It now appears certain that the Republican majority in the US Congress will pass a massively regressive package of tax cuts, with a cut in the rate of company tax as its central feature. Unsurprisingly, this news has produced a revival of the Turnbull government’s proposal to offer similar cuts here.
The primary claim put forward in support of company tax cuts is that they will lead to an increase in investment, or at least prevent the loss of foreign investors to the lower-tax regime being proposed by Trump and the US Republicans. According to Scott Morrison, quoting research from the Commonwealth Treasury, if we fail to follow the US lead we will be a less competitive destination for foreign investment.
The obvious question is whether higher foreign investment will benefit Australia or simply generate additional profits for the overseas investors. Unfortunately, the research findings quoted by Mr Morrison tell us nothing about this question. The headline result is that lower company tax will lead to higher gross domestic product, but GDP is irrelevant in this context.
That’s because GDP takes no account of the flow of earnings to foreigners (that’s where the D for Domestic comes from) or from the additional depreciation needed to service a larger capital stock (that gives us the G for Gross). And of course what matters in the end is not output (P for Product) but income and consumption. To sum up, there are only three things wrong with GDP as a measure of economic welfare: it’s Gross, it’s Domestic, and it’s a Product. As far as the national accounts are concerned, the relevant measure is net national income, the income that is actually received by Australian households.
There’s nothing new about this point. I made it in response to the Henry Review of the Tax system, back in 2010. More recently, the same observation has been made by former Reserve Bank Deputy Governor Stephen Grenville and, in the context of the Republican Party’s proposed tax cuts, by leading US economist Paul Krugman. Such repetition of long-refuted errors is characteristic of the zombie phase of neoliberalism which began with the Global Financial Crisis.
Yet the main Treasury analysis of cuts in company tax rates focuses mainly on GDP. The headline result is that company tax cuts, funded by a hypothetical “lump sum” tax would raise GDP by 1.2%, or more than $20 billion a year. Careful reading however, shows that the vast majority of this increase would be lost, either as profits flowing overseas or as costs incurred in maintaining a larger capital stock. Moreover, the notion of a “lump sum” tax is nonsense, used by modellers when they want to avoid specifying how a tax cut will be paid for, but non-existent in practice.
Buried in the report we find a more relevant model run, that of a company tax cut financed by an increase in personal taxes and a more relevant measure of benefits, the percentage increase in household welfare. This is estimated at a mere 0.1%, a couple of dollars a week for a household on $100,000 a year.
All of this is based on a model of long-run outcomes in a smoothly functioning economy, where capital investments adjust in response to the company tax cuts, leading to increases in labour productivity, which in turn flow through to households in the form of higher wages. There are an awful lot of steps in that process, leading to the question: how long is the long-run?
The Treasury modellers don’t even attempt to answer this question, but the redoubtable Paul Krugman has tackled the first one, for the case of a typical developed economy (he’s talking about the US, but his parameters work for Australia). Krugman estimates that the rate of of convergence of the capital stock at around 6% a year. That means that about half the adjustment will be completed 12 years after the tax cut is introduced, and around 75% after 25 years. Given the minimal expected increase in Net National Income, it’s only after this point that we could anticipate any net gain for Australia.
The second part of the process raises even bigger problems. For most of the 20th century, increased labour productivity generated higher wages exactly as the Treasury assumes. But the experience of the 21st century has been markedly different. Productivity has risen but wages have not.
In the unlikely event that everything works the way the Treasury modellers expect, the mythical average Australian will be better off by an undetectable 0.1% in 25 years or so. Meanwhile, the corporate beneficiaries of the tax cut will be massively better from day one, before they invest a dollar more or hire a single additional worker. It’s not hard to see who the government is working for, here or in the United States.
Beware Greeks Bearing Gifts
In my opinion Malcolm Turnbull’s proposed enterprise tax reduction plan has the potential to be Australia’s Trojan horse.
Students of history will know the story of how the ancient city of Troy was well protected by a high surrounding wall which, for a period of ten years, provided an effective defence barrier that an attacking Greek army was unable to penetrate.
However the Greek general Odysseus developed a clever plan of deception which involved the building of a giant wooden horse, to be placed outside the main gate of the wall to the city.
After the horse was built the entire Greek army pretended to sail away from the city of Troy, giving the appearance that they had finally admitted defeat.
Soon after, the jubilant citizens of Troy emerged from the city and found the Trojan’s wooden horse. In their excitement they dragged their seemingly harmless trophy inside the city gates and put it on display – which is just what the Greek general thought they might do.
However, unbeknown to the people of Troy, the hollow wooden horse contained thirty Greek soldiers hiding inside.
That night, when the people of Troy were sleeping blissfully after wild celebrations, the Spartan soldiers emerged from the horse, and opened the city gates to allow the waiting Greek army to enter and destroy the city of Troy and annihilate its citizens.
The moral of this story is that there are occasions when something that on the surface might appear benign, in fact has the potential to be dangerously harmful.
I’m suggesting the moral warning in the fable of the Trojan horse applies to Malcolm Turnbull’s proposed enterprise tax reduction plan.
If Malcolm Turnbull’s Coalition government is returned it will legislate to give Australian ‘small’ businesses tax cuts of 20%. That’s something I personally don’t have much of a problem with. However, like the soldiers in the wooden horse, the deceptive element of this policy is that the legislation will change the definition of a ‘small’ business to increasingly morph over the next ten years, until we reach the ridiculous situation where the big four banks, Telstra and BHP as well as large multi-nationals will all qualify for 20% tax cuts!
The cost to the Federal budget in 2026 alone is expected to escalate to an amount in excess of thirteen billion dollars! AND by 2019–20 it is projected to reach 15 billion dollars and keep rising.
From another perspective, the tax cuts to large corporations over the decade to 2026 will amount to some 50 billion dollars!
If legislated, Malcolm Turnbull’s Trojan horse suite of ‘small business’ tax cuts will slash a huge swathe of revenue from future Australian budgets and thereby ensure that our children and grand-children will be consigned to significantly lower standards of living than our generation has enjoyed.
Well said. Like you, I don’t have a problem with tax cuts to small businesses and wage earners. However, this tax cut, like most company tax cut is a form of theft from the people by the government to pay the minority rich. And yet the rest of us who pay the taxes don’t get the services we need. On the contrary, the polity is faced with cuts to services. The question is why do people keep buying that old chestnut that if you give a tax cut to rich people that will translate to jobs to ordinary folk when this has been debunked by empirical data the world over. Its a lie. The polity should wake up and simply turf governments who steal money in this way.
As usual its all the way with the USA. Whether its the drug laws that don’t work and fill our jails, or the USA-like shambolic NBN rollout, or as now, the utterly discredited trickle down economics, corporate tax cuts. Surely our politicians owe us more than policies we know won’t work.
Who pays the fiddle calls the tune – in this government’s case it’s big business (they’ve got piles – of the readies and dodges).
Cut revenue : cut services – where will this mob start? Down the bottom, as usual?
Yeah, what type of business leader advocates for such a pathetic tax cut and to companies only? Tax cuts across the board for companies AND individuals is The way to go. Like 10% flat rate on gross, no deductions, wth adjustment at the bottom end and a lifting of the tax free threshold for low income earners. Fund the cuts with a massive reduction in government service provision. Then watch the economy grow and employment rare rise.
Overall, an excellent article! Perhaps a tad more could be added.
If one were to cast an eye over the NZ Treasury Paper (Dec/04) “Average Marginal Income Tax Rates for New Zealand, 1907-2009” it would be apparent that from 1927 (to take a point but one could just as well include 1918 – i.e the end of WWI) to the year 2000 (and this year is flexible for the sake of the discussion too) it is apparent that circa 1920 personal tax (PAYE) and company tax were 20% and 50% with sales, land tax, estate duties etc comprising the remainder.
Nowadays the situation is in reverse; almost to the percentage in question except that company tax in NZ is closer to 10% than it is to 20%. The situation is representative in Australia : see https://archive.treasury.gov.au/documents/1156/HTML/docshell.asp?URL=01_Brief_History.asp
Now, lets consider some assumptions concerning Supply-Side Economics and the historical effects
Privatisation.
Some success here and there but by no means uniform. The selling the postal services and railways in New Zealand has been a disaster. All countries have similar stories.
Deregulation.
Some benefit – particularly regarding telecommunications services but not in every case. Regarding the sciences (and Economics is NOT a science) a “failure” of one observation justifies the rejection of a theory.
Reducing Income Taxes.
Anti-Keynesian (or neo Friedman) “beliefs”. If the policy was effective it would be a panacea for any recession. The is no trickle-down effect; the fat cats just get fatter.
Education and training.
One of the more realistic assumptions.
Removing Trades Unions.
To “fee-up” markets etc. because such an initiative should reduce everything from costs to unemployment. Unemployment has always existed (markets do not necessarily clear at any price); consider the necessity for the Factory Acts of the 1830s.
Welfare Benefits.
To be abolished because it is assumed that being paid about 1/4 of the average wage is a disincentive for the unemployed to take jobs.
Reducing Import Tariffs.
Because (it is assumed that) this effect will increase trade. The argument rejects the assertion that each market ought to be evaluated on its merits.
Removing bureaucracy.
which, apparently, adds to a costs of business; again a generalisation. Each case has to be examined
Each is a generalisation and only one or two have any basis in (economic) history. What is happening, as a global phenomenon, is that the middle class is being destroyed. Compare the salary of a CEO of a largish company (listed on the ASX) with that of a tradesman or a lawyer (of five years experience) 35 years ago and compare the ratio now. The numbers are relatively easy to obtain.
The Xmas present for the fat cats is to be a tax cut (at least in the USA). Providing a tax cut to the lower income groups has a positive effect via the multiplier but not so for the wealthy whose spending does not change, significantly, with changes in company tax. Those at $60,000 (and under) can expect to stay there for another decade at least.
So you believe that cutting axes across individuals and businesses, to put more of a persons own income in their own pocket won’t lead to increased spending, increased savings and investment, and increased debt servicing all of which makes stimulates economic activity. But government wastage and provision of services well beyond its remit that they provide for pork barelling is good. And what of the idea thatso much of a private income is expropriated so that that individual doesn’t have their own income to spend on services tailored to their own individual circumstance? If you are not minimising your tax you are funding the downfall of society.
The “good” aspect of economics is that, over time, the unsupported or non-empirical theories come to be refuted. Consider Friedman’s Permanent Income Hypothesis that he dreamt-up tapping a fountain pen upon his desk. The motivation for the construction of the hypothesis was to attempt a refutation of Keynesian methods; no more and certainly no less.
One or two of the assertions of the hypothesis are plausible, which gave it more life than it deserved, but as to how consumers ACTUALLY behave was recorded in a sociological study [Wilcox, D. Social Security Benefits, Consumption Expenditure and the Life Cycle Hypothesis Journal of Political Economy April, 1989.] Needless to say the behaviour supports Keynesian implications – and by corollary– refutes the Friedman’s PIH (or PYH – as some may prefer; “y” being the symbol for Income).
As to the topic at hand the economic growth models of Luigi Pasinetti (or the Keynes-Kaldor-Pasinetti models as some may insist) resolved this matter almost 50 years ago. But as with such topics climate-change or cancer and cigarettes or whatever the topics seem to continue with a life if their own irrespective of the peer-reviewed research.
As pointed out, above, (which would require about 2,500 words – and if Crikey wishes to provide the space I am only too happy to occupy it) except for one or two of the assumptions of the Supply-siders the remaining assumptions ARE at variance with history. As with the PIY the anecdotal propositions are suggestive but die rapidly under detailed (empirical) examination).
Paraphrasing a famous quote by a notable Englishman of the 19th century “the more a man insists upon the purity of his honour the more justified is an audit of the silver upon the fellow’s departure”. That observation itself has its origin with the ancient world. However the observation is particularly germane to economics.
Notwithstanding the amount of space given to the (quite unjustified) assertion than economics is a science (ipso facto is on the same plane as the “hard” sciences) in the first chapter of a 1st year text book the discipline is ideologically contaminated beyond redemption. (J.K.) Galbraith has been mentioned in these pages of late. Perhaps readers with a contrary view the above might begin with Galbraith.
to some specifics :
“So you believe that cutting axes across individuals and businesses, to put more of a persons own income in their own pocket won’t lead to increased spending, increased savings and investment, and increased debt servicing all of which makes stimulates economic activity.”
The question, with all due respect, betrays a simple-minded assessment of an economy [that is rife amongst our polies in Canberra – and elsewhere]. The current state of play is that the (mortgage) debt for individuals is just an entry in a ledger (as indeed is credit-card debt). Tax cuts to retire this kind of debt has NO multiplier effect because the “advance” of money has already occurred. Reducing company tax just blackens the bottom line and has no material effect upon the consumption of the fat cats. Company tax (considering Canada, USA, Australia, UK & NZ + elsewhere) did not change from the 30s to the “boom” periods of the 1950 through to the mid 70s to any great extent. Similarly for PAYE.
The above is all to evident in the Pasinetti models of growth. Further, consider the Gini coefficient for Australia (31.3 in 1981 and 34.7 – worse – in 2010). In un-egalitarian USA the value was 34.6 in 1981. [https://data.worldbank.org/indicator/SI.POV.GINI?locations=AU] A gentle read-up of Lorenz curves might come to be informative.
“If you are not minimising your tax you are funding the downfall of society.”
is not a creditable sentence. I (personally), while occupying positions of responsibility within the Public Sector, (in days gone by) have witnessed considerable waste of public money and ditto for anyone who has occupied such positions. But let’s not confuse the quality a vehicle with the competence of the driver. Consider the economies of northern Europe or indeed Scandinavia. Norway has the same GDP per capita as the USA but the life of the “average” person in the USA is a battle to say the least (qua Trump’s election) compared with the residents of Norway – and elsewhere where taxes approach 50%.