Company tax cut has a not-so-dirty little secret

Throughout their whole push for a cut in the company tax rate, there's been a key factor the business lobbies and government politicians simply haven't wanted to mention: our unusual system of dividend imputation.

That's because it so greatly weakens their case and questions their motives.

But that's not all. It's set to turn the limited reduction in company tax we're likely to get into tokenism: the cut will be of little benefit to the businesses receiving it, little net cost to the budget and little benefit to "jobs and growth".

Australia's problem isn't fake news, it's fake government. The coming company tax cut will be a classic case. But it will make the medium-term budget projections look a lot healthier.

Paul Keating introduced full dividend imputation in 1987 to eliminate the double taxation of company dividends. Domestic shareholders are given "franking [tax] credits" worth 30¢ in the dollar on those dividends that have already been taxed at 30 per cent in the company's hands.

Dividends are taxed at the shareholder's marginal tax rate, but less their franking credits. Should they not owe enough tax to extinguish the credit, the balance is refunded to them.

The effect of this for Australian shareholders and super funds is to render company tax little more than a withholding tax, like the income tax businesses withhold from their workers' pay packets.

This means the only significant continuing purpose of company tax is to tax foreign shareholders.

Since the franking credit rate moves up or down with the rate of company tax, Australian shareholders have little or nothing to gain from a cut in the company tax rate. Only foreign shareholders – present or prospective – would benefit.

When you remember how often the nation's chief executives make speeches claiming to have only their shareholders' interests at heart, it makes you wonder why the big business lobby has been so insistent on the need for lower company tax.

One possibility is they see their interests as managers as differing from their local shareholders'. Another is that outfits such as the Business Council of Australia are dominated by executives who owe their allegiance to foreign bosses and owners.

It hasn't suited the government to admit that its promised $48 billion, 10-year phase-down of company tax holds no benefits for local shareholders, only foreigners.

So anxious are the econocrats promoting lower company tax to avoid thinking about the implications of imputation that Treasury got caught overstating the (remarkably modest) benefits in its modelling. A rival modeller had to point out the error.

Smoke signals from Canberra suggest that all the government will manage to get through the Senate is a reduction to 27.5 per cent in the tax rate applying to companies with turnover of less than $10 million a year.

In other words, only small and medium incorporated businesses will get a cut.

Trouble is, almost all the shareholders in such businesses – many of them owner-managers – would be locals, not foreign investors, meaning they're already eligible for dividend imputation and so have little to gain from the lower tax rate.

In which case, their behaviour – their enthusiasm for creating "jobs and growth" – is unlikely to change.

But get this: since almost all the shareholders of small and medium-sized companies get franking credits, the reduced measure's net cost to the budget (less company tax collections, offset by a corresponding reduction in franking credits) is likely to be minor.

It's only when you're handing tax cuts to the foreign shareholders in much bigger companies, as originally planned, that the (mainly unfunded) cost starts to mount up in later years.

So if the smoke signals are right in predicting that, once the government's got the most it can get through the Senate, it will ditch the rest of its original plan, this will greatly improve the 10-year projections of the budget balance.

That's particularly so because the 10-year phase-down was partially funded by the tax increases announced in last year's budget: the further huge hikes in tobacco excise, the cut back in super tax concessions and the crackdown on multinational tax dodgers.

Further smoke signals say that, once the government's got through the Senate what it can of the unpassed, "zombie" spending cuts from its disastrous 2014 budget, it will abandon the remainder.

That will have quite an adverse effect on the 10-year budget projections – which is the very reason it has refused to kill the zombies until now.

Penny dropped? The time to kill off the zombie savings is when you're also killing off your grand plan to cut company tax to 25 per cent.

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Why the growth in wages is so slow

Economists may not be much chop at forecasting how fast the economy will grow in the next year or two, but that doesn't mean they haven't learnt a few things about how economies work that the rest of us could benefit from knowing.

It helps us get a better handle on the future if we remember the macro-economists' rule that economies move in cycles, not straight lines.

So something that's been going down will, one of these days, start going back up, and vice versa.

A related rule is that, at any point in time, what's been happening in the economy will be partly the result of "cyclical" (and thus temporary) factors, and partly the result of "structural" (longer-term, lasting) factors.

At any particular time, the bigger, easier-to-see factor is likely to be cyclical influences; the smaller, harder-to-see factor is the underlying, longer-term structural (or "secular") trend.

Let's use this understanding to look at the present weak rate of growth in wages.

As measured by the Bureau of Statistics' wage price index, wages have usually grown by between 3 and 4 per cent a year in nominal terms, though they got up to 4.3 per cent just before the global financial crisis.

Since their subsequent peak of 3.7 per cent over the year to September 2012, however, their rate of growth has slowed continuously to a pathetic 1.9 per cent over the year to December.

Some people have leapt to the conclusion that employers have finally got the upper hand over workers, so that wage slaves will never get another decent pay rise again and, indeed, will probably see their rises get even more microscopic.

Sorry, it ain't that simple.

The question of what's causing wage growth to be so low is examined in an article by James Bishop and Natasha Cassidy in the latest Reserve Bank Bulletin.

Not surprisingly, they account for much of the weakness as caused by cyclical factors – by the relatively weak state of the labour market.

Note that the fall in the rate of wage growth began after the prices we receive for our exports of coal and iron ore stopped shooting up and started falling rapidly.

When our "terms of trade" – export prices relative to import prices – were improving, the nation's real income was rising strongly (because we could now buy more imports with the same quantity of exports) and it wasn't surprising to see our wages growing strongly, more strongly than consumer prices were growing.

But when our terms of trade began deteriorating, it was equally unsurprising to see wages start growing more slowly, especially relative to consumer prices.

Roughly a year after minerals export prices started falling, the amount of mining construction activity began falling sharply as projects were completed and no new ones were begun.

Thus began a period of weakness in the economy. Mining construction activity contracted and we began the slow transition back to an economy led by the other sectors, which had been held back by the expansion of mining.

Economists expect wage growth to be slower when there's "slack" in the labour market – when unemployment is higher than normal, employers have less trouble finding the workers they need and workers and their unions are less inclined to campaign for big pay rises.

With the actual unemployment rate fairly steady at 5.8 per cent,  but economists having revised their estimate of full employment (known to economists as the non-accelerating-inflation rate of unemployment) down to 4.75 per cent, plus a relatively recent rise in under-employment, there's plenty of reason to expect wage rises to be small.

And, of course, there's less need for big pay rises because consumer price rises have been below the bottom of the Reserve Bank's 2 to 3 per cent inflation target for the past two years.

There's a circular, chicken-and-egg relationship between prices and wages. Wages don't need to rise as much when prices aren't rising much, but prices don't rise much when wages (the biggest cost most businesses face) aren't rising much.

Don't be a victim of what economists call "money illusion". It shouldn't matter to workers how big their wage rises are in nominal terms. What matters is how wages are rising relative to prices – that is, what's happening to real wages.

The good news is that real wage growth has generally been positive in recent years.

The bad news is that real increases have been minuscule, whereas in a normally functioning economy they should grow by a per cent or two most years, as workers get their share of the continuing improvement in the productivity of their labour.

The first point to make is that there are good cyclical reasons for wage growth to be low, meaning that as the economy completes its transition to more normal sources of growth, we can expect a return to more normal rates of consumer price inflation and wage rises.

But here at last is the point: the Reserve's Bishop and Cassidy admit that all the normal cyclical factors we've discussed simply aren't sufficient to fully explain why wage growth is so weak.

That is, there does seem to be some underlying structural change at work. And it's not peculiar to Oz.

"It has been posited in the international literature that low wage growth may reflect a decline in workers' bargaining power," they say.

With all the globalisation of production, all the technological change and digital disruption – plus, in Australia and elsewhere, all the changes to wage-fixing arrangements to shift bargaining power back to employers – that's not hard to believe.

It's a warning to governments that if they want to see their economies return to normal functioning - and workers return to voting for mainstream parties – they should have another think about whether they've got the balance of industrial relations bargaining power right. Doesn't look like it.

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