, lifting it to the bond rate plus 5 per cent, as in the Garnaut model. That would sharply reduce the miners' prospective tax bills: for a 15 per cent return, from 45 to 36 per cent, and for a 25 per cent return, from 50 to 44 per cent.

But almost certainly, such a change would also see the government scrap its promise to compensate miners for their losses. In effect, the Henry model would be replaced by the Garnaut model.

The government is looking at exempting low-value minerals such as gravel and phosphates from the tax.

But the real sticking point is likely to be the third issue. The miners are furious the government plans to impose the tax on existing projects, sharply reducing their profitability. They angrily call it a retrospective tax, a false claim, as it applies only to future profits. But the government could back down on this only if it were prepared to scrap all the measures to be financed by the new tax: company tax down to 28 per cent, tax breaks for small business, all the improvements to superannuation. Dream on, miners!

But it's already driven down the value of our mining shares.

Only marginally. Australian mining shares have fallen by much the same as mining shares worldwide, because of the European debt crisis.

How will it end?

It might not end until after the election. The miners have a tough call to make: do they negotiate with the government now, while they have leverage or maintain their rage, and punt on a Coalition victory? The government too has a tough call. It could try to turn down the heat by dumping the Henry model for the Garnaut model, and exempting low-value minerals. But then the miners would demand more. The election could decide it. If Labor wins, they and the Greens will see the tax become law. If the Coalition wins, it won't.

What if the miners take their business overseas?

The minerals won't go overseas, so they'll be mined later by someone else. Some mines will be deferred, but that's not a bad thing. Treasury and the Reserve Bank warn that with Australia close to full employment, mining can expand only at the expense of other sectors. Who wants that?