Penalising big companies means a bonsai economy

Do we want a bonsai economy for Australia? Everything in miniature, with growth actively discouraged. This is what many Australian politicians are apparently aiming for. Through explicit government policy, business growth is being suppressed.

Adding to the existing list of 1,001 policies discouraging business growth are the just-legislated company tax cuts, which have been restricted to small and medium enterprises — shutting out larger businesses.

There is only one substantial regulation that privileges big business: they can trade off lower penalty rates for improvements in other workplace conditions, with the agreement of unions, a flexibility that small business should also be able to access. However, in almost all other areas — such as payroll tax and land tax — regulations are a larger hit on big business.

Australia pays a hefty price for this burden on larger business. The imposition of payroll tax exclusively on larger business makes this tax one of the most inefficient taxes in Australia, according to KPMG, giving support to recent calls to reform and reduce this tax.

The stunting of business growth also means we are missing out on the strongest business performance. Pay is higher in larger businesses, and similarly almost every work condition is better at big business. This includes selection of shift, flexible work hours, and flexibility of leave. Larger businesses collaborate more and export more.

The surprise is innovation. It is largely stereotyped as coming from small start-ups, but the figures say otherwise:  73% of businesses with more than 200 employees are ‘innovation active’, in the ABS terminology, while about 37% of the smallest businesses — those with up to 4 employees — are innovation active.

This is not to denigrate small business. Running a small business is tough. Very tough. And successful larger businesses started out small at some stage. But this doesn’t negate the evidence that as small businesses grow into large ones, this leads to better performance on wages, employment conditions, exports and (particularly) innovation.

As a result, the omission of big business from corporate tax cuts is the wrong approach.

It will discourage medium-sized businesses from growing larger and send the signal that the best outcomes are to be penalised. Every time a politician wants to penalise big business they are indirectly arguing they don’t want higher wages, innovation, employment flexibility, and exports.

In addition, the largest businesses tend to be financed from international capital markets, which are the most sensitive to corporate tax rates, while Australia’s small businesses are mostly locally financed, where the imputation system means company tax — though not irrelevant — is less important. The greater use of capital in big business means a cut in the tax on capital, through company tax, will arguably provide greater benefits in larger businesses.

There have been argument that big businesses shouldn’t get the tax cut because they currently aren’t investing. And it’s true that big businesses aren’t investing enough. But neither are small ones. And that is an argument for the tax cut, not against it. One reason (among several) for the lack of investment is excessive taxes on investment. As our company tax rate is becoming less competitive, the incentives to invest are plummeting. And we are seeing the harmful impact of that today, with non-mining investment flatlining at a historically low share of the economy.

And we’ve seen those who think that a big business tax cut is a ‘gift’ to them. Yes, a tax cut generates higher returns, but we have to offer higher returns in order to attract extra investment. And any supposed windfall won’t last: the expected boost to investment from the tax cut will result in returns falling over time. In addition, the supposed windfall figures we have seen are greatly overstated as they don’t account for imputation.

It is also argued that big businesses shouldn’t get a tax cut because they supposedly have too much market power. But this is another own goal. Businesses with market power charge excessive prices, reducing sales and distorting the economy. Corporate tax worsens this distortion, provoking an even greater reduction in output or GDP. So market power enhances the case for a tax cut. This is supported by the evidence: one study found the harmful impact of corporate tax in the US is greater in more concentrated or monopolistic industries.

So far the debate over company tax has been half right: the case for a small business tax cut is understood and accepted by many. It is unfortunate that the stronger case for a big business tax reduction has not received similar support. If it doesn’t, Australia will need to get accustomed to our economy becoming more miniaturised, at great cost to us all.

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