Ask any businessperson if we should cut the rate of our company tax and, almost to a pale and stale male, they’ll unhesitatingly tell you we should. Why? Because our rate of 30 per cent is high among the rich countries, and this must surely be discouraging business investment. Sorry, not that simple.
Just how un-simple was something I didn’t realise until the Productivity Commission proposed cutting the company tax rate to 20 per cent in one of the reports it issued in preparation for last month’s economic reform roundtable.
At present, the general rate of company tax is 30 per cent, although smaller companies with annual turnover (total sales) of less than $50 million pay 25 per cent. The commission wants to cut the rate to 20 per cent for all companies with annual turnover of less than $1 billion.
The commission got two different modelling outfits – Chris Murphy, and Professor Janine Dixon’s Centre of Policy Studies (CoPS) at Victoria University – to use their “computable general equilibrium” econometric models of the Australia economy to estimate the likely effects of the company tax cut on the economy.
On the face of it, the two models’ findings were similar, though Murphy gave the change higher marks, so to speak. He found that, by 2050, the tax cut would cause the level of business investment spending to be 1.4 per cent higher than otherwise, with the level of output per worker 0.4 per cent higher, and real gross domestic product 0.4 per cent higher.
In contrast, CoPS found an increase in the level of business investment spending of only 0.6 per cent. It found a similar improvement in the level of output per worker of 0.3 per cent, and a smaller rise in the level of real GDP of 0.2 per cent.
But get this: whereas Murphy had the level of something called “gross national income” increasing by 0.2 per cent by 2050, CoPS had it actually declining by 0.3 per cent. What’s that all about? Good question.
Among economists, it’s a long known, but long forgotten truth that GDP isn’t the best way to measure our economy and its growth. The better way is what used to be called GNP – gross national product – and these days is called GNI, gross national income.
As you know, GDP measures the value of all the goods and services produced in Australia during a period. But this includes goods and services produced by foreign companies, so the profits made by those foreign companies in Australia belong to foreigners, not us.
Australians’ savings have always been insufficient to finance all the investment opportunities in the Wide Brown Land, so since white settlement we’ve gone on inviting foreigners to bring their savings and expertise to Oz and help us develop the place. We’ve ended up with a lot of foreign ownership of our economy.
That’s why GNP/GNI is the better measure of our economy. It measures the value of the goods and services produced by Australian citizens. It’s our bit of our economy. But that’s why GDP is bigger than GNP/GNI – although the two probably grow at much the same rate.
Historically, foreign investment in Australia is the big story. In recent decades, however, we’ve had investment going the other way: Australians investing in overseas businesses. That’s particularly the case since the introduction of compulsory superannuation in 1992. Rather than swamp the local share market, about half our total superannuation savings of $4.1 trillion is invested offshore.
So GNP/GNI is GDP minus income paid to foreigners, but plus foreign income paid to Australians. Combine those last two and you get NFI – net foreign income.
It’s after allowing for net foreign income that Murphy’s estimate of real GDP being 0.4 per cent higher turns into real GNI being only 0.2 per cent higher. But here’s the point: under the CoPS modelling, higher real GDP of 0.2 per cent turns into real GNI being 0.3 per cent lower. This translates as Australians being less prosperous by almost $300 a person.
How does that come about? It’s because Murphy’s model is “comparative static” whereas CoPS’ model is “dynamic”. Murphy compares the state of the economy before the tax change with its expected state after it has returned to equilibrium over the “long run” (about 20 years in this case).
In contrast, the CoPS dynamic model traces the economy’s path year by year between the pre-change equilibrium and its return to a new equilibrium X years later. But why should this approach suggest that the company tax cut would leave Australians worse off rather than better off?
Well, the first thing to remember is that Australia’s rare system of “dividend imputation” (franking credits) makes our story very different to most other countries. Because the Australian shareholders in an Australian company get a tax credit for their share of the company tax their company paid, they don’t have to care what the rate of company tax is.
So it’s really only the foreign shareholders in Australian companies who end up paying company tax. Thus, if we were to cut our company tax rate from 30 per cent to 20 per cent, it’s really only foreign shareholders who’d benefit.
And, as the CoPS people point out, cutting the company tax rate by 10 percentage points would deliver a massive windfall gain to the foreign owners of Australian companies. They were perfectly happy to invest in Australian companies when the tax rate was 30 per cent, but we cut it anyway.
And if foreign investors are paying less tax to our government, that leaves Australians bearing more of its costs. That’s true even if the lower company tax rate were to induce foreigners to invest more in Oz. We’d start with a big minus before we got any pluses.
But if our company tax rate is so high, how come foreigners have always been happy to invest here? Because we’re a highly attractive investment destination for many obvious reasons. Other countries may need to offer a low tax rate to attract the foreign investment they need, but we don’t.
