If something sounds too good to be true, it usually is. Such is the case with the Productivity Commission’s proposed new cash flow tax for corporate Australia.
In fairness, the commission was handed an unfair and unenviable task: propose reforms to the business tax system that boost investment, don’t stretch beyond the business tax remit, and make sure they’re not a big hit to the federal budget.
To balance these goals, the commission proposed that the corporate income tax rate be lowered to 20 per cent for companies with turnover under $1 billion and retained at 30 per cent for those above the threshold. The revenue shortfall would be recouped through an additional 5 per cent cash flow tax on top of the corporate income tax.
And in time, the cash flow tax would replace the existing corporate income tax system.
But the commission’s proposal is complex, is unlikely to be budget neutral in the long term, and probably won’t boost business investment as it hopes.
Why wouldn’t the reform be budget-neutral in the long term?
While the new cash flow tax might be budget neutral when operating alongside the existing corporate income tax, replacing it wouldn’t be.
In fact, the costs of transitioning to a cash flow tax are massive (and omitted from the commission’s report), which is why no country has ever instituted a national one.
First, since depreciation disappears under a cash flow tax, how you treat undepreciated assets during the transition matters. When New Zealand considered a cash flow tax (which it did twice and opted against), it realised that allowing firms to deduct the remaining unappreciated value of pre-existing assets upon transition to the cash flow tax would have blown a big hole in the budget and led to higher income taxes on workers.
Second, businesses need time to adjust from a system that incentivises debt and permits the deduction of debt interest to one that eliminates it.
Third, the legal implications of a cash flow tax for our existing international tax treaties are murky. When Norway considered introducing a cash flow tax, which it also opted against, a sticking point was that the different treatment of income and costs in different countries could lead to double taxation (with flow-on investment effects).
Fourth, by design, the financial sector – one of the largest contributors to corporate tax revenue – is excluded from the cash flow tax. So, another tax would be needed to offset the revenue shortfall.
Rather than setting out a path for long-term reform of corporate taxation in Australia, the commission’s proposal leads us down a cul-de-sac.
So what about the purported investment gains?
In theory, corporate taxes, such as a cash flow tax or an allowance for corporate equity, spur investment by only taxing above normal returns (super profits), something our current corporate income tax system doesn’t (exclusively) do.
Among large companies, a cash flow tax won’t increase investment since it is payable in addition to the 30 per cent corporate income tax. The commission reasons that this structure will raise more revenue from the big miners that arguably should pay more tax, but at the expense of raising taxes on other large, more globally mobile businesses, which are likely to choose to invest elsewhere.
For future investors, it’s hard to see how a complex combination of two, cumulatively high, corporate taxes lures them.
Meanwhile, while the commission’s proposal would reduce the corporate rate for medium and small-sized businesses, these companies have had access to a suite of investment incentives since the global financial crisis, with limited effect.
Small businesses can also exploit tax settings available across both the personal and corporate tax systems. The ability to split income and use a combination of trusts and company structures implies small businesses already access a maximum 25 per cent income tax rate. That’s before adding self-managed super to the mix. For them, a cash flow tax is unlikely to achieve anything, except a headache.
So, where to from here?
First, if broad business tax reform is desired, replacing the corporate income tax with an allowance for corporate equity is a more sensible and less risky approach.
As our 2022 report, Corporate Income Taxation in Australia, shows, an allowance for corporate equity achieves the same investment incentives as a cash flow tax, but without the transition costs or need for a separate tax on the financial sector.
The commission ruled out an allowance for corporate equity because it was too costly, assuming the corporate tax rate would need to increase to offset the revenue loss. But one of the benefits of the allowance for corporate equity is that its generosity can be pared back quite substantially to fit the budget envelope, without increasing the rate.
Second, to point out the obvious, many businesses are not captured, or are only partially captured, by the corporate income tax system. Policy reviews directed at increasing business dynamism, which exclude the personal income tax system from their remit, are incomplete.
A more serious attempt to build an efficient, sustainable, and equitable tax system means looking beyond the corporate tax system for budget-neutral reforms.
The Productivity Commission was given an impossible task, but even this task has better answers. It’s no surprise that others agree.
First published at the Australian Financial Review on Monday 22 September 2025.
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