Saturday, February 28, 2009

TAXING TIMES: Why Henry will cut the corporate tax rate

It's on. The Henry Review is set to recommend a lower corporate tax rate, unless there's a groundswell of complaints as well as good arguments raised against it.

That was the Treasury Secretary's purpose is taking the idea public in a speech Monday night and in announcing a roadshow of "town hall" style meetings that will travel to centres including Melbourne and Geelong next month.

Ken Henry isn't running with the idea on his own. His boss Wayne Swan said it had much to commend it when he spoke at a different tax conference on Wednesday.

An organiser of that conference, the Australian Council of Trades Unions, muttered darkly that it was the sort of idea to be expected from a panel on which business was represented, but workers and Australians on welfare were not.

But that misunderstands the genesis of Ken Henry's idea...

Australia's self-claimed "largest and most representative organisation" didn't even ask for a lower corporate tax rate in its submission to the Henry Review. The Chamber of Commerce and Industry instead asked the review to "gradually reduce the top marginal personal tax rate to the same level as the corporate tax rate," a stance that raises questions about who the Chamber actually represents.

Its argument was that "higher income earners are more responsive to taxes than lower income earners," a questionable assertion for which it offered no supporting evidence.

By contrast the evidence that foreign capital is responsive to a lower corporate tax rates is overwhelming.

Cutting Australia's headline corporate tax rate from 30 per cent to 19 per cent could be funded by abolishing Australia's almost unique system of dividend imputation. Estimates before the Henry Review suggest such a cut would boost foreign investment in Australia by one quarter.

This isn't the sort of dodgy estimate made the Ralph Review in the late 1990s that reported that halving Australia's headline rate of capital gains tax would be self-funding and would lead to a surge in investment in "innovative, high-growth companies". (What it lead to was a surge in negative gearing and real estate prices.)

The wise heads in the Treasury were locked out of that review, precisely because the then Treasurer Peter Costello wanted it to recommend a cut in Australia's capital gains tax rate. He even put it in the terms of reference.

The Treasury's thinking about that idea is driving its thinking about this one.

Dr Henry said Monday that if markets were efficient, any change in the taxation of Australian income from shares, "primarily through the taxation of dividends and capital gains at the personal level" would affect the total level of capital invested in Australia not at all.

That's right. In terms of pure theory Australia will get (got) next to no benefit from halving its headline rate of capital gains tax back in 1999, and no benefit from the up to $20 billion dollars it spends each year handing locals their much-loved dividend imputation cheques.

The locals who get the concessions certainly benefit - often handsomely - but to the extent that they invest in Australian companies as a result, they merely displace investment by foreigners.

But contrast cutting company tax will lift the profitability of Australian companies and genuinely suck in foreign investment, boosting national income and real wages as a result.

Dr Henry was careful to point out that these arguments don't apply to Australian small and medium-sized private companies which don't get capital from overseas in any event.

He seems happy for them to continue to face a 30 per cent tax rate and retain access to dividend imputation if they want.

See Also: TAXING TIMES - Could Henry be thinking really big? November 29, 2008

Tax revenue to GDP over time - from Budget - (click to enlarge)

Tax revenue to GDP over time - from November update - (click to enlarge)


Anonymous said...

Forward Ho! Insightful question raised by your article:
Chamber of Commerce represents who?

Tax breaks for the well off again. No surprise there. The trickle down economic theory is alive and kicking. Give the wealthy another tax break and they will collectively save the country. Has not worked yet, so it is obvious (using childish logic) that we have not cut taxes enough. To the trough, forward ho!

Another question I always seem to have: How does an economy run with ever decreasing tax revenue? What is the long term plan for a productive and stable society. I don’t get it.

Peter Martin said...

The TaxWatch paper used for the conference (not yet on the web) says:

Australian tax revenue has risen from an average of about 28% during the 1980s to about 30% during the last ten years. This increase is marginally less than the corresponding increase in the OECD average.

But it has recently been slipping back.

I have posed the budget table under my post to give you an idea.

Anonymous said...

Interesting article. Very enlightening about the Chamber of Commerce. One would have thought they'd be asking for a lower company tax rate. Perhaps they just represent the executives in Big Business.

I assume that budget table you provided is before they revised the tax revenue downwards in the last few months and implemented the two stimulus packages(?)


Peter Martin said...

It is Al, I should be able to get an updated one. I'll post that below it.

Nicholas Gruen said...

Yes, nice way of putting it re the Chamber of Commerce. Alignment might be called the New Zealand option - they're very hot to trot on alignment and reducing the top marginal rate there - which of course constrains the extent to which you can offer the tax cuts with the biggest efficiency gain - company tax cuts. Poor old NZ doesn't even know how to play its strongest card - the arguments that favour swapping dividend imputation for lower company tax are even stronger in NZ than they are in Australia - because a large part of the argument is a function of the size of the country. It's no accident that Ireland pioneered the yawning gap between company and the top personal rate. And while they're in a hell of a mess right now, even after the crisis fades, they will have gone from one of the poorest to one of the richest countries in Europe as the exemplar of what a low company tax rate can do.

Anonymous said...

Agreed NG, Ireland might be in a mess as its economy implodes on the heels of the collapse of its housing bubble. But as for being an exemplar of what a low company tax rate can do – there are two schools of thought on that matter.

The Mood. Housing Slump Hits Northern Ireland Economy Harder Than Bombs: Kingham has fired nine of his 12 workers as house prices plunge and sales dry up. “You can take me back to the days of the bombings,'' says Kingham, who has run A1 for 40 years. “Business was better then.” (Jul 2008) ”

As for low company rates you mention for Ireland, they may soon be a thing of the past or at least offset by increases in other taxes.

On 21Feb 2009, 120,000 protesters marched in support of a 10 Point Solidarity Plan designed by the Irish Congress of Trade Unions. Titled ‘There is a Better, Fairer Way’, the plan is aimed at National Recovery in the face of the GFC.

Here are number of points.

Note in particular the Public Service ‘Pension Levy’. My prediction is that this one will appear out of thin air in Australia after the QLD elections later this month. After all it is a global response, we will not be immune. All funds will be taxed.

Banking System / Public Interest: Bank Recap involves handing over €7 B (public money) from Pension Reserve Fund, to the same people who presided over the collapse. Their refusal to forego enormous personal salaries and bonuses speaks volumes about their contempt for the taxpayer.

Fairness & Taxation: capital and labour - must be taxed the same; Tax shelters without a proven economic gain should be abolished; property tax to apply to property other than principal private residence; levy on high earners (above €100k); New rate of income tax at 48 percent for high income earners;

Restoring Consumer Confidence: The property boom encouraged unsustainable levels of credit and spending. The failed policies of letting the wealthy off the hook, while forcing working families pay for the crisis, has already led to a slump in consumption unparalleled elsewhere in Europe.

Public Service ‘Pension Levy’: Financial Emergency Measures in the Public Interest Bill 2009 the Irish government intends to introduce an average pension levy of 7.5% on civil servants earning €50,000.

Pensions: Private sector pensions are in crisis and there is increasing doubt about the long term viability of many funds.

National Recovery Bond NRB: With the cost of this borrowing increasing, a domestic NRB could save the exchequer a lot of money. It could also be targeted at specific sectors such as school building or public transport, so people could see tangible gains. END

Would be nice for Ireland to return to some kind of intrinsically fair society rather than what it has been turned into by myopic policy makers and a corrupted banking/real estate industry. And not only Ireland.

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