Australia needs to change investment climate for good

Business investment in Australia is weak; built on foundations of straw. It would take a mere huff and puff from a downturn for it all to come tumbling to the ground.

Australia needs long-term structural solutions to this problem, not temporary ones. A time-limited investment tax credit — likely involving an additional and immediate tax rebate for part of the cost of new capital investment — might work as a short-term bandaid for our investment problems. However, it won’t be able to fix the weaknesses in the foundations, and will just be papering over the cracks.

We don’t need another temporary stimulus. And we’re still paying for the one we got back in 2008.

In addition, a temporary investment credit would clearly end at some point. And then we would face the same structural investment problems we face today. Treasury’s forecasts are for business investment falling to levels we haven’t seen since the middle of the 1990s recession. A temporary credit would simply postpone, not avoid, this slump.

In fact, the slump would likely be worse after the temporary credit ended, as businesses would undertake as much investment as possible before the credit’s end date. The temporary propping up of investment would actually make the foundations weaker: a solution likely worse than the problem.

We need a permanent solution to weak investment — a weakness seen in many other forecasts, including those by the OECD and IMF. We can’t assume that something will magically turn up to strengthen the foundations. And Australia’s flatlining investment can’t just be excused away as a universal problem affecting all developed countries, as our levels, excluding mining, have declined while investment has expanded in most other OECD countries since the GFC.

We should also acknowledge Australia’s already weak forecasts for investment are based on future foundations as flimsy as our current ones. What if China’s growth falters? This would cause significant unemployment, declines in wealth and a big hit to the government budget, according to recent estimates. And then there’s the fragility caused by high house prices and household debt levels.

Unfortunately, there is little potential for a permanent investment credit to fix the foundations, as the credit itself has many inherent problems. If the credit applies only to capital expenditure, it will generally exclude investment in goodwill and some other intangibles. This is not a minor problem: goodwill covers brand names, and good customer and employee relations. For example: buying a computer will earn the credit, but investing in better customer relations may not — and Australia’s (albeit weak) investment is increasingly going into intangibles.

A tax credit could be expanded to include these omitted investments, but this would come at the cost of increasing complexity, higher revenue cost, and more tax avoidance opportunities. The revenue impact may end up being similar to the impact of a company tax cut.

In addition, a fixed percentage credit would effectively give a greater subsidy to short-lived assets, such as computers, than long-lived assets, like bridges, which seems illogical.

And in the long term, when old assets have fully depreciated, businesses will have made every subsequent investment under the tax credit. Therefore, an investment credit would be nearly identical to a lower company tax rate, just with a much more complex tax system. The headline tax rate would also remain high, complicating the message of selling Australia as an investment destination.

It also isn’t clear how an investment credit would work with the newly legislated two-tier company tax rate, which applies a higher tax rate on big business — an unfortunate policy development. Would the credit apply to all business, so small business essentially gets a double incentive for investment? Or will it only apply to big business, so small business gets a company tax cut but big business gets an investment credit? Or would the credit replace the tax cut for small business? None of these options are sensible foundations for investment growth.

Instead, a company tax cut for all business still remains a better solution to Australia’s structural investment problems. Perhaps a faster cut, given our looming investment problems, but a cut nonetheless. Many other policies would help bolster investment; former Productivity Commission Chair Gary Bank’s ‘to-do’ list of policies is a great place to look.

But what Australia shouldn’t do is assume the foundations of business investment are strong when a chilling breeze could cause them to topple.

Michael Potter is a Research Fellow in the Economics Program at the Centre for Independent Studies and author of the article The looming crisis in business investment in the Summer 2016 edition of Policy magazine and the CIS research report Fix it or fail: Why we must cut company tax now.