Corporate income tax in Australia in 2014-15 collected $67.7 billion, or 15.2 per cent of all tax revenue and 4.2 per cent of gross domestic product. The 2016 budget proposed to lower the corporate income tax rate from the current 30 per cent, initially for small business and ultimately to a 25 per cent rate for all corporations by 2026-27. An important question is who will benefit from a lower corporate tax rate?
In the first instance corporations write a tax cheque to the government. In reality companies pass this tax to individuals either as lower after-tax shareholder returns, lower market wages, or higher product prices. There is a general consensus for minimal changes in product prices. The split of the tax between higher returns for resident shareholders, non-resident shareholders and employees, and the net loss of government revenue, are a matter of debate and empirical uncertainty. Key parameters affecting the distribution of the benefits include the time interval, the mix of equity returns to internationally mobile investment options versus geographic immobile options, the response of international capital inflow to higher after-tax investment returns in Australia, and the response of business investment to a lower required before-tax rate of return. There is legitimate debate about, and different estimates of, these parameters.
Corporate Income Tax
The corporate income tax base is a measure of income earned on shareholder equity investments. It is the residual of product sales less outlays on labour, materials, depreciation of capital, debt interest and other taxes, including state taxes and royalties. The return on shareholder funds includes: a normal return to compensate for saving rather than current consumption and for risk taking; economic rent on geographic immobile natural resources and domestic markets, monopoly power, and government provided services and infrastructure; and, quasi-rent on firm specific and likely long term internationally mobile technology and management skills.
Australia is a net importer of funds from a much larger international capital market, and with limited restrictions on the inflow of non-resident funds. Non-resident shareholders are an important share of equity investors in Australian companies, at least 20 per cent and as much as a half. To a large degree, non-residents search the world for higher after-tax returns. If investment returns improve in Australia, either because of new attractive projects such as a mining boom, or a reduction in Australian taxation of those returns, non-residents will allocate a larger share of their funds to Australia.
First Round Effects
Consider the “night after” distribution of a lower corporate income tax rate before companies and shareholders have time to change any investment, production and other decisions. The lower tax rate immediately becomes a higher after-tax income for companies.
In the case of resident shareholders and company income distributed as dividends, under the imputation system, the reduction in corporate tax credits is offset by an increase in personal income tax paid on personal dividend income. That is, no effective change in after-tax shareholder dividend income or of government revenue.
For the share of resident shareholder company income retained by the company for further investment, a lower corporate tax rate means a larger sum to reinvest. In time, government will recoup a portion of the additional income on the larger investment via capital gains tax of the higher share price and income tax on higher future dividends.
For non-resident shareholders, the initial effect of a lower company tax rate is close to a dollar-for-dollar transfer from the Australian government to non-residents. The withholding tax system on dividends and capital gains recaptures almost none of the first round reduction of the corporate tax rate. The more important non-resident shareholders, the larger the share of a lower company tax rate passed to non-residents.
Longer Term Effects
The lower corporate income tax rate increases the after-tax return for non-resident shareholders. The higher return in Australia induces some to shift additional funds from other countries to Australia. This initiates an expansion of Australian company expenditure on internationally mobile investment options. Investment increases until the additional investment drives the pre-tax return down to equate the after-tax return with the opportunity investment return available in other countries.
The complete investment response is estimated to take many years and in excess of a decade. The more price responsive or elastic both the supply of non-resident funds to Australia and the Australian company investment demand function, the larger the investment response and increase of the Australian stock of capital.
A larger stock of capital, together with associated imported technology and managerial skills, fostered by a lower corporate tax rate increases the productivity of, and the demand for, labour. With studies finding the demand for labour to be more elastic than the supply, most of the labour market benefits take the form of higher wages and a small share of more employment. Available studies find that from 30 to 70 per cent of the benefits of a lower corporate tax rate flow to labour as higher real wages. The larger the share of internationally mobile investments in the Australian investment mix, the more elastic the supply of foreign funds to Australia and the larger the investment demand elasticity, the greater the share passed forward to labour.
Government recaptures some but not all of the initial revenue cost of a lower corporate tax rate in several ways. For resident shareholders, the operation of the imputation system, plus higher capital gains taxes, recapture most of their first round benefit. Non-resident shareholders benefit from lower tax on current investments, and they pay the lower tax rate on returns on the additional induced investments. Labour income tax takes a share of the higher wage bill. A larger economy means larger GST, payroll and other tax bases. To the extent a lower corporate tax rate reduces the incentives and rewards for multinational corporations to shift their income from Australia to other countries with a lower rate to minimise global tax paid, there will be a revenue gain, but of uncertain magnitude. In aggregate, the magnitude of the net revenue cost is debatable.
Granted a net revenue cost, the case for lowering the corporate tax rate rests on reducing one of the more distorting and inefficient taxes. Increases in other less distorting taxes and reducing government expenditure are potential offsetting funding options to maintain budget balance.
Further Reading
Cao, L et al. (2015), ‘Understanding the Economy-wide Efficiency and Incidence of Major Australian Taxes’, Treasury Working Paper no. 2015-01.
Dixon, J and Nassios, J (2016), ‘Modelling the Impacts of a Cut to Company Tax in Australia’, Centre of Policy Studies Working Paper, No. G-260, Victoria University.
Freebairn, J (2015), ‘Who Pays the Australian Corporate Income Tax?’, Australian Economic Review, 48(4), 357-368.
Murphy, C (2016), ‘Efficiency of the Tax System: A Marginal Excess Burden Analysis’, TTPI Working Paper 4/2016, ANU.
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