Chapter 2: Consideration of a lower company tax rate and a broader business tax base



47. The Working Group received feedback from many businesses questioning whether net benefits would arise for those businesses from lowering the company tax rate funded by the options canvassed in the Discussion Paper. Overall, the Working Group has found there is a lack of agreement in the business community to make such a trade-off.¹⁸
48. While there have been a number of business tax reforms in Australia in recent decades that have traded off a lower company tax rate for a broader tax base, the Working Group has identified three key factors that have resulted in such a trade-off not being seen as beneficial at this time:
    • the level of uncertainty facing the business community as the economy is undergoing structural change;
    • previous reductions in the company tax rate were funded by making the business tax base broader, such that there would be lesser benefits associated with removing the remaining concessions (relative to a comprehensive business income tax base); and
    • the already lower rate of company tax compared with earlier business tax reform exercises, which means that the benefits associated with a further cut would not be as large as those achieved previously.

The economy is undergoing structural change

49. The Working Group's consideration of longer term reforms of the business tax system has come at a time of significant change and uncertainty for the domestic and international economy. These circumstances present both significant opportunities and profound challenges for Australian businesses.
50. Despite difficult international economic conditions, Australia's economy remains strong. However, economic activity is uneven, with mining and mining-related sectors experiencing relatively strong growth, while some sectors remain under pressure from the sustained high dollar, sector-specific structural changes and turbulence in the global economy.
51. The current economic environment makes it particularly important for Australia to ensure that businesses are well positioned to take advantage of emerging investment opportunities and are prepared to adapt to the changing economic conditions. Australia's future economic growth prospects are dependent on our ability to encourage new investment and enhance productivity growth within challenging international and domestic conditions.
52. In response to the adjustment pressures being driven by the high terms of trade, businesses across the economy are adopting new business models, sourcing new plant and equipment, investing in their workforce and exploring new markets and product lines. Businesses are also seeking innovative ways to adapt to ongoing changes in technology, consumer preferences and market conditions. New investment is needed to meet these challenges.
53. The Working Group's earlier recommendation to introduce limited loss carry-back, now being implemented by the Government, was proposed in this context. Loss-carry back will assist businesses with tight cash flows to internally fund the new investments they require for them to adapt to changing market conditions. Investments will be made with a greater expectation that a business will receive tax refunds if losses are incurred in future years. This will reduce the tax bias against riskier but worthwhile investment and support businesses adapting to changed economic conditions.
54. In a similar vein, the Working Group recommended that further analysis be undertaken with a view to developing a model for reforming the same business test (SBT). The Working Group remains concerned that the SBT too narrowly prescribes the range of activities that a company can engage in without risking forfeiture of its losses. Further, its application varies with a taxpayer's facts and circumstances making it difficult to determine prospectively whether or not the SBT is likely to be satisfied.
55. The treatment of tax losses will continue to play a role in determining the tax burden on new investment into the future. This report should therefore be read in conjunction with the Working Group's recommendations from its Final report on the tax treatment of losses.
56. There is also a significant pipeline of resource investments either recently committed or under consideration that have been initiated under the current taxation arrangements. Any transitional rules that quarantine the impact on existing investments would mean that the revenue savings resulting from a taxation change may take some years to flow.
57. In the context of the substantial pipeline of capital investment, adjustment pressures on many sectors and continued uncertainty in the international economy, changes to the business tax base (such as less generous rates of depreciation) would increase effective marginal tax rates on some marginal investments and could create uncertainty in the fiscal environment, which could harm investment prospects. In contrast, a lower company tax rate would assist businesses to invest in plant and equipment, innovate and adopt improved business models. This would improve business' ability to adapt to changing economic and market conditions, which is essential for future economic growth.
58. In weighing up these contrasting impacts, it was clear to the Working Group that there was not agreement in the business community to broaden the business tax base to fund a cut in the company tax rate at this time.

Australia has a broad business tax base

Chart 5: Company tax rates in Australia (1980-present)

Source: Business Tax Working Group Consultation Guide (2012)

59. Reductions in the company tax rate during the 1980s and 1990s were paid for by making the company tax system broader, such as introducing capital gains tax and fringe benefits tax, applying income tax to gold, and removing most accelerated depreciation.
60. As a result of these previous reforms, the Working Group has found it more difficult to identify ways to broaden the business tax base further. There is considerable debate and uncertainty around the magnitude of the distortion of the remaining concessions, including concessions that promote important activity like investment in infrastructure and research and development.
61. The Working Group consultation revealed that there is not agreement in the business community to pay for a company tax cut from within the business tax system. The base broadening options would have involved a reversal of measures that have recently been enacted, the removal of longstanding taxation treatments that were not changed in previous base broadening exercises, or would significantly affect small groups of taxpayers. Any cut to the company tax rate would, however, flow to all companies, including those relatively unaffected by the base broadening measures, including those in non-capital intensive service sectors.

Australia has a lower company tax rate than previously

62. The third key factor the Working Group has considered is that the economic benefits from a reduction in the company tax rate are less the lower is that rate.
63. As noted above, a lower company tax rate can reduce the deterrent effect of company tax on marginal investments and the extent to which departures from a uniform tax base distort business investment choices. However, as a rule of thumb, the efficiency cost of a tax relates to the square of the tax rate.¹⁹ This means that as the company tax rate is lowered, the additional efficiency gain from a further reduction is also lowered.
64. The company tax rate at 30 per cent is considerably lower tha
    n it was in the 1980s and 1990s. As a result, the expected gain from reducing the rate further is likely to be less than previous reforms, notwithstanding that capital may have become more responsive to tax rates in the meantime.

Economic impact of a lower rate and broader base

65. As outlined in the Chapter 1, Treasury modelling indicates that a lower company tax rate could boost the level of GDP and household consumption. This result occurs because Australia is a relatively small open economy with net capital imports, and faces a highly elastic supply of capital. Therefore a lower tax rate on the income earned on foreign capital would increase aggregate investment, which in turn would increase productivity and real wages.
66. While the economic modelling of the potential impacts of broadening the business tax base and lowering the company tax rate was not completed, in theory it may be possible for specific options to have an overall negative impact on GDP and household consumption. If the price responsiveness of the supply of international capital to the removal of existing tax concessions is greater than the price responsiveness of capital to a reduction in the company tax rate, then overall investment, productivity and wages could fall in response to a lower rate, broader base package.
67. For example, a company tax rate cut funded by a reduction in the diminishing value method rate of depreciation to 150 per cent (from 200 per cent) would likely benefit highly profitable projects, but theoretically may not increase investment if these projects would go ahead regardless. In contrast, more marginal projects may receive less benefit from a rate cut than the cost they incur from lower depreciation allowances, causing some to become unviable and reducing overall investment. Therefore, it is possible that some packages may not increase GDP or household consumption.
68. This is not to suggest that there would be benefits from introducing new specific concessions, which apart from likely efficiency costs, would raise administrative and political economy concerns that would need to be evaluated.

¹⁸ Details about the Working Group and its activities are provided at Appendix C. Details of submissions received in response to the Discussion Paper are provided at Appendix D.

¹⁹ Harberger, A. (1964), 'Taxation, Resource Allocation and Welfare', NBER chapters in: The role of direct and indirect taxes in the Federal Reserve system, National Bureau of Economic Research, pp 25-80.