Why does Australia attract substantial foreign investment? Broadly, because we offer better returns than similar investments overseas.
But Australia is a small country, and the pool of funds looking for good investments is vast, particularly with global interest rates so low. As a result, foreign investment into Australia can be particularly sensitive to returns.
Company tax clearly has an impact on these returns. But Australia’s company tax system is uncompetitive, and becoming more so as other countries cut their tax rates (as outlined in the research report The Case Against Tax Increases in Australia, publishing June 7). This may be one reason why non-mining investment is falling, despite the end of the mining boom.
The benefits of addressing this investment problem are shown in Treasury modelling. Lower tax equals more foreign investment; more investment means a bigger economy, which generates gains for wages, incomes and even a gain to government revenue (or a fiscal dividend), partly offsetting the costs.
Employment is missing from this list, but this is actually a result of the models assuming that there is full employment. If there is an unemployment queue, then a tax cut will provide more jobs. So write that up as an underestimate of the benefit of a tax cut.
A central part of these models is the company tax imputation system, which taxes distributed profits at an Australian shareholder’s marginal tax rate. A high, low or zero company rate makes no difference to the taxation of distributed profits. This also means the windfall gain to Australian banks from a tax cut is not large, contra the arguments of the Opposition leader.
Does this mean that the company tax rate doesn’t matter for Australian shareholders? No. Undistributed profits are affected by the company rate.
Listed companies retained about one third of profits on average from 2005 to 2015, according to the Reserve Bank, while ATO data suggests the average for all companies is about 45%. Effectively, the impact of the tax rate grows as income is retained longer.
Modelling results broadly include retained income on the cost side, but assume it away on the benefits side — so omitting another benefit of a company tax cut: increased incentives to invest out of retained income. Write that up as another underestimate, please.
Imputation generates a tax offset in Australia; there is another offset, which is for profits repatriated to the United States. For US multinationals, if tax payments in Australia are reduced, this could be fully offset by an increase in US tax.
So does this mean that US companies are indifferent to Australian tax rates? Very clearly no. Apple, Google, Uber, Microsoft and Chevron obviously care: the accusations that they avoid Australian tax are endemic, see for example the Senate Inquiry into tax avoidance.
These companies wouldn’t avoid Australian tax if it made no difference to their worldwide tax payments.
So most, if not all, US companies do feel the impact of Australian tax rates. They can postpone, almost indefinitely, the US tax offset by ensuring that Australian income is not repatriated to the US, and when they do repatriate, the offset is often not one-for-one.
Hence, the Henry Tax Review was fairly dismissive of this issue, as was a discussion in the New Zealand context by tax academic George Zodrow.
As noted earlier, the costs of a company tax cut are partly returned through higher economic growth. This fiscal dividend is also increased if the tax cut results in less tax avoidance, a likely result given the (allegedly massive) avoidance of US multinationals.
Modelling by Independent Economics has most of the fiscal dividend of a company tax cut coming from reduced tax avoidance. If this result is seen as implausible, then look to Treasury modelling: they have most of the fiscal dividend coming from growth and less than 30% (probably much less) coming from reduced tax avoidance.
Based on this Treasury modelling, the cost of the tax cut, net of the fiscal dividend, is $4.2 billion. The modelled increase in national income is about $11 billion: a benefit that is more than 2.6 times the cost. The modelled increase in GDP is $18.1 billion, more than 4.3 times the cost. Clearly a beneficial investment, particularly given that the modelling results are likely to be underestimates as argued earlier.
On this basis, a company tax cut is a particularly valuable policy for Australia’s economy — and should remain a priority.
Michael Potter is Research Fellow at the Centre for Independent Studies and author of the report The case against tax increases in Australia, to be released on Tuesday 7 June.
21 March 2017
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