Joe Hockey Tony Abbott

Is cutting the corporate tax rate a good idea? The Business Council thinks so — it wants to increase the GST on the rest of us to cut the company tax rate to 25%. The Australian Chamber of Commerce and Industry thinks it’s a good idea, albeit for the nebulous reason that it will “boost confidence”. The Coalition thought so in 2010, when it proposed a 1.5% company tax cut in that election campaign. But then the Coalition went off the idea and when Labor tried to cut the company tax rate by 1%, they joined with the Greens to block it.

The Coalition and the Greens, a unity ticket on blocking company tax cuts. Whodathunkit?

And Labor used to think so — Kevin Rudd’s original mining tax funded a 2% tax cut, curbed to 1% in the Gillard version, but after the Coalition and the Greens blocked it, Labor decided it had better things to do than wait for the business community to lobby the party of business to get behind a business tax cut.

Labor’s policy of course was based on the Henry Tax Review, which backed a corporate rate cut. The fact that Australia had a high corporate tax rate compared internationally meant, that review concluded, that we should reduce “the company income tax rate to 25% over the short to medium term, as fiscal and economic circumstances permit” — albeit coupled with a change in non-renewable resource rent taxation.

That important caveat was missing from this morning’s announcement by the Coalition of a 1.5% corporate tax cut, intended to offset its 1.5% tax rise on medium and large business to fund Tony Abbott’s paid parental leave scheme — the one the rest of his party and the Nationals hate.

The Coalition has declined to explain how the tax cut, likely to cost $5 billion over four years (the costing compared to the predicted cost of Labor’s tax cut is significantly lower, reflecting lower corporate tax revenue growth expectations) will be funded. “We are confident that the company tax cut will deliver some partially offsetting benefits to the budget bottom line over the medium term,” Abbott announced this morning. This, of course, is supply side nonsense, articulated by economist Arthur Laffer, that cutting taxes produces higher tax revenue, which has been repeatedly mocked by economists and shown to be wrong in practice.

George H. W. Bush called this sort of thing voodoo economics and he was proven to be right by the tax history of his, his son’s and the Reagan presidency.

Interestingly, though, the Business Tax Working Group last year wasn’t so enamoured of a corporate tax cut, having found some businesses, namely mining companies, didn’t like the idea of cutting tax concessions in order to fund cutting the headline rate:

“… the economic benefits from a reduction in the company tax rate from the current rate are likely to be smaller than when the rate was much higher in the 1980s and 1990s, notwithstanding that capital may have become more mobile since then. The Working Group considers that a cut of two to three percentage points would be required to drive a significant investment response …”

So, the Coalition line that a tax cut will drive greater investment and more jobs might be a little, shall we say, overstated.

Indeed, the Canadian experience — they’ve been cutting corporate taxes regularly since 1988 — suggests there is no evidence that cutting corporate taxes increases investment — if anything, lower corporate taxes there have accompanied a decline in business investment

Cutting taxes for companies has a different impact than cutting tax for individuals (the stimulus value of which is also problematic — many people save their tax cuts, rather than spend them). Companies can spend the money paying shareholders a higher dividend, or pay company executives higher remuneration or directors higher board fees. Super funds and other big investors will press companies to pay as much of the lower tax bill back to them by way of higher dividends. That will flow into higher fees for the super fund managers and their advisers, with anything left over going into the funds themselves for policyholders.

It’s higher aggregate demand boosts company sales and revenues (and, ideally, profits), not lower company tax — particularly if, as the BCA wants, you raise the GST to fund it. Australian companies have been saving as much of their surplus cash, echoing what consumers and mortgage holders are doing at the moment. In fact, Australian companies have an estimated $100 billion in cash tucked away in their bank accounts (much of it in the major banks on term deposits earning not very much).

That cash pile has been rising for the past three years — ever since super funds and other investors bailed out these big companies in and just after the GFC with more than $120 billion of new capital and loans. Companies have been slow to spend this money on new investment because of weak demand in the economy, not high taxes.

That makes it problematic to see how a 1.5% tax cut, in two years time, will help the economy grow and create more jobs — not for the next two years when the economy will be at its most vulnerable during the move from the resources investment boom to growth driven by higher domestic demand.

A far smarter idea for Joe Hockey and Tony Abbott would have been to look at the entire area of corporate tax, which includes dividend imputation, the tax deductibility of interest payments and depreciation. All should be put up for discussion — if you lower corporate tax, then dividend imputation is less needed as is tax deductibility for interest payments. Imputation costs the budget an estimated $18-20 billion a year by some estimates. The tax bill for interest payments is also substantial while depreciation is wreaking havoc on the budget at the moment and will do so for years because of the impact of the enormous mining investment boom.