Robin Rudd and Chicken Little vie for high groundWho to believe? The mining industry is doing a Chicken Little routine: "The sky is falling." And Kevin Rudd has dressed up like Robin Hood, nobly telling us he's taking from the rich multinational miners to give to those who are poorer, which is almost everyone.Each side has damaged credibility.For example, Xstrata Coal - part of the $US23 billion-a-year Swiss-controlled Xstrata PLC - said last week that it was suspending plans for a $6 billion coal project in Queensland because of the disastrous effect of the proposed tax.Yet it turns out this week that the company is still buying farmland in the area of its Wandoan mining lease.That's right. The tax will be so disastrous that the company is still spending money to increase its exposure to it.And the miners' claim that the tax will wreak havoc with your superannuation returns?The superannuation body that speaks for about 80 per cent of the industry, the Association of Superannuation Funds of Australia, reckoned this week that the introduction of the proposed tax would cut members' returns by an estimated average of less than 1 per cent. Its chief executive, Pauline Vamos, wrote to members: "The sky is not about to fall in."As for Rudd, the electorate must be wondering - after he shelved until at least the end of 2012 the emissions trading scheme he famously described as "the greatest moral and economic challenge of our time" - whether he believes in anything.It also must be wondering whether he can be trusted with any reform. He has a credibility problem of his own. He is suffering from a trust deficit.Here's what's right about the Rudd government's proposed mining tax, what's wrong with it and what's likely to happen next.One point that has been utterly lost in the noise is that the mining industry asked the government for tax reform. In the submission to the tax review chaired by the Treasury secretary, Ken Henry, the miners urged the federal government to scrap the existing system of state taxes on mining.The state royalties are a bad idea because they tax mine output per tonne, instead of taxing profit. And every state has different rates of royalty, and these further vary for different kinds of product - one for coal, another for iron ore and so on.It's a mess and miners wanted it cleaned up. In fact they asked for a new tax regime based on profit, which is what Rudd is now proposing. Rudd's tax plan would refund to the mining companies the money they pay to the states as royalties. The trade-off is that they would pay a new, uniform federal tax on super profits. So, on this principle, the miners and Rudd agree.Next, what is the concept of a tax on "super profits"? It's an established and respectable idea in economics.A super profit, which economists call a rent, is simple:"A soccer star may be paid $50,000 a week to play for his team when he would be willing to turn out for only $10,000, so his economic rent is $40,000 a week," in the example favoured by The Economist magazine.So taxing the $40,000 super-profit, or rent, shouldn't affect the soccer player's willingness to take the field.Super profits can occur in any industry under certain conditions - if there is a monopoly or a cartel, for example.Super profits are fairly common in the resources sector. Resources are essential yet non-renewable - dig them up once and they're gone forever.But how to measure exactly how much of a firm's profit is a super profit? How can you know for sure how much money the player needs to take the field? You can't just ask him. He won't necessarily give you a straight answer.So there is a particular definition of super profit. It's the amount of profit that the company makes above the risk-adjusted rate of return on an investment.In practice, this is impossible to specify exactly - each project has a different level of risk. So governments fix a reasonable average rate.For example, Australia for 20 years has been taxing the super profits of offshore oil projects by defining them as the 10-year government bond yield, plus 5 per cent. At the moment, the bond yield is about 6 per cent. So for offshore oil a super profit is defined as anything over 11 per cent. The government takes 40¢ in tax from each dollar of profit once that return has been reached.And that system has been working well for a long time. The oil flows, the firms profit, the government collects.That's why taxing super profits is a perfectly good idea. And now there is a historic surge in commodity prices. The mining companies are exporting ore for prices two and three times their wildest dreams of 10 years ago.As recently as 1840 China was the world's biggest economy, until the industrial revolution propelled the West far ahead. Now China has mastered the basics of the industrial revolution and the world economy is reverting to normal as China catches up, to be followed by India.So the miners can expect to continue to reap super profits for as long as this goes on or as long as the resources last. Rudd is quite right to try to claim a share of these super profits on behalf of the national interest.But if Australia already has a perfectly good system for taxing the super profits of offshore oil, why not just apply the same one to onshore minerals projects? Sigh. It's a very good question.Instead of applying a perfectly successful precedent, Rudd took the advice of Ken Henry's tax review panel and opted for a completely new structure.Instead of the 10-year government bond yield plus 5 per cent as the threshold rate for defining a super profit, the Henry - now Rudd - proposal plumped for the 10-year bond rate only.So for offshore oil a super profit is profit above a return of about 11 per cent, but for onshore minerals only 6 per cent?Yes, says Rudd, but check the added features.With Rudd's so-called Resource Super Profit Tax, there is an element of theoretical elegance. It's so elegant it's driving the mining firms crazy.The Henry-Rudd plan would tax a project's super profits at 40 per cent but it would also give the project a 40 per cent tax credit if it lost money. So it treats profits and losses symmetrically. This is the elegance.Why bother? It's supposed to encourage more exploration and, by underwriting 40 per cent of any loss, it's designed to encourage more risk-taking by miners.But in real life, it turns out the miners don't care about the tax treatment of losses. Perhaps with a bullishness typical of explorers, they are entirely confident of profits. And that is all they care about in this argument.So the outcome of Rudd's negotiations with the miners is likely to be that Rudd will scrap this 40 per cent credit for losses and change the threshold for super profits. Instead of the proposed bond rate alone, it's likely to be changed to the bond rate plus 5 per cent or some similar formula.If this happens, the miners would lose the ability to have the government underwrite losses but would get to keep more profits.What of Rudd's planned uses for the revenue? He plans to give it all away, not keeping any net revenue gain to pay down the deficit or save for the future when the resources run out. A smart country would keep part or all of the windfall in a sovereign fund of some sort, as Norway does.That's the main economic objection to Rudd's plan. He will be collecting the profit from a temporary boom, but spending it in a structurally permanent way. So when the boom ends, the revenues are gone but the spending is still in place. This leads to a structural deficit, though not, perhaps, for many years yet.Still, apart from that glaring fault, Rudd's plans for the money are reasonably responsible - cut the corporate tax rate from 30 per cent to 28 per cent, boost national superannuation savings and build new infrastructure, mainly in the resource states.So Chicken Little is hysterical. And while Kevin Rudd has every right to demand more tax from the miners, there is a better way to do it. He shouldn't really be playing Robin Hood with the money - he should be saving the windfall, not spending it.But if he must spend it, his plan is one of the more sensible ways of being irresponsible.Peter Hartcher is the political editor.