Guest Post: Michael Potter Big business is bad

A standard refrain of the left is ‘big business is bad’. It pops up in many guises, and the latest is in a claim that corporate tax cuts will disproportionately benefit Australia’s largest companies. We are told the largest 15 Australian businesses will supposedly receive one third of the ‘benefit’ of a tax cut, and these top companies are unlikely to increase investment in response, particularly because these businesses are oligopolies with significant market power.

But yet again these claims don’t stand up to scrutiny. A better analysis provides significant support for the tax cut.

First, the report tells us big businesses aren’t investing. On this the report is right: overall business investment levels are plummeting, and this isn’t just because of the end of the mining boom — non-mining investment is flatlining at historically low levels.

However, this goes against the report’s conclusion, and strongly supports the case for the tax cut. Australia’s investment performance is declining relative to other rich countries, so this is likely due to a worsening in our relative competitiveness. And a prime determinant of our uncompetitiveness is our tax on investment through company tax. We once had a company tax rate around average for OECD countries, now it is well above average.

Second, contrary to the report, various studies show corporate taxes are actually more harmful, not less harmful, when businesses have more market power, and the adverse effect of the tax on wages is larger. So if Australia is dominated by oligopolies — a debatable point, but let’s concede it for the moment — this makes corporate tax cuts more urgent, not less.

Third, the supposed benefit to big business is transient and small. The report argues that the top 15 companies will capture a ‘benefit’ of $6.7 billion in 2026–27, but this is wrong. The report fails to account for the Australian imputation system which fully offsets company taxes on dividends (distributed profits). In simple terms, imputation means dividends are subject to tax at a shareholder’s personal tax rate and the company tax rate is irrelevant. Assuming big businesses continue their current dividend payout ratio of 67%, this slashes the supposed ‘benefit’ to the top 15 businesses to $2.2 billion.

And the report’s author can’t get away with ignoring imputation: the same author previously argued that analysis of company tax should incorporate imputation.

In any case, this supposed benefit is ephemeral: the tax cut is phased in so that many business assets bought at the current higher tax rate will be mostly depreciated by the time the lower tax rate is in place in 2026–27.

Finally, the increasing reliance of tax revenue on a small number of large businesses is actually exposing the government to increasing risks. For example, BHP’s tax payments plummeted by $2.2 billion over one year (2013–14 to 2014–15) with the end of the mining boom. Australia is also more exposed to the possible risk of big businesses moving offshore, something that has been happening in the US.

So if we accept (for the moment) that Australia is dominated by big business, then the case for company tax cuts is strengthened not weakened. It’s yet another failure in the left’s arguments against big business.

Michael Potter is a Research Fellow in the Economics Program at the Centre for Independent Studies and author of the CIS research report Fix it or fail: Why we must cut company tax now and the feature article The looming crisis in business investment in the Summer 2016 edition of Policy magazine.

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23 Responses to Guest Post: Michael Potter Big business is bad

  1. Malcolm

    The top marginal tax rate should be cut before the corporate tax rate. We should reduce not increase the gap between the corporate and personal tax rates. Arguments by Potter et al are sophistry. Don’t they understand dividend imputation and the incidence of tax? A corporate tax cut is only a tax cut for foreign investors.

  2. A corporate tax cut is only a tax cut for foreign investors.

    Well that’s not right. It is a company tax cut is a tax cut on retained earnings as well. I discuss this in detail in my research report Fix it or fail: Why we must cut company tax now (linked above), see Box 1.

    The top marginal tax rate should be cut before the corporate tax rate.

    Both are worthwhile doing. But the only proposal on the table at the moment is a cut in company tax.

  3. Infidel Tiger

    A corporate tax cut is only a tax cut for foreign investors.

    Not this rubbish again.

    The top marginal tax rate should be cut before the corporate tax rate.

    Both should be zero.

  4. .

    A corporate tax cut is only a tax cut for foreign investors.

    Only if you believe no Australians own companies or shares in companies or that there are no Australian companies.

    Which is bizarre, to say the least.

  5. Nicholas (Unlicensed Joker) Gray

    The only good tax is a repealed one!

  6. mundi

    Don’t know why there is talk of cutting taxes when there is no talk of cutting expenses. When the budget is in surplus and ABC isn’t getting a $1b per year, let me know, they we can bother to talk about tax.

  7. Dr Faustus

    I have some sympathy for AI’s questioning whether the rather modest tax cuts will actually encourage large-scale investment, innovation and employment.

    Australia suffers from well-known competitive disadvantages that discourage large-scale investment: third-world regulatory/government policy risk, high labour costs, restrictive work practices, complex and expensive business compliance, a trivial domestic market to develop from, remoteness from international markets and eye-watering energy prices. And then high tax rates.

    Exactly as AI suggests, Australia is not a natural place to drop big licks of employment-creating capital (innovative, or not). Not unless you have a monster competitive advantage that offsets the disadvantages such as an essential product and an impenetrable domestic barrier to entry, or good title to a world class mineral/agricultural resource fixed to the land.

    Given the mainly self-inflicted shit-list noted above, I doubt that fiddling with the corporate tax rate is going to deliver us a Top- 15-scale, employment-rich, high-tech widget-manufacturing industry, exporting to markets around the world.

  8. mundi

    There is ZERO political push for deregulation of anything.

    The liberal government *barely* stops market crushing regulation (example: The Road Safety Remuneration Tribunal).

    If they can only sometimes stop new bodies from crushing the market, how can we expect them to roll back long established rent seekers both inside and outside of government?

  9. Malcolm

    I don’t agree Michael Potter. Retained earnings ultimately become dividends and hence taxed at the marginal tax rate. There is no doubt that a cut in the corporate tax rate benefits principally foreign investors – Peter Costello and the Treasury knew this back when I worked there. But Treasury is a pale imitation of its glory years and they now promote a myth that there are major economic gains from cutting the corporate tax rate. No, no a thousand times no. Cutting the top marginal tax rate has much larger benefits to the Australian economy. For a given $X cost to revenue, a cut in the marginal tax rate delivers more bang for the buck. This is not to say that corporate tax rates should not ultimately be cut. But in today’s climate of a large budget deficit, the focus should be on personal income tax rates.

  10. Malcolm

    It is exactly the same as tariff reductions. The marginal excess burden increases with the rate – hence the largest gains go to the reduction of the highest marginal tax rates.

  11. Waz

    The left are keen to state ad-nauseum that corporate tax cuts largely go to “the top end of town”. Given large corporations in Australia are now dominantly owned by local instos and superfunds this is rubbish, as the dominant beneficiaries of those investments are of course working people and their retirement incomes. Sure there is off-shore leakage, but hey, we also invest in off-shore companies and we benefit from their lower company tax rates already.
    The CIS should present some analysis of ultimate ownership distribution to put some sense back in the debate.

  12. B Shaw

    Waz, some analysis of ultimate ownership distribution . . sense . . in the debate.

    But it’s: ad nauseam
    Please. It’s needles to my eyes when people do the wrong thing with Latin.

  13. Waz

    add norzeum looks better. Geologists are not well known for their spelling ability!

  14. B Shaw

    🙂 Well, you’ve got broad shoulders.

    You could always go with “vomitabo”.

  15. Malcolm

    I’m no leftist yet it is easy to show that the benefits of a corporate tax cut go to foreigners. How stupid do you have to be to not understand this?

    Foreign investor X, no dividend imputation, receives the dividend from the Australian company and franking credits have no value. Hence reducing the corporate tax rate benefits the foreign investor – other things being equal the lower corporate tax rate means higher dividends.

    But the case for the domestic investor is quite different. For the sake of simplicity assume the top marginal tax rate is 50% and the the corporate tax rate (ex ante) 30%. An investor on the top marginal tax rate gets a franking credit of 30% and ends up paying tax on the dividends of 20%.

    Now the corporate tax rate is 25%. The same top marginal tax rate payer now pays tax on dividends of 25%.

    The domestic resident on a zero marginal tax rate would get a rebate of 30% before the corporate tax rate and 25% after the tax rate.

    So if 95% of the ownership of the companies is domestic, the net tax payable by individuals shifts only because the company pays less tax but the individuals more tax. It is only the foreigners who actually benefit. As for Potter’s sophistry about retained earnings – that is the same as higher debt leading to higher taxes – it is like Ricardian equivalence.

    So in respect of domestic investors there is no revenue impact from the tax cut, but there is for foreign investors. Hence a corporate tax cut is ENTIRELY a tax cut for foreigners.

    I want lower taxes for Australian citizens. The only way to achieve this is through a cut in income tax – especially the top marginal tax rate. That would lead to increased economic activity.

    So those who want a corporate tax cut in preference to an income tax cut want to look after foreign investors at the expense of Australian taxpayers. They are traitors and should be deported.

  16. Irreversible

    I do wish that people would worry less about taxing and more about markets. The obvious problem in the larger corporate situations is consolidation. It’s the reason today that investment bankers have cult status. Our boards and managements have been “growing” for decades by reducing competition through merger rather than pursuing opportunity. I reckon that’s why they fail overseas. (Banks, BHP’s six most recent major forays, Rio’s Alcan debacle, Woolworths, etc) Even the wood duck as the ACCC has finally noticed that our markets are not robust.
    Strong competition has proven time again to be the best way to improve citizen’s overall welfare. Just look at what it has done to cars since we dumped protection. A way better benefit that a marginal tax cut.

  17. Enthalpy

    One thing always puzzles me. The total tax take from any company operating in Australia is the sum of the taxes they pay on profits plus the tax they remove from workers pay packets. When this is discussed in parliament or the media they only ever talk about the tax paid on profits by the company and they fail to consider the taxes paid by the company on behalf of their workers even when they are operating at a loss.

    Why do taxes need to be separated in this way? Would it not be fairer to remove the personal income tax for wage earners and only tax business on sales? And, for individuals who have income from non wage earning activities such as interest bearing deposits, investment properties or stock investments the tax rate should be the same as for businesses, for incomes above the minimum wage level.

    This would simplify the tax system and reduce the cost of products and services, because when you increase the taxes paid by companies by 1 % the cost of products go up by 2 – 5 % to the consumer. Therefore excess tax levels place an unconscionable burden on all members of our society.

  18. .

    A non-marginal, meaningful tax cut could entice more foreign comp. and unlock domestic equity as well…

  19. Malcolm – Treasury’s modelling assumes, as you do, that the entire effect of a company tax cut is on foreigners alone. And yet making this assumption, they find that the tax is still the most inefficient federal tax. More inefficient than personal tax by a considerable margin. It is much more complicated than just comparing tax rates.
    Here it is:
    I argue that Treasury’s modelling underestimates the benefit of corporate tax cuts because of retained earnings. It probably underestimates the benefit of cutting the top marginal rate, but you’ll have to do better than argument by assertion to show that company tax is less inefficient than the top marginal tax rate.

  20. Ray

    Treasury has never modelled the efficiency of incomes taxes for the differing marginal rates. They have only calculated income tax at a flat rate equal to the effective average tax rate on household income given that their CGE model employs a representative agent rather than providing a model for all agents. Thus no one could be in a position to argue the relative efficiency of company tax against the top marginal tax rate based upon the Treasury modelling.

    So if Malcom needs to do better than argument by assertion, Michael Potter equally needs to do better for he has not shown that marginal excess burden does not rise with the marginal tax rate. Indeed, this is a proposition which Treasury themselves accept in principle even though they were not able to model this.

  21. Ray

    To the extent that corporate profits are paid out as dividends, it is correct to argue that a company tax cut has no meaning for Australian shareholders. Those shareholders receive a franking credit for all company taxes paid on such dividends which effectively eliminates the company tax such that the only tax applicable is the individual’s own marginal tax rate.

    Of course, where profits are retained, then company tax is applicable. Now Malcolm would claim that ultimately those retained profits will be paid out as dividends whereupon the franking credit will come into play once more and the only tax applicable will again be the individual investor’s marginal tax rate. However, this is not what happens in practice.

    Retained earnings are rarely paid out as dividends. Instead, the funds are invested in the business to buy stock, capital equipment or expand the work force. Such investment at the company level results is effectively spent and is no longer available for the company to pay out to shareholders. Yet these investments will, more often than not, generate additional income, the profit on which will be taxed and some of this will be paid to shareholders as dividends. Naturally those dividends will have new franking credits attached to them and so will be subject to the shareholder’s marginal tax rates alone.

    What is important to note here is that the future dividend is a separate cash flow from the retained earnings such that the company taxes paid on those retained earnings are real as Michael Potter suggests.

    Of course, this now becomes even more complicated. Ultimately the assets of the company will be sold and then these will be subject to capital gains tax. Let us assume that a shareholder owns an assets in a company which has not paid a dividend for many years. In other words, all profits have been reinvested into the business. Obviously these profits have been taxed at the 30% company tax rate and no franking credit applies since no dividends were paid. On the sale of their shares, the investor makes a sizeable capital gain which would be expected to include the amount of the retained earnings. If the shareholder is an individual on the top marginal tax rate, they will pay capital gains tax of 23.5%, on top of the 30% company taxes already paid, giving an effective marginal tax rate of approximately 46.5%. Cutting the company tax rate to 25% would produce an effective marginal tax rate on the capital gains of 42.6% for this shareholder. Thus the 5% cut in the company tax rate produces a 3.9% decrease in the effective marginal tax rate on the capital gains such that some but not all of the company tax cut benefits the individual shareholder.

    This scenario, albeit somewhat simplified, indicates that Michael Potter is only partly correct to claim that retained earnings generate real company tax revenues. Part of this is clawed back in higher income tax revenues despite the fact that franking credits do not apply to capital gains.

    As a result, company taxes do apply to domestic shareholders but only to those profits which are retained earnings and then only to part of those retained earnings. If 67% of corporate profits are paid as dividends, then 33% will be retained, of this 22% of the tax cut results in higher income taxes by shareholders and so we can estimate that approximately 26% of the company tax cut flows through to individual domestic shareholders. That would amount to 1.3 percentage points out of a tax cut of 5 percentage points.

    In this context, Malcolm does indeed have a strong case.

  22. .

    #2298105, posted on February 16, 2017 at 9:22 am
    To the extent that corporate profits are paid out as dividends, it is correct to argue that a company tax cut has no meaning for Australian shareholders. Those shareholders receive a franking credit for all company taxes paid on such dividends which effectively eliminates the company tax such that the only tax applicable is the individual’s own marginal tax rate.

    What about reinvestment and growth though? Of course it makes a difference.

  23. Malcolm

    Look, all I’ve argued that the priority is to cut the top marginal tax rate. That’s economics 101 – go for the highest marginal rate.

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