Thursday, August 08, 2013

Tax cut helps but levy doesn't

Milton Friedman famously said that he was in favour of cutting taxes under ''any circumstances and for any excuse, for any reason, whenever it's possible''.  On day three of the election campaign the Coalition, with its proposal to cut company tax by 1.5 per cent, almost put that idea to work.

This is a point of differentiation between the government and the opposition.  The government thought that cutting corporate income tax was a good idea right up until the Coalition pinched the idea.

Lowering the company tax rate was government policy until last year when the government couldn't afford to pay its carbon tax compensation.

In the 2010 budget papers, Treasury had modelled a 2 per cent company tax rate cut starting for small business in 2012-13 and for everyone else the rate would drop in two steps starting this financial year.

Treasury expected a short-term decline in revenue, but sold the idea on the benefits of reduced taxation.  The company tax rate would be more competitive;  it would attract foreign investment, create jobs, and lead to higher levels of economic growth and prosperity.

With all those benefits it is hard to imagine why the government abandoned the idea for a carbon tax.  Now Penny Wong would have us believe that a smaller tax cut than the government proposed in 2010 would increase the cost of living.

The problem, however, is that the Coalition isn't really cutting company tax.  It is also introducing a levy so that large companies still pay 30 per cent in tax overall.  Smaller businesses will pay 28.5 per cent.

It is actually quite hard to untangle the net effects of all of this.  The policy sounds good for small business, which now also gets its parental leave paid for by its larger competitors.  But will the broader benefits of a reduced corporate tax rate materialise?

I suspect not.  Revenue from the company tax is largely derived from large business.  Those businesses will still be paying 30 per cent and still incur all the compliance costs associated with the current tax regime.  The deadweight losses of taxation will remain largely unchanged.

So the benefits of this reform are smaller than we might otherwise believe.  Certainly smaller than the 2010 ALP proposal.

But it is still better than nothing.  If an incoming Abbott government introduced its changes and also included a sunset clause on the parental leave levy of, say, three years, business may have some confidence that company tax rates were actually going to fall and not simply be relabelled as a levy.

The final complication is how this levy will interact with dividend imputation.  This could very easily become an intergenerational transfer from self-funded retirees and superannuation funds to female employees in small business.  I suspect the Coalition has not thought about that.

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