Radical tax proposal to get the country back on track
In this crowded hour of productivity verbiage, will Treasurer Jim Chalmers be the gamechanger and use the big lever on tax?
The big bang reform era’s bounty is encrusted within the nation’s economic strata. From today’s relative stasis, we look back at the Hawkegene and Howardcene periods as ancient times, when we refashioned the ways of working, investing, financing, and creating wealth.
In the two decades after Labor was elected in 1983, material living standards rose by 50 per cent. Take your pick of the metrics – real wages, GDP per capita or labour productivity – all increased by half over 20 years, despite the painful blip of the early 90s recession.
Our living standards are now stuck in a rut, due to the worst productivity performance in 60 years. It’s a global problem, with many factors at play, including a lack of appetite by governments for economic reform.
A recent OECD study suggests up to one-sixth of the global productivity slowdown since 2005 could be due to fading effects of reforms in areas such as energy, transport and communications in the ’90s and early 2000s. Our record stands out as one of the worst in show.
Excavating the past offers lessons, for sure, but this epoch requires a different cadence and calibration. Productivity Commission chair Danielle Wood put it succinctly when she described today’s reform mission as a “game of inches”.
Ahead of the economic reform roundtable, Wood says we collectively need to aspire to a “growth mindset”. Yet we’re conditioned to incremental progress from a tweak here, a little something there. These are the “bite-sized chunks” of action favoured by Jim Chalmers: fiscal tidy-ups, banning non-competes in work contracts, new merger laws, and easier occupational licensing.
According to Westpac senior economist Pat Bustamante, over the two decades to 2020, the mining industry delivered half of the gains in living standards. But with weaker commodity prices and stalled investment, the dividend from mining has evaporated.
“Australia’s luck has quickly run out and it is now clear we can no longer rely on mining to deliver ongoing boosts to living standards,” Bustamante tells Inquirer. “Productivity will be the key moving forward, and historically, productivity growth in Australia has been driven by higher investment in capital items such as technology and infrastructure.”
Post-pandemic, investment has grown only in industries such as energy and ITC, and has gone backwards elsewhere. In new research, Bustamante notes the mammoth shift in resources from the higher productivity market sector (pumped up by mining) to the low-performing, non-market sector (of health, education and public administration), where post-Covid productivity has fallen by almost 10 per cent.
“A decade ago, two in 10 Australians were employed by the non-market sector; today it’s three in 10, and growing,” he wrote. “We are unlikely to see a shift of this magnitude in our lifetimes again.”
As the Reserve Bank’s head of economic analysis, Michael Plumb, detailed in a speech in February, our productivity slide is also due to declining “economic dynamism”. It now takes longer for capital, labour, land and entrepreneurship (the “inputs of production”) to move to higher productivity firms; it also takes longer for firms to catch up to the global frontier of performance and technology.
“Evidence suggests that at least part of the decline in economic dynamism relates to declining competition in the economy,” Plumb said.
“Regulatory barriers also appear to have played a role in Australia, notably in the construction industry. Other explanations include slowing human capital accumulation, declining trade integration, and mismeasurement.”
A big part of the story is the capital strike; since the global financial crisis, non-mining business investment as a share of the economy has fallen by 3.2 percentage points. In today’s dollars, the private sector is investing almost $100bn less in infrastructure, machinery, intellectual property, software and digital tools than the average of the pre-GFC years.
Given spectacular recent growth in employment, it means the amount of hard tools or computing power a worker has at their disposal has been falling (this is known as “capital shallowing”). To get higher rates of productivity growth, we need capital deepening.
Bustamante says we need a broad pick-up in investment to benefit from technological change. “While some may argue investment is less important in a services-based economy, think again – investment actually needs to pick up to keep up with the higher rates of capital depreciation,” he says.
“Policy incentivising investment and risk taking will help deliver our next wave of increases in living standards.”
The PC says in the long run prosperity boils down to new ideas, which are “the feedstock of growth”. One of the big levers the Treasurer has to stimulate investment and create a more dynamic and resilient economy is corporate taxation, which brings in one-fifth of all tax.
In the first of five reports to be released on the “pillars of prosperity”, the PC’s deputy chair, Alex Robson, and commissioner, Barry Sterland, have proposed a radical move that could revitalise company tax and growth.
But first, some analysis about the design of the system, which does not optimise investment. Our statutory tax rate (the rate imposed by law on companies’ taxable income), is high by global standards; the effective tax rate (the rate a company expects to pay, after accounting for deductions and exemptions), is also relatively high.
Robson and Sterland found the current system taxes both “normal” and “above normal” profits, which economists call economic rents, which come about because of market power or are specific to a location (such as a resources mine) and cannot be competed away. As our company tax system taxes both kinds of profits, it can deter investments that would otherwise earn normal returns, at a cost to productivity, employment and wages.
Treatment of depreciation, the approach to losses, and the different treatment of debt and equity financing also distort investment: “These factors ultimately make it less attractive for businesses to invest in Australia, and more difficult for new businesses to enter and challenge incumbents,” the PC said.
The first step in a proposed revenue-neutral package over the medium term and funded within the company tax system would:
• Lower Australia’s statutory company income tax rate for the vast majority of companies to 20 per cent (from 30 per cent or 25 per cent, depending on their turnover); the 500 or so companies with revenue above $1bn would still pay a headline rate of 30 per cent.
• Introduce a net cashflow tax of 5 per cent for all companies. This tax will minimise the negative impact on investment by allowing all spending to be deducted when it is incurred and any losses can be used to offset company income tax liabilities.
The supporting modelling for the inquiry estimates that the proposed first step would increase investment by $7.4bn, GDP by $14.6bn and labour productivity by 0.4 per cent.
The authors say the new net cashflow tax is “expected to create an increased tax burden for companies with revenue over $1bn, but is designed to minimise any negative impact on investment”. They argue both theory and evidence suggest this $1bn threshold will provide “the biggest dynamism and investment ‘bang’ for the government’s buck”.
“The PC’s judgment is that, based on the literature, the investment decisions of smaller companies are likely to be more responsive to changes in the company tax rate, because on average they operate under more competitive and contestable conditions than larger businesses,” the report states. “The reform will also improve dynamism by strengthening smaller companies’ ability to compete with larger incumbents.”
The big business lobby has been calling for a company tax rate cut for years, as well as a permanent instant write-off for investment. The big end of town may need convincing that there will be swings and roundabouts on tax and that we’ll end up with a bigger economy and a more efficient system.
Yet in its submission to the PC inquiry, the Commonwealth Bank said it did not believe that lowering the company tax rate should be a priority, provided there is no change to Australia’s imputation credit regime.
“Targeted interventions to encourage greater investment could be considered, potentially funded by reducing concessions which apply to nonproductive parts of the economy,” it said.
Again, there’s no big bang, rather a gentle assault on the old regime. “A 5 per cent rate will introduce the net cashflow tax to businesses and overseas investors to help them better understand it,” the report says.
“The modest rate will minimise unintended consequences and allow for evaluation and testing of the new tax, laying a base for its further expansion if that is desirable. Over the long term, the cashflow tax will ideally grow as a proportion of the revenue base.”
Chalmers this week said he doesn’t have an ideological view about company taxes and was open to considering “changes that make us more attractive as an investment destination”.
“I’m certainly interested in the more efficient attracting and deploying of capital in our economy,” he told the ABC.
The PC’s proposed method draws on, but is not a copy of, a model outlined in a 2020 academic paper, Replacing Corporate Income Tax with a Cash Flow Tax, by Ross Garnaut, Craig Emerson, Reuben Finighan and Stephen Anthony. That model would, over a decade, phase out the current company tax regime.
“There would be a decisive shift in the tax burden toward enterprises generating income from rent with little new investment, and away from businesses prepared to make large commitments to new investments,” the authors argued.
“The increased incentives for investment would be especially strong in the competitive parts of the economy, where small and medium-sized businesses are dominant.”
Former Treasury official Anthony, now head of macro research at Macroeconomics Advisory, welcomes the PC’s recommendation, with a caveat. “Our cash flow tax proposal was elegant and straightforward, but on top of the existing corporate tax, this proposal appears more complex,” he tells Inquirer. “That said, the PC’s approach is certainly a contribution to the national reform debate.”
In this crowded hour of productivity verbiage, will Chalmers be the gamechanger and use the big lever on tax?
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