The big problem with the government’s planned company tax cuts is that their medium-term impacts work against the stated long-term goal of boosting investment and growth.
That’s the conclusion arrived at through extensive computer modelling by economist and senior research fellow at the Centre of Policy Studies, Dr Janine Dixon.
Dr Dixon says the Department of Treasury, which backs the idea that lower company tax will boost inward investment, bases its judgement on “long-run competitive equilibrium models”.
That is, Treasury is answering the question: ‘When everything’s settled down and the new tax rate is in place, will it attract more capital to Australia?’
The answer to that question is ‘yes’, because lower company tax produces higher profits; higher profits are distributed as higher dividends; and that makes investing in Australia more attractive.
What’s missing from that answer, says Dr Dixon, is any accounting for the huge sums of money that will change hands before things ‘settle down’.
Dr Dixon’s modelling covers that transition phase and has led her to the startling conclusion that “you’d be better off doing nothing than making these tax cuts”.
The first thing to note about Dr Dixon’s analysis is that it isn’t just a few figures punched into a spreadsheet.
Her research is based on “large-scale dynamic computable general equilibrium modelling”.
That means the various parts of the model interact in a step-by-step way – each point in time is the result of a continuous chain of events, a bit like those slow-motion maps that show weather systems interacting.
Modelling the economy-wide effects of the company tax cuts reveals, she says, one giant unintended consequence.
As each phase of tax cut is introduced through to 2026, there will be a corresponding flow of money out of Australian hands and into the pockets of overseas investors.
That’s because of Australia’s franking credit system for share dividends.
When a local Aussie holds shares in, say, Telstra, they will receive dividend payments that have already been taxed at 30 per cent.
But when it lands in their bank account as ‘income’, they are required to pay tax on it at their marginal rate.
To avoid double-taxing the same source of income, the company tax is refunded to them via a franking credit.
That means that whether the refunded company tax is 30 cents in the dollar or 25 cents is irrelevant – local investors won’t see a difference in their returns.
Overseas investors, however, will benefit by pocketing the extra five cents in the dollar.
Investors are already here
For future investors, that extra incentive should boost inward investment flows.
The problem, says Dr Dixon, is that “we already have a heap of foreign capital invested here – and those investors voted with their feet and brought their money to Australia while the company tax rate was 30 cents”.
Those foreign investors, she says, will receive a juicy windfall increase in their earnings – money that will add to the final demand of their economies, not ours.
That “transition effect” is vitally important, says Dr Dixon, because although gross domestic product (GDP) will increase due the tax cuts, the better measure of prosperity in Australia – gross national income – will fall.
That’s because GDP is a measure of what’s produced here, while GNI is a measure of where the profit and income of that production actually flows.
If Australia were an isolated nation looking to welcome capital investment for the first time, the one-off windfall described above would not happen.
But the stage Treasury has skipped over in its long-term modelling – the flow of money away from Australia’s tax coffers and into the pockets of overseas investors – will happen if the government’s full tax package is legislated.
As for that longer-term equilibrium, won’t Australia suffer by having an uncompetitive company tax rate?
Hardly. Investment decisions are always based on risk and return, and there are many factors affecting both.
A high company tax rate is a negative, but Australia’s generous tax write-offs are a positive. So too is Australia’s skilled workforce, stable political environment, strong and predictable rule of law, access to Asian markets, sophisticated financial system and so on.
Put in its full context, a plan that costs Australian taxpayers money and provides a giant windfall to foreigners really is worse than ‘doing nothing’.