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)