The argument that dividend imputation or US tax treaties make a company tax cut pointless does not stack up. A company tax cut will deliver significant gains to Australian business and workers, even in the presence of dividend imputation.
One of the bright spots in an otherwise lacklustre 2016-17 federal budget was the Turnbull government's plan to reduce Australian corporate income taxation rates.
The reform consists of a lower statutory tax rate of 25 per cent for all companies over 10 years, eventually replacing the existing progressive tax structure of 28.5 per cent for small business entities and 30 per cent for large corporates.
The budget papers say that the reasoning behind cutting company taxes is to "encourage investment, raise productivity, and over time raise real wages and living standards".
This claim is backed up by economic theory, not to mention empirical studies, highlighting the potentially immense gains associated with reducing the burden of a notoriously inefficient company tax regime.
The Coalition outlined its lower-tax path and even Labor in recent times, most notably through its shadow treasurer Chris Bowen, has endorsed the economic case for lower company taxes.
But there still are some holdouts who argue certain features of the Australian company tax mitigate the benefits of tax rate reductions.
The Australia Institute and Grattan Institute suggest dividend imputation arrangements, providing a tax credit to domestic shareholders for the company tax already paid on dividends paid to them, imply the benefits from tax cutting largely goes to foreigners.
From that standpoint, any reduction in our company tax, let alone a 10-year program to modestly shave the headline tax rate, is not worth the effort.
But modern Australia was undeniably built on foreign capital, and our continuing development will depend critically upon making this country a more attractive destination for overseas investors in the future.
"GIFT" CLAIM DUBIOUS
A recent Minerals Council paper by respected tax economist Jack Mintz suggests that cross-border investment decisions may be positively influenced by taxes, "with foreign direct investment flows growing as much as 2.5 per cent for each one-point reduction in the corporate income tax rate".
Since non-resident investors are unable to claim franking credits, a good way to attract their productive capital is to reduce the Australian corporate tax rate, alongside ensuring a stable, pro-growth economic environment underpinned by the rule of law and less red tape.
But the proposition mounted by the Australia Institute, that a company tax cut represents a massive funds transfer to the US Treasury by virtue of our lower tax rate, is questionable.
The 2010 Henry tax review indicated that for countries with worldwide income company tax regimes, such as the United States, "the ability to avoid or defer taxation can reduce the value of credits and may limit the extent of the 'treasury transfer' effect".
The institute's claim of an Australian "gift' to the IRS is undermined to the extent that tax avoidance on repatriated profits actually takes place, and in any case a lower Australian tax rate would encourage US firms to reinvest here.
As for domestic investors, the intent of the dividend imputation regime is to eliminate the double taxation of dividends and reduce corporate bias towards debt financing, both laudable goals in their own right.
"MOST INEFFICIENT" OF TAXES
But with the passage of time some economists have engaged in revisionist thinking, suggesting that the tax benefits of imputation may encourage Australians to invest greater funds in domestic firms than would otherwise be the case.
It might be claimed that reducing the company tax rate would reduce such funding allocation distortions faced by domestic investors, at least at the margins, though it isn't necessarily the case that Australian shareholders would miss out on benefits arising from a company tax cut.
Corporate taxation still distorts decision making and investment choices on the part of domestic firms and, indeed, modelling previously commissioned for the Australian Treasury has shown that company tax is the most inefficient of commonwealth taxes.
A company tax cut would be expected to encourage incumbent firms to seek additional value-added investment opportunities, potentially yielding greater earnings which are then distributed back to shareholders through higher dividends.
Reduced taxes also encourage new domestic business entrants to challenge the incumbents with better value propositions and deepen the domestic capital stock, and there is sufficient empirical evidence illustrating that lower corporate tax burdens bolster entrepreneurial activity.
The arguments for reducing Australia's company tax are compelling, and are a reform that should be pursued vigorously.
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