When politicians talk about business tax reform, and talk about using it to stimulate investment, they are usually referring to one of (or a mix of) three things:
cutting the company tax rate
offering investment incentives
broader corporate income tax reform.
The first two change features of the system, the last one changes the system itself.
Industry Minister Husic’s much-talked-about remarks at a Financial Review summit on Tuesday touch on all three.
Asked whether, with investment in manufacturing shrinking, Australia needed to look at the 30% company tax rate, Husic replied
I believe, in the strongest Labor traditions, we need to be able to bring business and labour together […] How we do that, either through corporate tax reform or the way in which we provide investment allowances for the uptick in manufacturing capital, that is something long term, I think, does need to be considered.
But what should Australia do; change the features, or change the entire system?
Should we cut the rate?
Globally, corporate income tax rates have been falling since the 1980s.
Across OECD countries, Australia’s current company income tax rate – the 30% rate applicable to large companies – is only exceeded by Portugal and Colombia.
So if most other large industrial countries already have corporate income tax rates lower than Australia’s, shouldn’t Australia reduce its rate too?
No, it shouldn’t. Australia’s rate is high relative to other OECD countries for a good reason: Australia is rich in natural resources.
When Australia’s Mineral Resource Rent Tax was abolished by the newly-elected Coalition government in 2014, the higher company tax rate picked up the slack.
About half of all company tax collections come from mining and finance, and company tax is the government’s second-largest source of revenue.
Small businesses get a lower rate: 25%. For some of those that use trusts, it can be lower still.
What about investment incentives?
Investment incentives, including accelerated depreciation, apply only to companies that actually make new investments.
Unsurprisingly, this makes them more effective at stimulating investment than cuts in the company tax rate that apply whether or not companies invest. The international evidence is clear on their impact: they boost investment.
Australian evidence about the measures introduced during the global financial crisis is consistent with this finding, although forthcoming research suggests that investment incentives introduced after the crisis might have been less effective.
They don’t spur all types of investment equally. By design, they disproportionately benefit companies that invest in expensive machinery with a long life (and stimulate investment in them).
So what about companies that don’t quite fit this bill? Those that don’t have many expensive, long life assets to depreciate but that we still want to thrive in Australia?
Better still, an allowance for corporate equity
In 2022, Robert Breunig, Alex Evans and myself suggested replacing our system with one built around an Allowance for Corporate Equity (ACE).
It would tax company income only after deducting an allowance for a reasonable rate of return on the capital invested.
This means it would tax some companies barely at all – those that made only a reasonable rate of return on the capital invested.
It would tax other companies – those that make returns that exceed a reasonable rate – more highly.
What could it achieve that our current system does not?
Imagine I ask you (the reader) for a $20 cash investment in my burgeoning company. Then I add that I’ll give you back the $20 in 30 years. I suspect you’ll say no, you want a return. I’ve no choice but to give you a return; otherwise I won’t get investment.
And that return will be taxed anyway, as income in your hands. It’s not clear why I should have to pay tax on it, given that’s a business cost.
If the $20 was a loan, I would be able to deduct my interest payments as a business cost.
An ACE would treat the payment of an ordinary return to an equity investor (say 6% per annum) the same as a 6% interest payment on a loan.
The current absence of equal treatment has serious consequences.
It encourages the use of debt rather than equity. Companies that are funded by equity have to generate a higher return than those funded by debt to stay afloat and pay their tax bill.
Some can’t. Relieving them of the need to pay tax on ordinary returns to investors would keep more of them afloat and get more investors to invest in the first place.
The ACE rate could be the bond rate
My coauthors and I have suggested setting the ACE rate at the ten-year government bond rate, which is currently 4.4%. Returns above that would be taxed, returns below it would not. Some would be below it.
Austria, Brazil, Belgium, Croatia, Italy, Portugal and Türkiye have experimented with such a system.
In countries where the ACE has been evaluated, it seems to have boosted investment without the need for a special incentive. It applies to all companies, regardless of what they produce.
Former Treasurer Wayne Swan became keen on the idea after the 2011 business tax summit. He dropped it after there was insufficient support from business.
Ed Husic’s remarks suggest it might be time to take another look.