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For a small open economy, such as Australia, its living standards (per capita income) are determined by the level of its terms of trade, labour productivity, labour force participation and population. Australia’s terms of trade, labour force participation and population growth are expected to be flat or declining in the foreseeable future which implies any improvement in Australia’s living standards must be driven by a higher level of labour productivity. This paper shows that a company income tax cut can do that, even after allowing for increases in other taxes or cutting government spending to recover lost revenue, by lowering the before tax cost of capital. This encourages investment, which in turn increases the capital stock and labour productivity. Analysis presented here also suggests the long-term benefits accrue to workers and households via permanently higher after-tax real wages and consumption.
The goal of this paper is to provide a clear exposition of the likely activity and welfare effects of simple company tax cut scenarios. The tax package announced in the 2016‑17 Budget has more detailed funding components than analysed here so this paper does not provide specific estimates of the economic gains of that proposal.
1. Macroeconomic Modelling and Policy Division, Macroeconomic Group, The Treasury, Langton Crescent, Parkes ACT 2600, Australia. Correspondence: department@treasury.gov.au. We acknowledge that the calibration discussion of this paper (Section 2 and Appendix A) draws heavily on the text in Cao, Hosking, Kouparitsas, Mullaly, Rimmer, Shi, Stark and Wende (2015). We thank Roger Brake, Graeme Davis, Amanda Hosking and Nigel Ray for their support, insight, guidance and drafting suggestions throughout this project. This project has also benefitted from the valuable research assistance of Robert Foley, Xavier Rimmer, Mosfequs Salehin, Jazmine Smith and Sebastian Wende. We also thank Matt Brine, Tanuja Doss, Sally Etherington, John Fraser, Rob Heferen and Nicole Mitchell for valuable comments and suggestions on an earlier draft.
2. The views expressed in this paper are those of the authors and do not necessarily reflect those of The Australian Treasury or the Australian Government.
*External economic analysis - As part of the tax reform process, Treasury also commissioned external analysis of the economic impacts of a reduction in the company tax rate. This analysis is published in the below papers by Independent Economics and KPMG. The views expressed in these papers are the views of the authors and do not necessarily reflect those of the Treasury or the Australian Government.