How maths killed the company tax cut

The company tax cut is dead. Maths killed it, last week.

It happened with the release of an innocuous-looking report from the Parliamentary Budget Office entitled Changes in average personal income tax rates: distributional impacts.

Those changes were baked into, but not spelled out in, the May budget.

They are needed for it to whirr back into surplus by 2020-21 as promised.

They come about because, aside from boosting the Medicare levy to help pay for the National Disability Insurance Scheme, the budget proposes to do nothing about the income tax scales whatsoever. Nothing. For four years. That's how it whirrs back into surplus.

Normally budgets cut income tax every few years. They have to, because otherwise wage increases would push more and more of our incomes into higher tax brackets. The misleading term for what happens is "bracket creep". But it happens whether or not we are pushed into a higher tax bracket. Any increase in wages, even within a bracket, pushes more of our income into our highest brackets, pushing up the total amount of tax we pay and pushing up our total tax rate.

Here's how it would work if you were on $50,000. If your pay climbed 3 per cent to $51,500 you wouldn't change brackets but your tax bill would climb from $7797 to $8284. More tax would be taken out at 32.5 cents in the dollar and proportionately less at 19 cents. Your average rate would climb from to 15.6 to 16.1 per cent.

To prevent this sort of thing happening, budgets repeatedly adjust income tax scales. Since the turn of this century, budgets have cut tax rates in 2003, 2004, 2005, 2006, 2007, 2008, 2009, 2010, 2012 and 2016. A gap of four years or more without cuts, as is baked into the 2017 budget, is unusual.

All the Parliamentary Budget Office did was calculate what the budget projections would mean for various types of taxpayers.

For middle earners (those in the middle 20 per cent) they will mean an extraordinary jump in overall tax payments from 14.9 to 18.2 per cent. Only 0.5 points of the increase would be due to the higher Medicare Levy.

For earners one rung up (the next 20 per cent) they will mean a jump in tax paid from 21.9 to 24.1 per cent. For those at the very top they will mean a jump from 32 to 33.9 per cent.

One rung below the middle (a rung centred around $28,000) the tax take will jump from 5.5 to 8 per cent. Only at the very bottom (a rung centred around $8000) would there be little change. That's because most of the bottom rung would remain below the tax-free threshold.

The figures are projections out to 2021-22. It's true that we might get extra tax cuts not accounted for in the budget projections. But if we do, there won't be a budget surplus, not without an unexpected mining boom-style windfall or something else to fund them.

And there will have to be. A ramp up in the tax taken from middle Australia from 14.9 per cent to 18.2 per cent is unthinkable.

The only obvious place to grab the kind of money that will be needed is a program that hasn't yet become law.

Only half of the government's $50 billion program of company tax cuts has become law. The Senate passed $24 billion of it. Company tax is set to fall from 30 per cent to 25 per cent for small and medium size businesses, but not for big ones.

Forced to choose between finishing the job in order to help big business and cutting tax rates for individuals in order to stave off implausible bracket creep, there's no choice.

Businesses don't suffer bracket creep. Individuals do. Businesses don't vote. Individuals do.

And despite all the talk about how uncompetitive Australia's company tax rate is, or would become if Donald Trump succeeded in convincing Congress to cut the US tax rate to 20 per cent (the Business Council put out another brochure this week), and despite all the talk about how dynamic Australia would become if the company tax rate was cut to 25 per cent, the truth is the cut wouldn't pay for itself. The Treasury says so. The cost, to be paid for somehow, would be $8 billion per year.

It might well be that wages don't increase by anything like as much as is forecast and that bracket creep is less severe. But that would just create another set of problems. The government would fall well short of its targeted surplus and be under further pressure to find money from somewhere, most likely the yet-to-be legislated tax cuts.

The most important insight from economics is that actions have costs, often opportunity costs. Richard Thaler won a Nobel Prize last week in part for pointing out how little that is understood. There may well be great benefits from cutting the company tax rate. But there would also be great costs. One of them would be the lost opportunity to support middle earners, who'll need it.

In The Age and Sydney Morning Herald

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True. Treasury thinks cutting company tax helps workers

"Treasury believes if you reduce company tax, you increase pay, you increase GDP and you increase employment."

Tony Abbott, press conference Wednesday August 7

To hear Tony Abbott speak, you would think a cut in the company tax rate was good for workers. He is promising to cut the rate from 30 per cent to 28.5 per cent per cent in mid 2015.

“Go back and look at the papers that the government released as part of the Henry tax review,” he said on Wednesday. “And you will see that Treasury believes if you reduce company tax, you increase pay, you increase GDP and you increase employment”

Supporting evidence

The Treasury itself has been silent on the question. But at the 2011 business tax summit its former head Ken Henry left those present in no doubt about his toughts.

At issue was the “incidence” of company tax. Did it fall on the owners of the companies or on their workers.

“In the case of a relatively small, open economy like ours, there is simply no debate in the academic community,” he said. “There is a strong consensus among tax academics that the incidence of the tax falls predominantly on labour.”

It’s a hard proposition to get your head around. The argument is that businesses have a choice about where they invest. The lower Australia’s company tax rate, the more likely it is that they will invest here. Those arriving or staying will employ workers and spend money putting up buildings and buying equipment, each dollar of which will make the workers they do employ more valuable, and more worth paying higher wages to keep.

But does it stack up?

The studies cited in the the Henry tax report do find such an effect, but it is far from complete. In the short term a move in the company tax rate appears to move wages little. In the longer term a 10 per cent adjustment in the company tax rate appears to move wages 7 per cent.

Abbott pointed to modelling prepared for the government which finds that “every 1 per cent cut in the company tax will boost jobs by about 10,000”.

The modelling itself refers to it less grandly: “A small increase in labour supply of around 0.1 per cent”.

But on receiving the Henry report Kevin Rudd was convinced. He promised to cut the company tax rate to 28 per cent, only to have the Coalition block the cut in the Senate because it was to be funded by the mining tax.

Finding

Abbott is probably right about what the Treasury thinks. Whether the likely gains in wages and jobs are worth the expense is another question.

Politifact rates the claim ‘true’.

In Politifact and The Sydney Morning Herald

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MYEFO. Expect more cuts

It's usually the first week in November

A fresh collapse in company tax collections has increased pressure on Treasurer Wayne Swan to make cuts to preserve the budget surplus in the mid-year update due in November.

The final budget outcome for 2011-12 was a deficit of $43.7 billion, close to the May budget forecast of $44.4 billion.

But Mr Swan said the figure masked “a hefty fall of $876 million in company tax receipts”, due largely to lower corporate profits.

The drop means the government took in the best part of $1 billion less in company tax in May and June than it expected in May. Unless things pick up it suggests that each month will bring in much less company tax than budgeted for in May, destroying the paper-thin forecast surplus of $1.5 billion.

It suggests the profit-based minerals tax which began in July will also fall short of expectations.

“This will hit government revenues significantly, which makes it harder to deliver a budget surplus,” Mr Swan said. “It means we will have to find more savings. But we have a proven track record of finding responsible and measured savings which accord with Labor values - and we’ll do that again.”

“We've had big revenue writedowns and of course there are challenges to the revenues, but we will absolutely stick with our fiscal discipline.”

Finance Minister Penny Wong said Labor’s approach would be very different to that demonstrated by the Coalition in the Treasurer's home state of Queensland...

“There the Premier told the public service they had nothing to fear, and then promptly sacked 14,000 people. We don't resile from the fact you have to make difficult decisions, but we certainly take a very different approach to the one that's been demonstrated in the Coalition states and the one which Joe Hockey brags about being the one he wants to implement."

Shadow Treasurer Joe Hockey said the 2011-12 deficit was double the $27 billion forecast when that budget was delivered in May 2011. “They are patting themselves on the back because they got $44 billion. I mean this is a joke, this is a serious joke,’ he told reporters in Sydney.

Mr Hockey said the government had fudged the numbers by making the 2011-12 deficit look bigger in order to make a 2012-13 surplus look possible, but said the deception would become harder in the mid-year budget update.

“Sooner or later the rubber hits the roads when it comes to the numbers. And Labor has to account for its $120 billion of new spending promises on top of their four record deficits already,” he said.

Mr Swan would not be drawn on whether the mid-year review would be brought forward from early November, when it is traditionally delivered six months after the May budget.

“In the last three months of the year which is when it normally is,” he told a Canberra press conference, giving himself licence to deliver the update as soon as next week.

Asked whether the economy could withstand another bout of budget tightening in order deliver the surplus he said he would do what he always did - “put in place the appropriate settings for the time”.

In today's Age


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More tax, new taxes - Treasury prepares the way

Treasury boss Martin Parkinson has raised the prospect of new taxes on presently-untaxed activities, saying the days of big budget surpluses are gone forever.

In a sombre assessment of Australia’s tax position - the second in a fortnight from a senior Treasury official - Dr Parkinson told a corporate audience in Brisbane Australia would soon be unable to meet demands for new government spending from its existing taxes.

“These are expected to deliver less revenue as a proportion of GDP, given capital and labour will become more mobile and the costs of securing that revenue will increase,” he told the Committee for the Economic Development of Australia.

“In addition, greater use of the tax bases we currently rely most heavily on - personal and corporate income tax - can adversely impact on productivity, participation and investment if not designed well.”

The Treasury Secretary's warning against attempting to squeeze more out of existing taxes did not extend the goods and services tax.

Earlier this month Rob Heferen, head of Treasury’s revenue group, told a Canberra audience Australia undertaxed the consumption of goods and services compared to other developed nations but said “a sustainable rebalancing” would need to gain community acceptance.

Dr Parkinson told CEDA in Brisbane that “with hindsight” it was apparent the Howard government’s run of surpluses during the mid-2000s were the result of “a temporary bubble”...

Australia’s terms of trade have since peaked and economic activity is shifting into forms that can not be as easily taxed.

“The takeout message is that the days of large surpluses being delivered by buoyant tax receipts are behind us,” he said.

“While economic activity rebounded quite quickly after the global financial crisis, tax receipts are expected to remain substantially lower - around $20 billion per annum lower at the Commonwealth level alone - than pre-crisis projections.”

This was happening at a time when rising incomes propelled Australians to demand more of government. So called “superior goods” such as health, disability care and education were rising were becoming more important. The aging of the population would only exacerbate the pressures.

“We will not be able to meet these demands for new spending by increasing the efficiency and effectiveness of existing government spending alone, although this is important in its own right,” Dr Parkinson said. “Nor can we rely solely on our existing tax bases.”

“What will be required to meet the community's demand for new spending will be more revenue or significant savings in other areas.”

“In short, the public will need to make thoughtful decisions about what it wants government to provide, and how it expects these things will be provided.”

Dr Parkinson said his own department was already attempting to do more with less.

“As with a number of other agencies, we have already started the process of downsizing. Indeed, we are reducing staff numbers by over 20 per cent by mid 2014, a reduction that some business stakeholders are already noticing,” he said.

Treasury has commissioned a panel of outside experts to review the quality of its macroeconomic and revenue forecasts.

In today's Sydney Morning Herald and Age


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Olympic Dam. Why will BHP be charged so little?

Let's start with the ANU's Paul Cleary, author of the just-released Mine-Field - The Dark Side of Australia's Resources Rush

Here he is in The Australian:

"This deal is a monumental example of state government incompetence when it comes to acting as custodian of the nation's mineral wealth.

South Australia has agreed to a regime based solely on percentages and even cents per tonne of the mine's production. Mike Rann, who stands down today as Premier, has done South Australians a disservice that will cost them dearly for almost half a century.

The then premier Mike Rann and his administration should know full well that these royalties fail to capture a fair share of mining profits. This has been in the economic literature since the 1970s and was made more prominent by the Henry review. Yet the deal does not contain a single element of profits-based taxation.

The case for such measures is all the more compelling given that the mineral resources rent tax will not tax the millions of tonnes of copper, uranium, silver and gold the mine will be produce under the 45-year agreement, because the MRRT only applies to coal and iron ore.

Given that this is an agreement negotiated in the 21st century, it beggars belief the state could have agreed to a regime based exclusively on production-based royalties that hark back to medieval times.

But none of these ideas penetrated the thinking of the South Australian government when it negotiated its 45-year agreement for BHP's $30 billion expansion.

The three-tier regime involves 3.5 per cent for refined mineral products, meaning copper and gold, and 5 per cent for uranium oxide and uranium-bearing copper concentrates.

There's also 35c per tonne on extractive minerals sold to a third party, but this is not even indexed for inflation, so its value will diminish over the life of the agreement."


They were points he was making on ABC Adelaide 891 Tuesday when the man who negotiated the deal, former state Treasurer Kevin Foley rang in:

Play or CLICK THEN CLICK AGAIN to download mp3

Foley: “You don’t even understand the state-based royalty system. A royalty is a tax on the quantity of the mineral taken from a mine. It’s not a tax in a, as a profit-based tax. That can only be levied by the Commonwealth government.

Cleary: The previous government...

Foley: No that’s just not true, you don’t know what you are talking about. A royalty is what a state government can apply, a tax based on profit can only be applied by the Commonwealth government.

Cleary: That is not the case.

Foley: It is true. We don’t have access to the company profitability, it is only held by the Australian Tax Office and the national government. They are the only body by which a profits-based tax can be applied, so you don’t even know what you are talking about."

One of them had to be wrong, either Cleary or Foley.

It was Foley, the man who negotiated the Olympic Dam deal, as I outlined on Wednesday.

South Australia is perfectly capable of imposing a profits-based royalty but decided not to.

But listen in, to a conversation between Foley and me that actually gets somewhere...


18 minutes, play or CLICK THEN CLICK AGAIN to download mp3




To recap:

Our system of distributing money between the states is so warped that states that impose high royalties get almost all of their excess earnings taken away from them, and states that impose profits-based royalties (which by definition earn little money in the early years allowing projects to go ahead that otherwise would not) get penalised.

Is there a better way?

You bet.

Ross Garnaut is on the case:

Ross Garnaut, Submission to GST Review, July 2012



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You want to cut the company tax rate? It'll cost you bigtime

That's what the Treasurer's Business Tax Working Group concluded...

...which, as it happens is NOT what was previewed in The Australian on Thursday.

Never mind.

Here's my preview from this morning:

NO EASY ANSWERS

As the business tax working group sees it

. Cutting the corporate tax rate is expensive, up to $2 billion per percentage point

. Axing accelerated depreciation concessions would save just over $1 billion

. Axing R&D tax concessions would also save just over $1 billion

. But there are good reasons to keep some R&D tax concession

. Also in the spotlight are thin capitalisation rules, primary producer tax concessions and film tax incentives

. Giving firms an allowance for corporate equity as proposed by the Treasurer would be too difficult without lifting the 30 per cent tax rate

Set up amid optimism about finding ways to cut Australia’s 30 per cent corporate tax rate almost a year ago the Treasurer’s business tax working group will report this week the task is harder than it seems.

Contrary to some newspaper reports, the discussion paper to be released early in the week will contain no recommendations.

Nor will it identify a target rate of company tax the government should aim for.

At the heart of the paper prepared by panel of business, union and academics chaired by former KPMG partner Chris Jordan is a brutal equation - for every 1 percentage point the government cuts the corporate tax rate, it loses the best part of $2 billion. Although some of those losses would be recouped over time by greater foreign investment, for a corporate tax cut to be “revenue neutral” as demanded by the Treasurer in his terms of reference it would have to be funded by big cuts in corporate tax breaks.

The two biggest tax breaks identified by the working group are those relating to accelerated depreciation and research and development. If eliminated each would buy just over $1 billion of room to cut the corporate tax rate, not enough by itself to cut it one complete percentage point.

Cutting R&D tax concessions is particularly difficult because there are good public policy reasons to encourage research and development. The discussion paper explores the possibility of eliminating the concessions and funding R&D directly from the public purse or cutting the the size of the concession.

The group is unsympathetic to accelerated depreciation rules, finding the instant write-offs for explorers particularly hard to justify given the working life of mines...

Other concessions attracting the group’s attention apply to primary producers, multinationals taking advantage of thin capitalisation rules, and film finance.

The group is using as reference points the 1999 Ralph Review of business taxation commissioned by then Treasurer Peter Costello and the Treasury’s Tax Expenditure Statements released at the end of each year.

The expenditure statement acts as a sort of ‘shopping list’ of concessions that could be used to pay for a lower corporate tax rate, listing 113 business tax breaks estimated to cost a total $7.3 billion in 2011-12. Many of these tax breaks are both small and popular, meaning tackling them would involve a disproportionate amount of political pain given the savings on offer.

Treasurer Wayne Swan’s terms of reference require “off-setting budget savings,” denying the group the opportunity to argue that over time a cut in the 30 per cent company tax rate would be partly self-funding as investment was drawn to Australia.

The terms of reference have also effectively ruled out the introduction of a so-called Allowance for Corporate Equity that offered a tax deduction for a normal return on equity, cutting the tax rate faced by most firms to zero. It could only be funded by a much higher headline rate of tax on high profit firms in sectors such as mining and finance sectors. An appendix to this week’s discussion paper expresses little enthusiasm for the idea pointing to practical problems and saying it would have to be part of a much broader reform of the tax system.

The working group is due to deliver its final report in December.

In today's Sydney Morning Herald and Age


Find the report itself at: Business Tax Working Group website

Discussion Paper August 2012



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Like to look inside the ATO's risk engine?

The “risk engine” used by the Tax Office to single out Australians for audits may itself face an audit as part of the new work program being developed by the complaints watchdog.

Inspector-General of Taxation Ali Noroozi puts the risk engine at the top of a list of eleven priorities for investigation in the year ahead, along with what seems to be a systematic bias in the delay of tax returns, the ATO’s choice of penalties and the distance it keeps from the Australian Valuers office.

“The Tax Office no longer does random audits,” Mr Noroozi told BusinessDay. “They use what they call a risk-differentiated model, focusing audits on what they think are the riskiest clients.”

“We’ve had a good few complaints from people who think they are being targeted when they should not be. These complaints are also coming to other professional bodies.”

“At the very least an inquiry would shed light into how this risk engine works, so that people have more confidence in it. At the moment people see it a black box.”

Under the legislation setting up his office Mr Noroozi has the power to decide which matters of tax administration he will investigate without reference to the government...

“Delayed tax returns may be related. The new Tax Office computer system may be picking up more returns for closer examination and a delay. This could be quite valid, but we would like to find out what is going on.”

Mr Noroozi is also considering investigating the ATO’s administration of tax penalties, an area in which he says it has considerable discretion.

“The penalties for false statements vary by criteria such as whether you were fraudulent, whether you were reckless, whether you had a reasonably arguable position. People are saying it is sometimes used as a bargaining chip. At the initial meeting with the Tax Office they are told it has discretion. We need to find out what’s going on.”

The draft work program would also shine a light on the ATO’s relationship with the Australian Valuation Office.

“There are many things in the Tax Act that require market values - transfer pricing is one,” Mr Noroozi said. “The Valuation Office appears to be not wholly removed from the ATO. One of the things people raise is its relative independence.”

The Inspector-General has already inquired into the ATO’s compliance approach to so-called larger small and medium enterprises and high wealth individuals, making more than 40 recommendations. His draft work program would set up the same sort of inquiry for micro enterprises and individuals.

"I really want feedback on these ideas,” he told BusinessDay. “I want my Work Program to target the areas that provide the greatest opportunity to improve tax administration.”

“My legislation permits me unrestricted access to the ATO’s internal system, records and personnel. I can navigate the system, address information imbalances, report on the issues and make recommendations to improve the system.”

Mr Noroozi is seeking submissions on his draft work program by September 28.

In today's BusinessDay Online


Ideas for Ali Noroozi's work program:

. the ATO’s Risk Engine;

. delayed income tax refunds;

. the ATO’s compliance approach to the micro enterprises and individuals;

. the ATO’s administration of penalties;

. the ATO’s interactions with the Australian Valuation Office;

. the ATO’s use of client feedback questionnaires;

. the ATO’s administration of the general anti-avoidance provisions;

. the ATO compliance approach to transfer pricing;

. ATO services and support for tax practitioners;

. the ATO’s Test Case Litigation Program; and

. Project Wickenby.



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Business lobby on another planet. Smith on tax and investment

A key member of the Henry Tax Review has rounded on business lobbyists calling for a cut in the company tax rate saying the government was right not to cut it and it’s wrong to say the review wanted it to.

“I advocated a cut in the company tax rate when I signed the Henry report,” former Treasury deputy secretary Greg Smith told a Committee for the Economic Development of Australia function in Canberra.

“But that was - from our point of view - a ten or a twenty year reform. We certainly didn’t see it as an immediate thing. And I certainly also imagined it would only occur in the context of a significant increase in rent taxes.”

“We’re not going to get that. With tax reform you’ve got to look at the whole, and once you fail on one front what’s desirable and the timing of what you do on another front has to change. I think the government is right to go slow on company tax.”

Mr Smith was particularly scathing of calls by the Business Council and others for even more investment in Australia.

“We already have the highest investment rate in the developed world. The idea that we can increase it in the next five years is ridiculous, completely absurd".

“We can try to restructure it and we should. We do infrastructure in the wrong places, we do the wrong things. But we are not going to get a higher share of GDP higher than 29 to 30 per cent without enormous trouble.”

"Already it's an enormous stress on our economy... It is leadign to a massive switch in the utilisation of rents from profit earners to workers in those industries."

“If you tried to go to 35 to 40 per cent of GDP all that would happen is that you would see interest rates and other adjustments creating further problems in order to offset the inflationary and other and marcoreconomic problems that such an investment level would bring."

Australia’s biggest problem was changing demography, not lack of investment. Life expectancy was advancing a year every decade and yet the super system encouraged retirement at 60.

“Now I’ve been personally associated with creating the superannuation industry in this country,” Mr Smith told the conference, referring to his role as an advisor to Treasurer Paul Keating in the 1980s. “I don’t feel very proud about that. I think it’s an achievement yes, but it’s not the answer.”

“We cannot have retirement going for 25, 30 years. That’s why the Henry Review wanted to get the preservation age of super up from 60.”

“Super is basically an early retirement system. It is not dealing with the very high costs of aged care and health in late retirement.”

The planned increase in compulsory super contributions was set to cost more in tax concessions than it would save by taking retirees off the pension.

In today's Sydney Morning Herald and Age


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Lift the GST. The arguments are mounting

Me on Adelaide ABC 891, Wednesday May 16

16 minutes, play or CLICK THEN CLICK AGAIN to download mp3





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Claw back tax you've already paid? Now that's a refund.

The words “tax refund” will have a more concrete meaning from mid-2013 when for the first time Australian companies will not only be able to claim back tax they have overpaid in any financial year but also tax they have actually paid in the previous two years.

The “loss carry-back” provision to be announced by Treasurer Swan on budget night will bring Australia into line with Canada, the United States and the United Kingdom, all of which allow the reclaiming of tax actually paid in at least the previous year.

Recommended by the Treasurer’s business tax working group after he asked it to fast track a report on the tax treatment of losses the measure will be capped at $300,000 per company, meaning at the 30 per cent tax rate they will be able to claim back tax paid in respect of $1 million of losses.

“It’ll mean businesses can use their tax losses now, when they need to, rather than in the future when their businesses are performing better,” said assistant treasurer David Bradbury. “It will help struggling companies adjust to the challenges and opportunities of the patchwork economy by improving cash flows and reduce disincentives for businesses to take sensible risks.”

The measure is expected benefit 110,000 firms at a cost of $700 million over the next four financial years, none of which is in 2012-13... the year the budget is scheduled to return to surplus. Refunds in respect of losses claimed in 2012-13 will be paid in 2013-14.

The working group was unable to come to a decision about how to fund the reform, identifying but not endorsing a number of possibilities including statutory effective life caps in the oil and gas infrastructure as a means of winding back accelerated depreciation.

The Minerals Council yesterday released a paper disputing the view “that the Australian mining industry pays a disproportionately low amount of corporate tax”. It said Tax Office data showed mining companies paid tax at close to the statutory rate of 30 per cent.

It said the fuel tax credit scheme - reportedly under threat in the budget - was not a “subsidy”.

From July 2012 small businesses will also be able to immediately deduct the cost of any new business assets costing less than $6500, for as many assets as they purchase.

“We recognise that for many small businesses their biggest asset is their ute or van, Mr Bradbury said. “Small businesses will also be able to immediately deduct the first $5,000 of a new or used motor vehicle, purchased from 1 July this year. These reforms will make the tax system simpler for small businesses, whether they are run by sole traders, partnerships, trusts or through a company.”

The Government will release a discussion paper about the introduction of the loss carry-back after the budget.

In today's Sydney Morning Herald and Age


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