Welcome to Ascent’s Monthly Focus: March Edition. In this edition, we analyse the proposed corporate tax cuts: what are the experts saying and what is best for Australia?
What are the economists saying?
There is flurry of conversation within the economic community about tax rates, in particular, dropping the corporate tax rate from 30% to 25% over the next 10 years. In recent weeks, many prominent economists have flagged a need for re-assessment of corporate tax (and income tax too). Andrew Mackenzie, the CEO of BHP, praised the proposed changes, saying that BHP could improve investment immediately (1). McKenzie highlighted the myriad of smaller projects within BHP that would be given the green light, should a smaller corporate tax rate be introduced (1). However, asking for even greater reform, is CEO of Magellan, Hamish Douglass, who overseas $60 billion of international investments. Douglass believes that a 5% drop will be ineffectual to remain globally competitive (1).
These contrasting views from two prominent CEOs, raises an interesting question: should Australia lower its corporate tax rate to boost domestic businesses development or to become more globally competitive? If the answer is the former, then a decrease from 30%-25% is a good start; reduce the fiscal strain in order to give businesses more confidence to re-invest profits. However, if Australia is looking to be more globally competitive, a 5% change may not be enough. John Key, former NZ Prime Minister and now director of ANZ, suggests that Australia needs to look at re-assessing its uncompetitive corporate tax position and its high personal tax levels, in favour of bringing overseas businesses to Australian shores (2). And as much as we enjoy a ‘bit of banter’ with our cross-Tasman cousins, John Key knows a thing or two about building strong economies; during Key’s two terms as New Zealand’s prime minister, the national GDP grew by 4.71% per annum – Australia has been experiencing shrinking GDP growth over the same time frame (3).
In the next three sections, we will explore the merits of a corporate tax cut in Australia. The primary focus will be on the domestic effect; how does tax policy effect Australia on a local level? Well, when big Australian businesses make billions of dollars in profit, the initial, seemingly logical reaction, is to increase taxes. However, often, less is actually more.
As the corporate tax rate drops, the amount of tax that companies pay, increases.
As the Australian corporate tax rate progressively dropped from 49%-30% since 1986, the amount of tax revenue from companies, increased. And more interestingly, the amount of tax revenue from companies as a percentage of overall tax revenue (GST, personal income tax, imports etc) also increased! In layman terms, tax revenue from companies grew faster compared to tax revenue from GST, personal income tax, tax from imports etc. Quite literally, as tax rates were cut, big corporations actually paid more tax (4).
Figure 1. Falling tax rates (blue line) compared with increasing tax paid by companies (green columns). Data on “tax revenue” unavailable for 1986-1991.
Corporate tax rate deductions and Australian GDP are near-perfectly correlated.
As corporate tax rates have been progressively lowered, Australian businesses have flourished, and as a result, Australia’s GDP has increased (Australia hasn’t had a recession since 1991). Figure 2 demonstrates an 80% correlation between GDP and lowered tax rates (4). The comparison between GDP and lowered tax rates, suggests that there is a strong relationship between these two factors.
Figure 2. Growing GDP (orange columns) compared to reducing corporate tax rate (blue line)
But there is a negative trend, not readily apparent in this graph; since 2001, with a constant corporate tax rate (30%), GDP growth has declined, as has tax revenue growth from companies. Put simply, as corporate taxation policy has remained the same, and not evolved with the changing economic landscape, the economy and the tax office have felt the pinch.
Australia is not America! But we are similar to Canada.
Often, advocates of corporate tax cuts are accused of following the USA’s lead; “we are not America!”. And since the USA’s economy is nearly 2,500% bigger than our own, we are definitely not America. Instead, let’s look at Canada, a country of similar economic size to our own. In a 2012 study, published in the National Tax Journal, the relationship between corporate tax cuts and GDP was explored (5). In this study, it was found that a 1% drop in corporate tax rate was correlated to an increase in GDP of 0.1%-0.2%. That means, each time the corporate tax rate is lowered, the GDP increases. In Australia, a comparable change would boost our GDP by $3.31 billion, and influencing a drop in tax revenue of $2.37 billion. This is a positive gain of $940 million to the Australian economy. And furthermore, despite the initial drop in tax revenue, tax revenue actually increases above current levels after two years.
Figure 3. Boosted GDP and reduced tax revenue; if Australia produced similar results to the 2012 Canadian study on GDP and Corporate Tax Rates
As mentioned above, the tax revenue drop above would be a one off: as GDP rises, business profits also increase. This means that businesses now have a larger ‘profit base’ from which they are being taxed. And the last time corporate tax rates were adjusted in Australia (over a period of 11 years from 1991-2002), business profits increased by an average of 16% per year!(4) The graph below, figure 4, is a forecast based on these historical increases in corporate profits and lowered tax rates. From figure 4, it is clear that even with a decreasing corporate tax rate of 30% to 25% (green line), the tax revenue from businesses (blue line) is forecasted to keep increasing. In fact, as mentioned earlier, it only takes two years until the tax revenue from businesses exceeds the level it is today, despite the lower tax rate.
Figure 4. The forecasted decreasing corporate tax rate from 30% to 25% (green line) compared to the forecasted increasing revenue from corporate tax (blue line). This increase is based on the Australian historical average of 16% increase in business profits when corporate tax rates are reduced (World Bank Data – reference 4).
There is a lot of data to suggest that Australia should look to lower its corporate tax rate. The reason for this, is two fold. Firstly, the current rate of 30% has been in place since 2001, which has not provided Australian businesses the flexibility to create more appropriate fiscal strategies around a changing, globally-integrated economy. Secondly, a lowered tax rate, even a reduction from 30% to 25%, positions Australia as a greater value investment for foreign businesses. This will create a positive inflow of investment into Australia, and likewise, prevent already established businesses taking their operations offshore. Overall, a re-assessment of the corporate tax structure is necessary.
Mark O’Toole (CFP)
(1) Patrick, A., Mather, J. & Kehoe, J. 2018, ‘Douglass proposes two-tier company tax system’, The Australian Financial Review, 7 March, page 1.
(2) Durkin, P., 2018, ‘Family package key to company tax cuts: John Key’, The Australian Financial Review, 2 March, page 1.
(3) New Zealand GDP, , 2018. Available from < https://tradingeconomics.com/new-zealand/gdp> [March 9, 2018]
(4) The World Bank Australia, 2018. Available from <https://data.worldbank.org/country/Australia> [March 9, 2018]
(5) Ferede, E. & Dahlby, B. 2012, ‘The impact of tax cuts on economic growth: evidence from the Canadian provinces’, National Tax Journal, September 2012, Volume 65, Number 3, pp-563-594
Bibliography (sources not directly referenced)
- King, G., 2018, ‘Australia’s high company tax rate is wage theft on a grand scale’, The Australian Financial Review, 5 March
- Paterson, J., 2018, ‘Why Australia needs to cut company tax’, The Australian Financial Review, 11 March
- Greber, J., 2018, ‘Ken Henry laments a lost decade of tax reform’, The Australian Financial Review, 1 March
- Corey, P., 2018, ‘Malcolm Turnbull says 70pc of company tax cut benefit will flow to workers’, The Australian Financial Review, 23 February