Company tax cuts won’t “cut inequality”

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By Leith van Onselen

The debate over the Turnbull Government’s company tax cut agenda has gotten even more bizarre, with economist Professor Richard Holden seizing on new research from Germany claiming that cutting company taxes actually lessens inequality. From The AFR:

…a recent empirical study by three German economists, published in the flagship American Economic Review… find that higher company taxes reduce wages most for the low-skilled, women, and younger workers. Overall, this implies that once the hit that workers take from company taxes is factored in, personal income-tax-systems in countries like Germany and the US are as much as 40 per cent less progressive than one would otherwise have concluded.

These lessons are highly applicable to Australia. The authors are even able to test how different labour market institutions – like collective bargaining at the company and industry level (enterprise bargaining) – affect the nexus between taxes and wages. They find that there are stronger wage effects for firms that collectively bargain – just as theory would predict. That’s because this form of collective bargaining allows workers to share a portion of the economic pie created by both them and the company: and taxes shrink that pie. Australia’s enterprise bargaining system fits right in with this.

The striking implications of how high company taxes can undermine the progressivity of the income-tax-transfer system certainly apply to Australia, too.

The best, most credible evidence we have suggests that a cut in the Australian company tax rate is not a gift to the so-called “big end of town”. It provides a benefit to businesses and workers in fairly equal measure. And the benefits to workers tend to flow disproportionately to women, young people, and the less skilled.

Cutting the Australian company tax rate from 30 per cent to 25 per cent is not just good for business, and workers. It is also helps to redress economic inequality. Surely this reform is something that deserves across-the-board political support when it comes before Parliament again this year.

Sounds like a slam dunk, doesn’t it? Not really. Professor Richard Holden has forgotten to mention that Australia’s tax system is unique in that it has dividend imputation, whereas Germany does not (Germany abolished dividend imputation in 2000). This means that any reduction in corporate taxes will not materially benefit Australian business owners/investors. Effectively, any cuts to the company tax rate will be largely offset by commensurate cuts to franking credits, as explained by former Treasurer and Prime Minister Paul Keating:

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“Australia’s dividend imputation system works such that the company tax is, in effect, a withholding tax – a tax temporarily held by the Commonwealth which is returned to shareholders when their dividends are paid. So, whether the company tax is withheld by the Commonwealth at a rate of 30% or 25% is immaterial – the Commonwealth is going to return the money to shareholders anyway, regardless of the rate. But the shareholders who will receive a benefit are foreign shareholders”.

As noted by Keating above, the prime beneficiaries of a company tax cut will be foreign owners/shareholders, since they do not receive franking credits. By extension, larger corporations would benefit from company tax cuts at the expense of small businesses. This is because around 98% of small businesses (i.e. those employing four or less people) are wholly Australian owned and, presumably, indifferent to slashing the company tax rate. By contrast, 30% of large companies (i.e. those employing more than 200 people) are at least partly owned by foreigners, who would be the primary beneficiaries from the Coalition’s policy.

So, the Turnbull Government’s company tax cut plan would represent a direct financial transfer from Australian taxpayers (via loss of Budget revenues) to foreign owners/shareholders, in turn reducing Australia’s national income. How is this a good deal?

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Moreover, Holden has not given due consideration as to how the Coalition’s company tax cuts would be funded. According to the Australian Treasury’s initial modelling, released in early 2016, the full company tax cut package was estimated to cost the Budget some $8.2 billion a year. The Treasury’s more recent modelling, released in November last year, downgraded the cost of the Turnbull Government’s company tax cut package to around $4 billion a year.

Either way, the cost to the Budget would be significant and would need to be made up somehow, most likely by increasing the tax burden on workers, as well as cutting expenditure in other areas (e.g. social services). Such actions would necessarily lower growth and offset any benefits to workers from cutting company taxes.

Herein lies the fundamental problem with the Turnbull Government’s company tax cut plan. The Treasury’s own modelling showed minimal benefits to either jobs or growth – primarily because the benefits flow to foreign business owners/shareholder – but a seismic shift in the tax burden from companies to individuals.

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Finally, other notable commentators have contended that cutting company taxes would worsen inequality. For example, Richard Vann, the Challis Professor of Law at the University of Sydney, claims that “it’s the high net wealth individuals who will benefit and this is because they will get a lower tax rate on their bucket companies”… “very wealthy Australians would continue to stash family money in bucket companies held within trusts and taxed at whatever the company rate is”.

Former RBA governor, Bernie Fraser, has also expressed concern that cutting company taxes would deliver minuscule benefits “in the never never” and worsen inequality.

In other words, it’s a policy with immediate large direct costs to the Budget but vague potential economic benefits very long into the future.

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.