ANDREW LEIGH. Why the government’s company tax cut is a carnival sideshow.Jun 9, 2016
In the 1890s, Texan cowboy Clark Stanley began marketing a new product at medicine shows.
A man who could kill rattlesnakes with his bare hands, Stanley promised people that his rattlesnake extract would bring relief from rheumatism, sprains, swelling, back pain and toothache.
It wasn’t until 1917 that Stanley’s operation was finally shut down, with a court finding that the product not only didn’t provide a cure; it wasn’t even made from snakes. And so the term ‘snake oil’ was born.
I’ve been thinking about Clark Stanley since budget night, as Coalition leaders have boldly claimed that a cut to company taxes will whiten your teeth, improve your car’s fuel efficiency and make your chooks lay more eggs.
Yet just as Stanley didn’t want people to read his recipe, so too I’m not sure the Coalition wanted Australians to delve into the Treasury report that underpins their big business tax cut.
Titled ‘Analysis of the Long Term Effects of a Company Tax Cut’, the Treasury analysis makes clear how a company tax cut is supposed to help households. You’ll have to bear with me, because this one’s longer than a scrub python.
Since Australia has dividend imputation, domestic shareholders don’t benefit much. As the Grattan Institute’s John Daley has pointed out, local shareholders only gain if profits are reinvested rather than paid out. However, our firms tend to have pretty high payout ratios, so this turns out to be a modest impact in practice.
So in the first instance, most of the gains go overseas. There will even be some cases in which US-based multinationals repatriate their profits, paying the difference between their higher rate and our lower one.
In such cases, an Australian company tax cut simply flows into the coffers of the US Treasury – meaning that some of the reduced revenue from an Australian company tax cut would be available to be spent by the successors to President Clinton or President Trump.
Having enjoyed the first-round benefits of a company tax cut, the Treasury report then argues that foreign shareholders will respond to higher after-tax profits on their Australian investments. The theory goes that overseas shareholders then invest less in other countries, and more in Australia. More investment means greater demand for land and labour. So in the long run, land prices and wages are supposed to rise.
As Keynes famously put it, we are all dead in the long run – so it’s worth asking how long we’re talking about. And the answer, typically, is 7 to 10 years. Since Malcolm Turnbull’s tax cut only reduces the tax rate on big business to 25% on 1 July 2026, this means that the Coalition is promising to raise wages somewhere between 2033 and 2035. At that point, Turnbull would be in his late-70s, and well on the way to becoming the longest-serving Prime Minister since Robert Menzies.
And how big will the gains be? It depends how you pay for the company tax cut. The Treasury report suggests that tax cuts could be funded by a nationwide land tax, higher personal income taxes, or lower government spending. Since that the federal government last levied land taxes in 1952, that option can be safely set aside as hypothetical.
So that leaves a company tax cut funded by less spending or higher income taxes. According to Treasury, if a big business tax cut from 30% to 25% is funded by lower spending, the boost to households is 0.7%.
But for every ladder in the Treasury report, there’s a snake. In this case, the modelling is based on the idea that none of us get any direct benefits from roads, schools and hospitals.
As the authors note:
‘It is important to recall that the modelling of government spending is assumed not to affect directly the welfare of households. While this is a common modelling assumption it ignores the fact that government spending provides goods and services that would otherwise not be provided by the market sector; households derive direct utility from government spending; and infrastructure spending can improve market sector productivity.
This suggests the results reported in this section overstate the benefits of this funding alternative.’
In other words, Treasury knows that the benefit to households of a company tax cut funded by less government spending will be smaller than 0.7% – they just can’t say how much smaller.
One more reason not to rely too strongly on the idea that we can get a big boost out of a company tax cut funded by lower government spending. Since the Abbott-Turnbull government won office, spending as a share of the economy has gone up, not down.
So that leaves as the most likely option a company tax cut for big business that’s funded by higher personal income taxes. According to the Treasury report, the benefit to households is 0.1%.
How big is a gain in household incomes of 0.1%? To test this, I pulled up data back to the early-1970s, to see how household income (specifically, real net national disposable income per person) has grown. It turns out that over this period, household income has risen by an average of 0.1% each month. So Treasury’s most likely scenario is that a company tax cut delivers an extra month of household income growth.
To see how risible this is, you need to recognise how poorly the economy has been performing for middle-income households since 2013. Living standards are down 4%. Wage growth is at a 30-year low. The home ownership rate is at a 60-year low. Inequality is at a 75-year high, with the top 1% having doubled their share of income in the past generation.
In an environment like that, you might expect that supporting average households would be a national priority. And yet Malcolm Turnbull’s first budget contained precious little for middle Australia. One of its most expensive measures was a tax cut for those earning over $180,000. Ninety-four percent of that tax cut will go to the top 1%.
While the top 1% get their tax cut the day before the election, the benefits of Turnbull’s company tax cut will trickle down very slowly… if at all.
For all the hype, Treasury’s own modelling suggests that the Coalition’s company tax cut will deliver one more month’s growth – in the 2030s. Even the great snake oil salesman Clark Stanley couldn’t sell that as a recipe for ‘jobs and growth’.
Andrew Leigh is the Shadow Assistant Treasurer.
This piece originally ran in Business Insider Australia.