Our current tax mix relies too much on income taxes and not enough on consumption and broad-based taxes.
The pre-budget debate over the feasibility – and now it seems, even the desirability – of tax cuts is hotting up.
Fifty eminent Australians wrote an open letter to the Prime Minister alleging Australia is a low-taxed country so tax cuts cannot be justified, especially for companies and ‘the top end of town’. Research from Victoria University’s Centre of Policy Studies (CoPS) argues a cut in the company tax rate would result in a reduction in gross national income(GNI) in the long run.
KPMG would beg to differ on both these assertions. Australia's tax system is dangerously unbalanced. Recently released ATO statistics show the top 3 per cent contribute $15 in every $100 of government tax revenue. In 2013-14, the latest figures available, KPMG analysis shows the 370,000 people in the highest tax bracket contributed $50 billion to the nation’s $350 billion overall tax take. Our 49 percent top marginal rate is one of the highest in the world.
At 30 per cent, our corporate tax rate is also well above the OECD average of around 23 percent. We need to be mindful of Singapore and Hong Kong, our main competitors as service providers to the rising Asian middle class. Many countries are lowering their corporate tax rates, so staying the same is effectively falling behind. While there is no shortage of overseas capital looking for a home, things change quickly in the international investment environment and Australia needs to have a competitive rate, given our position as a net importer of capital.
Put simply, our current tax mix relies too much on income taxes, personal and corporate, and not enough on consumption and broad-based taxes. Taxing mobile assets, such as people and capital, the heaviest opens up greater risk to the tax base. Taking the perspective that assets won’t move to jurisdictions that provide better after-tax returns on a risk-adjusted basis is naive. It is harder to re-attract disenfranchised investors and human capital than get them here in the first place.
While we accept the pressure on the budget may mean no immediate action, a long-term plan of company tax reductions is certainly needed.
In terms of the CoPS research, the corollary of its argument is that government can increase Australia's GNI in the long run by hiking up company taxes. This does not seem plausible: in the long run, capital is globally mobile and will move to activities that maximise risk-adjusted post tax returns.
KPMG Economics has undertaken extensive research in this area and believes the CoPS work cannot be reconciled with the economics of company taxation.
Company tax has consistently been shown to be the most distortionary of all taxes in Australia, including in a 2015 Treasury paper. It is important to recognise that while the statutory burden of company tax is on corporate income, its economic burden falls on a mix of consumers(as higher prices), investors (as lower returns) and employees (as lower wages).
A decrease in the company tax rate has the effect of reducing the cost of capital for businesses in Australia, creating an incentive for them to invest in new plant and equipment and other tangible assets. Much of this increased investment is likely to come from foreigners, who will supply this capital only if they can get a decent return.
For a small open economy like Australia, the after-company tax rate of return on capital (investment) is set on global capital markets. Any decrease in the company tax rate will initially raise the after-tax rate of return for investors, thus providing an incentive for increased investment by foreigners until any differential between the domestic and global after-tax rate of return is eliminated.
The work by CoPS assumes that this does not occur. Instead they assume that the after-tax rate of return rises for foreigners and falls for domestic investors, which results in higher capital income payments to foreigners, and a lower capital income to domestic households. Both of these effects separately reduce GNI. Also, assuming that the after-tax rate of return rises for foreigners underestimates the increase in foreign investment; assuming the after-tax rate of return falls for domestic investors will cause them to reduce investment.
By underestimating the increase in total investment from a company tax cut, the CoPS work also underestimates the increase in the capital stock over time. A larger capital stock increases the amount of capital per worker. This means higher labour productivity and thus higher real wage rates in the long run. In the CoPS work, these effects are muted. This explains the too small increase in GDP it estimates from reducing the company tax rate from 30 percent to 22 percent.
One reason why CoPS gets the outcomes it does is that the dynamic mechanisms in its model are playing out in an unexpected way. An unusual feature of its work is that while GDP stabilises in the long run, GNI does not. Clearly, the economy has not reached a long-run equilibrium in its analysis, which after nearly 30 years is surprising.
As a capital-importing nation, reducing the most distortionary tax – company tax – would be beneficial for all sectors of the Australian economy in terms of output (GDP) and welfare (GNI). Companies must pay their fair share of taxes for the common good – and extravagant tax avoidance strategies discouraged – but a competitive corporate tax rate would be of benefit to all Australians.
Content originally produced by the Australian Financial Review on 15 April 2016.
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