Thursday, March 29, 2018

Company tax cuts: all right for some

Parliamentary debates don’t matter much any more. We were never going to get much of one if the government had submitted its company tax bill to the Senate.

It was planning to ram it through as soon as it believed it had the numbers, if necessary sitting beyond midnight on Wednesday.

But when it discovered it didn’t have the numbers, the Coalition decided not to submit the bill at all, meaning no debate, until - if and when - it gets the numbers. Then it will probably revert to Plan A - and ram it through.

Which is a pity, because a proper parliamentary debate might have teased out what would actually happen in the event that company taxes were cut.

So much of what is proposed has been modelled and examined and tried out in the United States that we’ve got a pretty good idea of what would happen, one that’s worth sharing in case the idea comes back.

Employment

Put to one side any suggestion that a cut in the rate of company tax will create jobs. And there have been many such suggestions, from the Prime Minister, the Business Council, and Finance and Treasury ministers Mathias Cormann and Scott Morrison. Their own departments’ modelling comes up with a gain in employment of just 0.1 per cent - so embarrassingly low as to be indistinguishable from a rounding error. That's if the cut is funded by either higher personal taxes through bracket creep or by cutting government spending.

The gain would be higher, but still low, if the company tax cut was funded by a Thatcher-style fixed levy imposed on households. Separate independent modelling commissioned by Treasury as a check comes up with an even lower, barely perceptible, gain of 0.04 per cent, which has since been revised down to a barely perceptible loss of 0.02 per cent.

The reason why a company tax cut would on balance destroy as many jobs as it creates lies in its chief virtue: extra foreign investment.

When foreigners invest more in their own or in another’s Australian operations, the operations will find it easier to expand, either by employing more people or by investing in more modern equipment (which will mean there is less need to employ as many people). In the modelling, the two effects roughly cancel each other out.

Investment

A company tax cut will push up after-tax returns and make propositions that were previously line-ball more attractive, but not for everyone. Australians (and also some well-advised foreigners) are already as good as exempt from company tax through the dividend imputation system. It refunds to shareholders whatever tax has been paid in the creation of dividends, making the company tax rate close to irrelevant.

But some foreigners will find investing in Australian companies or their own Australian operations more attractive. The Treasury thinks the tax cut will boost investment by an eventual 2.6 per cent, although it has been acknowledged that in the first months of Trump tax cuts this year, investment in the US went sideways rather than climb as expected. What did climb were share buybacks, which are a means by which companies distribute windfall gains to their shareholders as an alternative to ploughing them back into the business. It’s one of four options the Business Council included in a survey of its members about what they planned to do with Australian tax cuts.

Wages

If foreign owners invest more, either in more workers or in machines that require more skill to operate, they’ll have to pay higher pre-tax wages. They won't do it for some time. This  effect shouldn't be confused with any pledges made about immediate increases for public relations reasons. Post-tax wages won’t increase by as much, in part because the company tax cuts would most likely be partly or fully funded by higher personal tax rates than would otherwise be needed.

The Treasury says pre-tax wages would eventually climb an extra 1.2 per cent, and post-tax wages by a much lower 0.4 per cent. A competing analysis by Victoria University’s Janine Dixon finds that higher income taxes could eat up “most or all” of the increase in pre-tax wages.

But employers would certainly have to pay higher pre-tax wages. Not all of them would reap the benefit of the tax cut. The Council of Small Business says all but 200,000 of Australia’s 2.2 million smallest businesses use the personal rather than the company tax system. The government is offering them an improved Small Business Income Tax Offset, but the total payment under the offset is limited to $1000, meaning many will get nothing to compensate them for the eventual increase in their wage bill, unless they switch to the company tax system.

Windfall gains

Super profitable corporations such as the banks (and mining companies during booms) will enjoy windfall gains. They are already investing what they would. It’s why the Henry Tax Review, lauded by the Business Council, recommended the introduction of a special mining tax “at the same time” as the company tax cut. It’s why Britain, pointed to as an example by the Business Council, imposed an extra tax on bank profits at the same time as its company tax cuts.

They’re ideas worth considering next time around.

In The Age and Sydney Morning Herald