Company Tax

2018 ANU Working Paper:
Australia's company tax system: a poor recipe for a small open economy?

By international standards, Australia’s business tax system combines a high company tax rate of 30 per cent with low taxation of domestic investors through dividend imputation.

This prioritising of domestic investors over foreign investors is at odds with the evidence in this paper that the marginal investor is foreign. Better aligning Australia’s business tax system with international practice would encourage business investment, reduce tax avoidance and reduce the riskiness of national income.

This paper assesses the evidence on the size of these three effects and models the consumer benefits of better aligning the Australian business tax system with international practice.

Download the paper on Australia's company tax system

Murphy, C. (2018), “Australia's high company tax rate and dividend imputation: a poor recipe for a small open economy?” , ANU Tax and Transfer Policy Institute Working Paper, 9/2018, May 2018.

2018 Australian Tax Forum Paper:
Modelling Australian company tax reforms: updated for US reforms

My October 2017 Working Paper described below has now been fully updated for the major US corporate changes legislated in December 2017. The updated paper has been published in the Australian Tax Forum Journal and can be downloaded below. It supersedes the working paper.

The updated paper finds that the already substantial benefits from business tax reform in Australia identified in the Working Paper have increased as a result of the US changes. Following the US changes, the limited US tax credits for Australian company tax that were available have been abolished. This means that US investors in Australia are now fully exposed to Australia's company tax rate, increasing the gain in foreign investment from Australian tax rate reductions.

For more explanation of the recent US tax changes, what they mean for Australian corporate tax policy, and updated estimates and explanations of the benefits from specific Australian corporate tax changes, see the updated paper.

Download the updated company tax reforms paper

Murphy, C. (2018), “Modelling Australian corporate tax reforms” , Australian Tax Forum, 33:1, 5-49.

2017 ANU Working Paper:
Modelling Australian company tax reforms

As a small open economy, Australia can expect that foreign investors will add our corporate tax burden to the hurdle rate of return that they require to invest here, rather than absorb it. This discourages foreign investment and leaves local labour to bear the final burden of local corporate tax, discouraging labour supply. This double disincentive effect led Gordon to recommend against applying corporate tax in a small open economy.

More recently, Auerbach, Devereux, Keen and Vella have argued that international profit shifting has added to the case against corporate tax in its current form. Australia further undermines the efficiency of corporate tax as a revenue raiser by returning a substantial portion of the revenue through a dividend imputation system that Fuest and Huber show is undesirable for small open economies.

At the same time, Boadway and Bruce showed that corporate tax can be efficiently applied to the returns from immobile assets such as land, minerals and local market power, leading to calls to narrow the corporate tax base to only capture such economic rents.

Using economy-wide modelling, this paper quantifies the substantial consumer benefits from tax reforms that reduce the corporate tax rate, narrow the base to economic rents, or replace imputation with less generous dividend tax concessions. The substantial benefits of reducing the local tax rate increase if the USA makes the corporate tax changes proposed by the Trump administration.

Download the company tax reforms working paper

Download "Modelling Australian company tax reforms", ANU Tax and Transfer Policy Institute Working Paper, 8/2017, October 2017.

Benefits of a company tax cut:
reply to Craig Emerson
Chris Murphy, Australian Financial Review
28 March 2018

Download the latest AFR article

"Benefits of a company tax cut: reply to Craig Emerson".

Company tax cut:
high economic benefit for low budgetary cost
Chris Murphy, Australian Financial Review
23 June 2016

A senior government official recently commented to me that “cutting company tax is really cheap”. Indeed, in today’s terms the proposed cut in the company tax rate to 25 per cent has a long-run annual cost to the government budget of only $3.7 billion.

This cost estimate is based on my modelling for the Treasury, which was released with the May Budget. Yet for this modest cost to the budget, there is a much larger annual gross benefit to consumers estimated at $8.9 billion.

So for every $1 of cost to the government budget, the company tax cut provides a gross benefit to consumers of $2.39 in the long run (using unrounded benefits and costs). If you cut any of the other major taxes such as personal income tax or the GST, the consumer benefit is nowhere near as large for each dollar of budget cost. It is also difficult to think of a government spending proposal that would offer such a high payoff ratio.

Let me explain why the payoff ratio is so high for cutting company tax, before addressing some noisy claims to the contrary. Finally, I’ll explain how our company tax rate compares to that of other countries that compete with us to attract foreign investment.

The high pay-off ratio

The CGETAX model of the Australian economy used in our modelling for Treasury factors in four years of research, from 2012 to 2016, on how company tax and other taxes affect the economy. An early version of the model was used to model a company tax cut for the Business Tax Working Group established by Wayne Swan when he was Treasurer. The latest version distinguishes 278 different industries, and models how company tax affects investment in each industry in up to 10 different types of business assets.

CGETAX takes into account the six main channels, four positive and two negative, through which a lower company tax rate will affect the economy.

It stimulates business investment, leading to higher productivity and more tax revenue.
This higher productivity pushes up real wages, encouraging more labour supply.
A lower company tax rate reduces the incentive for multi-national companies to shift their profits offshore, helping Australia to claw back some lost company tax revenue.
It reduces the value of franking credits, adding to government revenues from taxing dividends received by individuals and superannuation funds.
On the hand, a lower company tax rate does not stimulate investment if foreign investors receive a tax credit for Australian company tax in their home country – but this only applies for 5 per cent of company tax.
Lower company tax on so-called economic rents associated with lack of competition, minerals or land won’t stimulate additional investment either.

When these four economic positives and two economic negatives are carefully modelled, using mainstream estimates for the economic parameters associated with each channel, we arrive at the very high consumer benefit to budget cost ratio of 2.39 for the proposed company tax cut.

Noisy claims

Following this careful, balanced modelling based on years of research, including for Treasury under both Labor and Coalition Governments, a number of critics have made counter-claims in the political atmosphere in the lead up to the Federal Election.

Some critics have claimed that company tax is mostly nullified by franking credits, apparently unaware that Australian Tax Office data shows that utilised franking credits consistently represent only around 30 per cent of company tax collections, and this is fully factored into the modelling for Treasury.

Similarly, The Australia Institute claims that “a key beneficiary of the proposed company tax cuts is the American tax office”. However, they don’t acknowledge that US Internal Revenue Service data implies that the US tax credits in question represent only 5 per cent of Australian company tax collections. This has already been fully taken into account in the modelling for Treasury.

The Australia Institute has also ridiculed as a “morality dividend” the idea that a lower company tax rate reduces shifting of profits offshore. In fact, the sensitivity of the company tax base to the company tax rate has been the subject of extensive international research over the last decade. That research is consistent with the sensitivity built into CGETAX and rejects the idea that this effect does not exist. At the same time, the way that the profit shifting effect is applied in CGETAX has been improved in the Working Paper discussed above, and it is now plays a smaller role.

International ranking

The international competitiveness of our company tax rate can be tracked over time using the effective average tax rates (EATR) maintained by the Oxford University Centre for Business Taxation. They state that the EATR “is generally the relevant measure for comparing the incentive to locate new economic activity in different countries”.

The last major cut in company tax in Australia in 2000-01 was supported by both major parties. It improved our EATR ranking among the G20 major economies from 10th in 2000 to 5th in 2003. Since then other countries have continued to cut company tax.

By 2015 our ranking had slipped back to 11th. After taking into account announced future changes in corporate tax in different countries, in March the Oxford Centre projected that Australia will have slipped to 15th by 2020. If countries continue to cut company tax rates at the rate they have over the last two decades – at around one percentage point every two years – by 2027 we will be 17th in the G20 without the proposed Australian company tax cut.

This would be poor economic policy for a country like Australia with a high reliance on foreign investment. A recovery in non-mining business investment would be needlessly stunted and profit shifting out of Australia would accelerate.

Company Tax Cut and Tax System Efficiency
Chris Murphy, The Australian newspaper
8 June 2016

Introduction

The May Federal Budget included a reduction in the company tax rate from 30 to 25 per cent. With the Budget, The Treasury released both its own modelling, and modelling from myself on the economic impacts of this cut. This modelling is comprehensive, taking into account the six main channels through which the cut will affect the economy.

Both modelling groups found long-run gains in GDP and real wages of around 1 per cent. I have recently released a further study at ANU (there is a hyperlink below) comparing the cut with other options for reducing taxes and it finds that the proposed cut is the top priority for tax reform, as I will explain.

Some groups have publicly questioned the company tax cut. Informed debate is always welcome but the Grattan Institute, the Australia Institute and the Centre of Policy Studies have raised issues such as franking credits and foreign tax credits, which are already fully taken into account in my modelling. The three groups have not always acknowledged this and none of them has produced comprehensive modelling of their own.

Company Tax in an Open Economy

International economic authorities such as the OECD and IMF have found that company tax imposes a high drag on the economy and should therefore be levied at a moderate rate. Consistent with this, the Henry Tax Review, commissioned by the Rudd Government, recommended that the Australian company tax rate be cut from 30 to 25 per cent, as now proposed by the Turnbull Government.

This negative view about high company tax rates starts with an understanding about how open economies such as Australia operate. Foreign investors have a wide choice of countries in which to invest. For them, each country’s company tax is simply a cost that they add to the hurdle rate of return they require on an investment before it is worthwhile for them to invest in a country. Pursuing their self-interest in this way, for a given level of risk, foreign investors obtain similar post-tax returns wherever they invest and whatever the company tax rate.

Benefits of Company Tax Cut

This has two implications for the proposed company tax cut. First, in the long run the cut does not boost the after-tax returns received by foreign investors; it boosts Australian real wages instead, stimulating labour supply. Critics of the cut gloss over this benefit to workers. Second, the cut makes more Australia investment projects worthwhile, thereby boosting labour productivity. Higher labour supply and productivity combine to provide the predicted permanent boost to GDP of around 1 per cent.

Cuts in personal income tax provide an alternative way of boosting after-tax real wages and stimulating labour supply, but without the benefit to investment and productivity of a company tax cut. This is what leads international economic authorities to find that company tax should be levied at substantially more moderate rates than personal income tax.

In Australia’s case there are two additional factors that increase the economic drag from company tax per dollar of government revenue.

First, our company tax rate is high by international standards. The Oxford University Centre for Business Tax projects that by 2020, after taking into account announced future changes in corporate tax, Australia will rank 15th among the G20 countries for having an internationally competitive effective average tax rate (EATR). They state that the EATR “is generally the relevant measure for comparing the incentive to locate new economic activity in different countries”. This uncompetitive EATR for corporate tax is despite Australia’s high reliance on foreign investment.

This high company tax rate exacerbates the investment disincentive effect. It also stimulates profit shifting to lower-taxed jurisdictions. This profit shifting erodes government revenue and wastes resources on tax avoidance activities.

Second, Australia is unusual in having a system of franking credits. These credits rebate around 30 per cent of company tax collections, substantially reducing the overall gain in government revenue from company tax, while providing only a modest improvement in saving incentives.

Costs of Company Tax Cut

Besides factoring in these four benefits of company tax cuts – higher labour supply, higher investment and productivity, less profit shifting and less revenue leakage through franking credits – the modelling also recognises two costs.

First, around five per cent of Australian company tax is rebated to foreign investors through tax credits from their home country governments. An Australian company tax cut won’t stimulate additional investment from such foreign investors.

Second, some foreign investment is in industries where there are so-called economic rents associated with lack of competition, minerals or land. Tax cuts on such economic rents won’t stimulate additional investment either.

Consumer Benefit vs Budget Cost

When these six factors and many others are weighed up, the new study finds a consumer benefit to budget cost ratio of 2.39 from the proposed company tax cut. If our company tax rate had already been cut to 25 per cent, the benefit-cost ratio for a further cut to 20 per cent would be more modest at 1.96. And without a franking credits system, it would also be more modest at 1.85.

This consumer benefit to budget cost ratio for the company tax cut of 2.39 compares very favourably with the option of cutting other major taxes. For personal income tax the ratio is 1.31 and for GST it is lower still at 1.18. So the proposed cut to company tax is the top priority for tax reform in Australia.

Company Tax Cut Report
May 2016

At the request of the Department of the Treasury, I prepared a consultancy report modelling the economy-wide effects of the proposed cut in the company tax rate from 30 to 25 per cent. His report was released by The Treasury on Budget night.

Economic Channels

A company tax cut:

raises the capital-to-labour ratio by reducing the tax burden on capital, lifting productivity;
encourages the labour supply as the company tax cut makes room for higher real wages; and
reduces wasteful tax avoidance activity by reducing the incentive to shift profits to lower-taxed jurisdictions.

Key Effects of the Proposed Company Tax Cut

a gain in real wages of 1.0 per cent;
a gain in annual consumer welfare valued at $4.1 billion to $5.2 billion, depending on the method of funding; and
a gain in real GDP is from 0.7 to 0.9 per cent, again depending on the method of funding.

Key Features of the CGETAX Model

The report uses the CGETAX model developed by me. CGETAX incorporates major advances in modelling tax reform compared to the original Independent CGE model. It:

uses the latest ABS input-output tables, which are for 2012-13, with a baseline scenario uprated to 2015-16;
has rich industry detail that distinguishes 278 industries;
allows for oligopoly power in industries with sustained above-normal rates of return on capital;
includes sophisticated modelling of production in each industry incorporating inputs from eight types of labour, land, mineral resources and nine types of produced capital;
reflects many features of the company tax system including interest deductibility, dividend imputation, tax depreciation based on historic cost, immediate write-off provisions for some investment, and foreign tax credit arrangements;
realistically assumes that hurdle post-company tax rates of return for new business investment are set on world asset markets;
allows for tax avoidance through shifting of profits to lower-taxed jurisdictions; and
allows for labour force participation to respond to the real after-tax wage.

Further Information

Access the report prepared for Treasury.
Read Chris Murphy's commentary on the report.
Read his academic paper on the report - ANU Working Papers in Trade and Development, Working Paper No. 2016/10, May 2016.

Business Tax Working Group:
Using the Independent CGE model
1 November 2012

The Business Tax Working Group established by the Australian Government released its final report in 2012. The BTWG final report includes analysis of the long-run economic impacts of company tax reform using the Independent CGE model.

Working with Treasury

The report explains how the Independent CGE model was developed for this project.

"Treasury and Independent Economics worked together to extend and calibrate the model to make it suitable for modelling the business tax system. The model has been designed to represent economic effects of the company tax system on:

the size of the capital stock in each industry;
the mix of capital types;
labour force participation;
the location of multinational profits; and
the location of multinational firm-specific assets, such as intellectual property."

Effects of Cutting Company Tax

The BTWG final report describes the Independent CGE model results for a cut in company tax as follows.

"The modelling suggests that a company tax cut from 30 to 29 per cent would increase the level of GDP by 0.2 per cent compared with what would otherwise be the case. This increase in GDP is driven mainly by greater foreign investment flows into Australia to fund additional projects that are made viable by the reduction in the tax rate. Under reasonable assumptions in the model, additional capital investment increases the capital stock by 0.3 per cent.

The modelling also suggests that Australian workers benefit from the company tax cut in the long run. The productivity of labour increases with the increase in the size of the capital stock and this flows through to an increase in after-tax real wages of 0.2 per cent and a small increase in labour supply of around 0.1 per cent. Overall, the modelling shows that cutting the company tax rate can deliver an improvement in consumption by Australian households of around 0.05 per cent."

Key Features of Our Model

The report notes eight key features of the Independent CGE model for modelling these economic effects:

an up-to-date database representing the Australian economy in 2011-12;
rich industry detail that distinguishes 111 industries;
sophisticated modelling of production in each industry incorporating inputs from labour, land, fixed factors and nine types of produced capital;
reflection of many features of the company tax system including debt deductibility, dividend imputation, tax depreciation based on historic cost, immediate write-off provisions for some investment, and foreign tax credit arrangements;
economic rents for location-specific and firm-specific fixed factors;
business investment at the margin is funded by foreigners;
shifting of profits between countries for tax purposes; and
labour force participation responds to the real after-tax wage.

BTWG final report

Access the "BTWG final report" (see Appendix B).

For more information, email me.

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