The cloud over China's coal imports

Beijing stunned Australian coal miners and free trade agreement negotiators last week with a tariff increase on coking and thermal coals. The move is widely interpreted as an attempt by China to shore up its struggling domestic producers.

The China Coal Industry Association estimates that more than 70 per cent of coal miners have made losses this year and has been lobbying Beijing intensively to impose tariffs on imported coal. They got what they wanted last week when Beijing imposed a 3 per cent tariff on coking coal and a 6 per cent tariff on thermal coal.

The Abbott government is trying urgently to find the reasons behind the surprise increase and is pinning its hopes on signing the free trade agreement to reverse this damaging policy change for Australian coal exporters.

However, at the same time as people are indignant over the Chinese protectionist move, Beijing also introduced a long-awaited coal resource tax of between 2 and 10 per cent on the country's already struggling domestic coal producers.

The net profits of the coal industry nosedived by as much as 46 per cent during the first eight months of the year and 70 per cent of medium- to large-sized coal mines made losses during the same period, according to the National Development and Reform Commission and the China Coal Industry Association.

Why is Beijing introducing the much debated resource tax on the struggling coal industry while simultaneously lifting tariffs to protect it? The introduction of a comprehensive nation-wide resource tax is one of the top fiscal reform priorities for Beijing. The Chinese government has been running several pilot schemes with different resource-rich provinces for the past four years. 

For example, the State Council, the country's cabinet, introduced an ad valorem resource tax back in June in the resource-rich province Xinjiang, imposing a 5 per cent tax on petroleum and natural gas. In December 2010, the government expanded the pilot scheme to 12 western provinces. In November 2011, the resource tax on petroleum and natural gas has been levied on the basis of price instead of volume.

The biggest and most significant move for the new tax is to shift from volume-based taxation to ad valorem taxation; the move is designed to better reflect fluctuating commodities price as well as streamline the country's byzantine tax code.

In China, the resource tax only accounts for about one per cent of the total revenue of the central government. So the industry is lightly taxed in theory, but is subject to a myriad of local charges, fees and levies, according to an estimate by Caixin, a respected Chinese business publication.

For example, China has 109 coal industry-related taxes and fees, which include 21 types of taxes and 88 kinds of fees and charges, according to a report produced by the Coal Industry Research Institute at the Central University of Finance and Economics in 2013.

All these fees and charges can account for as much as 43 per cent of the net profit of coal producers.

With the introduction of this new tax, Beijing wants to abolish many of these local charges and fees to relieve tax burdens on domestic coal producers. However, it is much easier said than done. While the central government collects resource tax, provincial and local governments get to levy and charge all other additional fees.

These hidden and sometime outright illegal fees are often used to replenish local government slush funds that can sometimes function as personal ATMs for corrupt officials. There would be considerable reluctance on the part of local governments to enthusiastically support Beijing's effort to replace these complex resource-related fees with a much more transparent national tax.

Some Chinese domestic coal producers have already voiced concerns about the new tax, saying they are not confident that local governments would want to reduce fees and charges in favour of a more transparent and accountable national tax.

The success or otherwise of this new tax is dependent on the ability of Beijing to rein in hidden fees and charges relating to the country's coal industry. The introduction of the new resource tax is likely to mitigate the price impact on Australian coal exporters of the surprise increase in tariffs last week -- well, at least for the short to medium term.

Another reason for the introduction of ad valorem tax on coal is to better reflect the environmental costs of coal mining in China. The country is the world's largest producer and consumer of coal and is in the midst of a worsening environmental crisis.

Beijing was once again shrouded in grey smog last weekend and we should not underestimate public anger about air quality nor Beijing's resolve to mitigate the harm. In future, it seems that both domestic and foreign coal producers will come under increasing pressure.