The tax review discussion paper echoed the longtime call from business leaders for a cut to the company tax rate. But while Australia’s company tax rate and our dependence upon such revenue is higher than most other nations, any cut to the tax rate would need to be financed by either increased revenue or reduce expenditure.
Ending dividend imputation – where Australian shareholders receive a credit for company tax when they pay tax on dividends – would be a smart way to finance it, but it seems to be a path Joe Hockey is unwilling to take.
Pretty much every review of taxation over the past quarter of a century has called for a cut in the company tax rate. Cutting the company tax rate is seen as almost a fast track to growth, and certainly all across the OECD, nations for the past 30 years have been cutting their company tax rates:
In the 1980s Australia’s company tax rate was between 46% and 49%, and at the time the average across the OECD was a rate of 48%. By 2003 the average OECD rate was 30% – the same as the rate here in Australia.
Since then however, 28 of the 34 OECD nations have cut their company tax rate, to the point that the average is now around 25%, while Australia’s rate remains at 30%:
And yet while other nations were cutting their rates, we didn’t for the very good reason that not only we didn’t need to, we actually had more investment than we needed.
The investment boom that occurred during the early-mid 2000s was so large that it helped fuel growth in the economy to the point where it was almost overheating. Inflation was rising and the danger was that too much investment was coming into the country at the same time.
Cutting the corporate tax rate at that point would not only have served to throw gasoline on an investment bonfire, it would have also been a case of giving away tax revenue for no good purpose. We didn’t need to do anything to attract investment – the iron ore in the ground was doing that for us.
But now the mining investment boom is no more and thus the pressure is on to cut the company tax rate to encourage investment.
This argument was made by the deputy secretary of the Treasury, Rob Heferen, in a speech just prior to the release of the taxation discussion paper. Heferen argued that cutting the company tax rate could also help improve productivity because it would “increase the capital available for existing labour” – more technology and equipment for each worker to use.
The other reason most tax reviews suggest we need to cut company tax rate is because Australia is more dependent on that revenue than most nations. In OECD nations, only Norway is more dependent on company tax revenue:
Some context is needed, however. Australia has always been more dependent upon company tax revenue than most in the OECD. In 1969 we were the fourth most dependent, a position we still held in 1989, and by 1999 we were third:
And remember this was during a period where our company tax rate was either on or below the OECD average.
One reason our dependency upon company tax revenue is so high is because our companies have been quite profitable and as a result we raise a lot of company tax:
Since 1965, Australia has raised on average 1.6 times the level of company tax revenue compared to the average across the OECD (measured as a percentage of GDP). On that score, our current level of around 1.8 times is not a significant increase.
The Henry tax review in 2010 also looked at company tax rates and noted that while our rate of 30% was higher than others, that was partly due to differences in the measurement of such taxes across the OECD and also because our companies were rather more profitable than most firms across the OECD due to our “natural resources”.
Kevin Davis from the Australian Centre for Financial Studies noted that unlike most countries, one of the differences between tax measurements is that Australia has a dividend imputation regime.
Most other nations have a “classical company tax system” where the company pays tax on its profits and then shareholders also pay income tax on dividends they receive on top of that. We had that system until 1987 when Paul Keating introduced dividend imputation. Under the current system the shareholder is provided a rebate on the tax already paid by the company.
This means that, for example, if you are in the top tax bracket you do not pay 47% tax on your dividend, but rather 47% less the 30% company tax.
The ATO points out that under a classic tax regime in the case of a $100 profit, the company would pay $30 in company tax and the remaining $70 would go to the shareholder as a dividend. The shareholder (assuming they are in the top tax bracket) would then pay 47% tax on that $70 ($33) – leaving just $37 in net income from the dividend.
Under the dividend imputation regime, the company still pays $30 in tax and the shareholder still gets a $70 dividend. But now the shareholder gets an imputation credit of that $30.
It means investing in Australian companies by Australians is actually much more attractive than were we operating under a classical system.
It also means the government raises less tax. Under the classical tax system the government would have raised $63 in revenue, under the current scheme it is just $47.
Davis estimates the dividend imputation regime means for Australian investors our company tax rate is equivalent to around 16% of a “classical company tax rate”. Similarly, in a 2006 paper for Lateral Economics, economist Nicholas Gruen suggested removing dividend imputation would allow cutting the rate to 19% tax rate without any hit to the budget.
And certainly cutting the company tax rate would need to be balanced by increasing revenue or reducing spending elsewhere. Even an optimistic view would be that only around 50% of lost revenue from cutting the tax rate would be made up by increased investment.
But the problem with cutting the tax rate or removing dividend imputation is that mostly overseas companies and current investors would benefit. Overseas investors are unable to access the dividend imputation regime – so they get the full benefit of any rate cut.
For Australians the dividend imputation scheme means they would see little change as they would still be taxed at their marginal income tax rate and they would still get a credit through the dividend imputation system.
Heferen noted as well that a company tax rate cut provides “a windfall gain for existing investments, which were funded on the assumption of a higher company tax rate”.
Foreign investors would get all the benefit of the rate cut. Importantly, Heferen also notes that this money could leave the country. “If investors repatriate this gain, the Australian economy does not benefit,” he said.
In its submission to the corporate tax avoidance inquiry, David Richardson of the Australia Institute noted that while many suggest we need to lower our interest rate to attract investment, the reality is most of our foreign investment already “comes from Asian countries with much lower company tax rates”.
He also noted that the difference between Australia’s company tax rate and most major economies was “small – plus or minus five points” and that this “hardly matters compared with tax havens that often have no tax at all”.
Richardson also argued that only looking at company tax rates ignores the impact of the top marginal tax rate, and imputation. Looking at both sees “what happens to a dollar of taxable corporate income by the time it is received in the hands of investors on the top marginal tax rate in that country”.
On this score we have the 14th highest rate and are just 3.4 percentage points above the average:
For the moment, the treasurer Joe Hockey seems unlikely to touch either dividend imputation or even lower the company tax rate. He told the Australian Financial Review last week that dividend imputation had helped to “influence the culture of the nation” in becoming “one of the biggest share-owning nations in the world”.
That’s a pretty week argument. It’s a bit like saying we can’t get rid of negative gearing despite it distorting the housing market because it has helped introduce a culture of people buying investment properties.
Also, nearly 50% of share dividends value goes to those in the top tax bracket:
If we are to cut the company tax rate, removing the dividend imputation would be a progressive way to fund it. But given the number of self-funded superannuants who rely on dividends, Hockey would need to persuade them that the lower tax rate would see little change to their income and any new investment due to the tax cut would see the value of their shares rise.
That’s a tough sell, but for a treasurer desperate to find revenue and also looking to reform the tax system and encourage business, it might be one he needs to make.
