Thursday, March 22, 2018

The best case for the company tax cut isn't that good

What’s the best case for a cut in the company tax rate? It’s that we’ll be better off and earn higher wages, eventually.

The modelling published by the Treasury looks at what will happen in the long term, after the company tax rate has inched down from 30 to 25 per cent and everything has settled. That could be in 10 years' time, or it could be in 20.

It produces a one-off change, rather than an annual change. So, in the modelling first published by the Treasury after-tax wages would eventually be 0.43 per cent higher than they would have been. With wage rates at present growing by 2 per cent a year, it’s four months' worth of wage increases, delivered well into the future.

That’s not to say it’s not worth having. It is to say that it would be worth being patient, and the eventual reward would be low by the standards of what happens every year.

The modeller who prepared those projections for the Treasury in 2016 has just updated them to take account of new data. If the company tax cuts are funded by bracket creep (he has also modelled funding them by other means including a lump sum tax, and increase in the GST and cutting government spending) the eventual boost to after-tax wages would become 0.29 per cent rather than 0.43 per cent: about two months' worth of wage growth rather than four. Its a pay rise delivered two months earlier.

The boost to gross domestic product is similarly slight, given the long lead-up. Eventually, after 10 to 20 years, GDP would be 0.79 per cent higher than it would have been according to the original modelling, now 0.72 per cent.

That’s about three months' worth of GDP growth. Whatever GDP was going to reach in 2030, it’ll get there three months earlier with a company tax cut, according to the modelling.

Employment, which wasn’t going to grow much as a result of the company tax cut in the first lot of modelling, will now slip somewhat as a result of the tax switch, but not enough to notice. The company tax cut was always about wage growth, not jobs growth.

And it was going make people better off. The original estimate was for a one-off gain in consumer welfare of $4.5 billion, now a lower $3.8 billion. But it would need to be shared between 24.8 million people, almost certainly more by then. That’s a one-off gain of just $150 per person – two to three months' worth of the internet – after perhaps 15 years of waiting. That’s the best case being put before the undecided senators who are asking for modelling.

Another scenario is worse. Professor Peter Swan, one of the people who can justly claim to be the father of dividend imputation, claimed on Thursday that it wouldn’t materialise. It derives from a jump in foreign investment. If it doesn’t happen, because for foreign investors the effective tax rate is already very low, the other benefits won’t flow.

Swan thinks it won’t happen, because the foreign share investors who are sensitive to tax have already found a way not to pay it. It’s easy enough to hold Australian shares, sell them before dividend time to an Australian who can make use of the tax credit offered with dividend imputation, and then buy them back for less, cutting the foreign’s effective tax paid to nearer zero than the new low US rate of 21 per cent offered by President Trump. That near-zero effective rate wouldn’t much change as a result of an Australian company tax cut, which means foreign investment wouldn't be likely to change much either.

Except for direct investment in businesses or factories started from scratch, and funded independently of the share market. A 25 per cent rather than a 30 per cent rate would help for these businesses, but they are generally not as tax sensitive as might be thought. To physically set up in Australia you need to be certain you’ve got a very good business plan, often based on your own technology or systems, like McDonald's, Aldi or Ikea, to the extent those companies pay tax. The investment proposition needs to look so compelling that tax is a second or third order issue, according to Swan.

Even if Swan is right, there might still be a small case for a company tax cut, but it needs to be set against the much bigger case for personal tax cuts. The Parliamentary Budget Office has bracket creep pushing up the average tax rate paid by middle earners from 14.9 to 18.2 per cent over the next four years. It’s a projection based on the budget’s own figures.

The mathematical truth is that every dollar that is shovelled into company tax cuts can’t be shovelled to us in tax cuts. And we’re likely to need them more.

In The Age and Sydney Morning Herald