The Henry Tax Review identified 125 taxes within Australia levied by all levels of government. Of those 125 taxes, just 10 taxes raised 90% of all tax revenue. The company tax is the second largest source of revenue to the Commonwealth. This consideration immediately suggests two points:
The Australian company tax is a successful tax in that it generates substantial revenue.
The integrity of the company tax is particularly important for public finance purposes.
Yet the public debate seems to suggest that the integrity of the Australian company tax system is compromised. Late last year the Tax Justice Network Australia released a report that suggested widespread tax avoidance, if not outright tax evasion. In particular, it claimed:
The average effective tax rate of the ASX 200 was 23%, and
If the ASX 200 were paying tax at the statutory rate an additional A$8.4 billion could be raised in company tax revenue.
While these claims were well received in parts of the Fairfax press and the Australian Broadcasting Corporation, Australian Treasury officials testifying at Senate Estimates were nonplussed. Referring to the 23% average effective tax rate, Rob Heferen, executive director of the Treasury Revenue Group, told the Senate, “I must confess I was surprised it was so high”. That comment in turn suggests two things; first deviations between average effective tax rates and the statutory rate are not unusual and, more importantly, it is very unlikely that $8.4 billion could be raised by increased compliance activity.
In short, there is no fiscal free lunch. If government wants to raise more revenue in taxation, it is going to have raise taxes.
When thinking about Australian company tax, the first thing to understand is that financial accounting is very different from tax accounting. The former communicates information to shareholders while the latter communicates information to taxation authorities. There is far more leeway in how firms communicate to shareholders than there is to the tax authorities. As such we expect to see differences between effective tax rates calculated from information contained in annual financial statements and the statutory company tax rate. That difference can be calculated from the ATO Tax Statistics.
In the academic literature that difference is referred to as “the book-tax income gap” and has been extensively studied by academics. Alfred Tran summarises the book–tax income gap (emphasis added):
The major causes of the book-tax income gap are attributable to deliberate government policies and different objectives of the tax and the financial reporting systems. Tax incentives, dividend rebates, concessional treatment of capital gains, and non-deductibles are all the results of government policy decisions. There are good economic, political, and administrative reasons for these policies.
In short – not only does the ATO know about the book – tax income gap, it is a direct result of deliberate government action.
So the mere existence of a book–tax income gap doesn’t necessarily mean there is widespread tax avoidance. On the other hand just because we can explain the gap doesn’t mean that some firms aren’t avoiding company tax either.
There is an argument that suggests that large companies are more likely to avoid taxation than are small companies – that was the clear implication of the Tax Justice Australia report. Alfred Tran and Richard Yu suggest that large firms can afford better tax planning activities: that is, engage in aggressive tax minimisation and are better able to “influence political processes in their favour”. Grant Richardson and Roman Lanis (2007, 2008) are predisposed to the latter view pointing to a “political power hypothesis” that suggests an inverse relationship between firm size and effective tax rates.
By contrast in joint research with Richard Heaney of the University of Western Australia, I find evidence of a “political cost hypothesis” – the notion that larger firms would be subject to greater scrutiny from the taxation authorities leading to higher effective rates of taxation. Heaney and I conclude:
Claims that larger firms are paying substantially less than the headline rates of taxation or even less than smaller firms should be viewed with some caution. This in turn suggests that policy efforts to increase revenue from the corporate tax by closing the book-tax income gap are less likely to be successful. In other words, increased enforcement of existing tax laws is less likely to raise revenue relative to policies that reform the tax base or change the tax rate.
So the very companies that more likely to be in a position to engage is tax avoidance attract the attention of the tax authorities and are so unable to avoid much tax at all. That should provide some confidence that large companies are not engaged in widespread tax avoidance.
This still does leave unanswered the question as to whether multinational companies are able to pay less tax than purely domestic firms. Kevin Markle and Douglas Shackelford explicitly investigate this question. They employ data for 11,602 companies over the period 1988 – 2009 across 82 countries (including Australia) to investigate the impact of domicile on company effective tax rates.
After controlling for country, industry, and firm effects, they report that multinationals and domestic-only firms face similar effective tax rates. In the case of Australia, they report, everything else being equal, domestic-only effective company tax rates and multinational corporation effective company tax rates vary by 1% and that difference is not statistically significantly different from zero.
All up, the integrity of the Australian company tax system is sound. That isn’t to say that there aren’t some companies that cut corners and evade tax when they should be paying tax, but there is precious little evidence of systematic rorting of the company tax system. That reflects well on the efforts of the ATO who police the system - but it does make life difficult for politicians hoping for quick and easy fixes to the budget deficit.