Swan’s budget is a lame effort from a dying government

Lame duck, dying swan - headline writers have had fun with the treasurer’s sixth budget, but the fact is this budget will be remembered for its fiscal irresponsibility. Image sourced from www.shutterstock.com

It has been pretty difficult to get too excited about the latest budget – it is a lame Swan effort from a dying government. It will mostly be remembered as a monument to fiscal irresponsibility.

The budget deficit will come in at some A$19.4 billion this financial year after the MYEFO forecast a A$1 billion surplus. That is a A$20 billion turn-around in seven months.

So far Wayne Swan has accumulated $191.7 billion of accumulated budget deficits.

The government is wont to quote Lord Keynes arguing that the facts have changed and so too the budget strategy has changed. Yet scrutiny of the budget papers doesn’t support that claim.

When you untangle the impact of policy choices and so-called parameter variations on the budget since 2007 you find that policy choices have driven the deficits. The facts haven’t changed so much as the government has spent too much money.

Over the same period forecast revenue has been over-estimated by A$133 billion. This is explained by the difficulties of forecasting revenue from the corporate income tax and the failure of the mining tax to raise any significant revenue.

So while everyone is focused on the spending side of the budget, I want to look at the taxation side and especially the corporate tax side of the budget. We have come a long, long way from the 2010 budget where the government was promising to cut the corporate income tax rate.

There were some significant announcements in the corporate tax area. In the first instance, the budget builds on a policy introduced in the MYEFO just six months ago. Last October it was announced that “large” businesses would be required to remit their tax to the Australian Taxation Office on a monthly basis as opposed to a quarterly basis. That was expected to raise some A$8.3 billion over three years starting in July 2013.

This policy has now been extended – even before being actually implemented – to trusts, superannuation funds, sole traders, and large investors; it is expected to raise an additional A$1.4 billion over two years beginning in July 2015.

This policy was already scheduled to expand from corporates with a turnover of A$1 billion to corporates with a turnover of just A$20 million in July 2016 – expected to be some 10,500 companies. This policy will have, at least, two effects. First it is likely to drain working capital out of the small business sector making it difficult for those firms to continue their operations. It will also massively increase the compliance burden of paying tax.

That increase in compliance – especially for small business – will not actually raise very much additional revenue. According to the ATO’s latest Taxation Statistics the top 4000 corporate entities pay 77.8% of net corporate income tax.

I suspect the extension of this tax policy beyond very large corporates will never actually happen. It is safe to assume the Coalition, in government (a very likely outcome of the September election), will not implement it.

The Coalition is already under pressure from its small business constituency over the decision to increase the superannuation levy from 9% to 12%. It is true the incidence of the levy ultimately falls on employees, but in the short-run it is likely to be paid by employers. Massively increasing tax compliance will lead to some very unhappy constituents, donors and pre-selectors.

The other corporate tax policy that particularly caught my eye related to so-called “thin capitalisation”. This is also called profit shifting. What happens is that foreign subsidiaries operating in Australia are burdened by high levels of debt by their parent company and required to pay interest on that debt. This has the effect of reducing their liability for Australian corporate income tax.

The important issue here is whether this is primarily a tax avoidance mechanism (something that is already illegal the general anti-avoidance provisions of the Tax Act) or whether there is some economic logic that underlies the practice. I am of the view that the economic logic is two-fold. First it is a mechanism whereby foreign investment is facilitated.

It is important to remember that foreign investment is risky and debt provides some security to foreign investors that they would be in a position to recover some of their investment. Then we should consider that debt has good corporate governance characteristics – viable firms with high levels of debt are less likely to squander funds on frivolous expenditure.

All up there are very good reasons why foreign investors are likely to employ high levels of debt. It allows them to have greater control over their foreign operations while reducing the risks that they may face. Reducing taxation is an added bonus.

Increased economic activity is far more valuable to Australians than the marginal increase in taxation that multinational corporations may pay if this policy were implemented. So it sounds good, but will we be better off for it? I suspect not.

Other changes to corporate taxation were also mostly underwhelming. Reducing the eligibility for the research and development tax credit makes me wonder whether it is a good policy at all, while changing depreciation allowances when the mining investment boom looks like it might be ending seems somewhat trivial.