Published daily by the Lowy Institute

Company tax cuts: America versus Australia

Rather than continue a race-to-the-bottom on company tax, a sensible global regime is needed.

Mining in Kalgoorlie (Nigel Killeen/Getty)
Mining in Kalgoorlie (Nigel Killeen/Getty)
Published 27 Feb 2018 

The expert panel on the ABC’s Q&A program earlier this month was hopelessly confused in comparing Donald Trump’s cut in US company tax with the proposed company tax cuts in Australia. Although it’s often useful to compare domestic economic policy initiatives with those overseas, in this case the seemingly similar policies are like chalk and cheese.

America will cut the rate of company tax from 35% to 21%, allow accelerated depreciation for investment, and change the tax status of foreign earnings. This, together with spending initiatives, would provide a substantial positive fiscal impulse over the next two years. Just how much effect this would have on GDP depends on how much spare capacity remains in the US economy (unemployment is below what is often regarded as “full employment”), what the Fed does with interest rates, and what happens to the exchange rate.

There is sure to be some positive effect on GDP over the next few years. Even more surely, there will be a significant widening of the budget deficit (from 3% of GDP to more than 5%). Government debt is estimated to rise from around 80% of GDP to nearly 100% percent within ten years.

The effects of corporate tax cuts in Australia are quite different because of Australia’s system of company tax imputation. Thanks to imputation, company tax for Australian shareholders is effectively a withholding tax that is returned to them when dividends are paid. With the interests of Australian shareholders in mind, a company has no incentive to increase investment in response to a cut in Australian company tax. The direct benefit of a cut is confined to foreign investors, with the largest benefit going to existing foreign investors (the stock of foreign investment is around twice GDP).

Lower corporate taxes should attract some new foreign investors to Australia. But just how many is hard to know. For many foreign investors, tax paid in Australia is an offset to tax paid at home when profits are remitted; lower Australian company tax, therefore, only means more tax at home, with no incentive for additional investment.

For many foreign investors coming to Australia, company tax is not a key issue: they come to exploit our specific resources, benefit from our geographic position, or to enlarge their market by adding Australian customers who they need to service with a presence here.

Other foreign investors arrange their affairs to pay little or no tax in Australia: reducing the statutory rate here has no effect on them. This is particularly true for Big Tech companies (such as Google, Amazon, and Facebook), where intellectual property makes it easy to shift profits to low-tax jurisdictions. For any company motivated largely by company tax, a 25% rate won’t entice it away from the very low rates on offer in Ireland, Singapore, or Luxembourg.

Treasury modelling asserts that there would be enough extra foreign investment as a result of corporate tax cuts to raise GDP by about 1% (although it will take decades to achieve this increase). Of course, the foreigners have to be recompensed for this extra investment, so they take nearly half of the extra GDP, leaving 0.6% additional national income for Australians to share. The expected increase in jobs is 0.1%, and “welfare” rises by 0.1%.

Modelling is, however, an inexact game: a well-regarded alternative model predicts a small increase in GDP but no gain at all for national income accruing to Australians.

Rather than continue the race-to-the-bottom on company tax, the international community needs to agree on a sensible global regime which allocates company tax revenue among the various countries involved in generating that revenue. The OECD seeks to achieve this objective through the Base Erosion and Profit Shifting initiative. Not waiting for the snail-like progress of such international consensus, some countries, including Australia, are going ahead independently, imposing specific ad hoc taxes on companies whose business model avoids taxation in the country where they derive their profits.

Rather than attempting to attract footloose global capital through low company taxes, we should focus our full efforts on getting all companies to make a fair contribution to the cost of running the country.

You may also be interested in

Australia Day holiday

We'll be taking a day off so fewer posts than usual tomorrow, back to normal on Friday.