CANBERRA (Reuters) - Australian mining shares tumbled on Monday after the government slapped a 40 percent tax on mining profits to fund a boost to workers’ incomes in an election year, sparking warnings that huge new investments could be lost.

Shares in mining giants Rio Tinto and BHP Billiton fell sharply on the new tax, which Canberra expects to raise about A$12 billion ($11 billion) in its first two years and help fund a rise in retirement incomes.

The center-left government, which has made the tax a centerpiece of its re-election agenda this year, sought to defend the proposal against miners’ assertions that it would force them to review A$100 billion in projects in one region alone.

Prime Minister Kevin Rudd, in a pitch likely to strike a chord with voters, said Australians had been shortchanged during a 10-year resources boom in which profits soared by A$80 billion, while only A$9 billion extra flowed into national coffers.

“BHP is 40 percent foreign owned, Rio Tinto is more than 70 percent foreign owned. That means these massively increased profits ... built on Australian resources, are mostly in fact going overseas,” Rudd told Australian radio.

The tax, to apply from 2012, sent a chill through mining sector mergers, too, with shares in takeover target Macarthur Coal dropping 9.5 percent, suggesting U.S. bidder Peabody Energy might pull its $3.7 billion bid.

Under the tax reform package unveiled on Sunday, workers will get effective wage rises as the new mining tax will help pay for a cut in corporate tax and a requirement for employers to raise the amount they pay into workers’ pension funds.

Western Australia, the largest mining state, warned of investment and job losses from the tax, without quantifying them, while BHP Billiton and Rio Tinto and a third global miner, Xstrata, said investment could be jeopardized.

Investors sold off mining stocks, sending the sector sub-index down 2.5 percent in a wider market off just 0.5 percent. The only mining stocks to gain were those working offshore, with shares in PanAust, which focuses on Southeast Asia, up 1 percent in a sea of red.

“There’ll be a huge number of investors in Australian resource companies who will vomit into their cornflakes when they read this,” said Richard Morrow, stockbroking director at E.L. & C. Baillieu.

GOVT, MINERS DIG IN

The government has picked a fight with the country’s most important single industry, which accounts for about half of exports, in a gamble that taking money from rich miners and using it to boost workers’ pension funds will prove a vote-winner.

Rudd faces elections in the second half of 2010, most likely in October. He is ahead in opinion polls and tracking to win a second term in office.

The reforms also included a cut in the company tax rate to 28 percent from 30 percent, in addition to the gradual increase in compulsory employer contributions to pension funds to 12 percent from 9 percent over the next decade.

All the changes depend on the mining tax going ahead, and the government faces a difficult fight on two fronts, with upper house opponents also ramping up their attacks on the new resources tax, pointing to eventual rejection in the Senate.

But the Senate, in which the government is 7 votes shy of a majority, will also change shape in the election, making the future of the tax bills uncertain. The next Senate is expected to have fewer conservatives, but more crossbench greens.

While analysts predicted the tax would be publicly popular and many callers to radio stations on Monday backed the move, a key independent senator said it did not do enough for families.

BHP, RIO LEFT FUMING

The hugely profitable iron ore industry, dominated by Rio Tinto and BHP Billiton, is seen as most vulnerable to the new tax. BHP Billiton estimates its local tax rate will climb to around 57 percent from 43 percent.

Rio Tinto, the second-largest iron ore miner behind Brazil’s Vale and ahead of BHP in third, said new tax sent a bad signal to investors. UK-based miner Xstrata agreed.

The only clear winners from Sunday’s tax reform package were those benefiting from the boost to Australia’s A$1.2 trillion retirement savings pool, the world’s fourth largest.

Shares in fund managers AXA Asia Pacific and AMP firmed, as did the major banks, which stand to benefit from the pension and other lesser reforms.

(Additional reporting by James Grubel in CANBERRA and Joseph Chaney in HONG KONG; Editing by Ed Davies and Ian Geoghegan)