Company tax cuts won’t solve anything – getting them to pay up might

It says something about how capitalism works within our political system that in the week in which the Paradise Papers revealed the ways companies use tax havens and complex accounting methods to avoid paying tax, the government has again been pushing its case for a cut in the company tax rate.

The Paradise Papers, with its trove of information on how companies shuffle money around the planet in order to reduce their tax liabilities, highlight just how warped the economic system has become.

The system in which we operate is one where the impetus is always towards lowering taxation for companies, and which is partly justified on the basis that doing so will reduce the incentive for companies to engage in the kinds of tax minimisation practices revealed in the Paradise Papers.

And thus we have a race to the bottom in order to make ourselves attractive to companies who will continue, regardless of our tax rate, to shuffle money around the globe so as to reduce their tax obligations.

The race to the bottom was given some theoretical heft this week from a paper by three economists within the Treasury department which suggested that, were the US to cut its tax rate by the amount Donald Trump hopes – from 35% to 20% – then we would likely need to follow suit or face lower GDP growth and lower real wages.

But, for a paper that focussed on the impact of the US tax policy, the reporting was rather curious. The Australian ran it on its front page as an exclusive and pushed the line that the research revealed “the full rollout of the Turnbull government’s company tax plan will deliver a $30bn revenue return to the federal budget.”

This was a rather curious lead given the report did not actually provide any such new information. What it did was repeat a line from another widely reported Treasury research paper written in May last year : “the total revenue loss from the company tax cut that is recovered in the long run through second-round effects is estimated to be around 45 cents per dollar of net company tax cut with 8 cents accruing to sub-national governments and 37 cents to the federal government”.

We’re in a pretty weird place where a line repeated from research written 18 months ago is now held up as new information deserving of a front-page headline.

And we’re in an even more weird place when the suggestion that 37 cents of every dollar lost in revenue returning to the federal government is “effectively halving the claimed total cost of the policy.”

Thirty seven percent of $65bn is just over $24bn, which is a bit short of the “$30bn boost for Turnbull’s tax reform plan” which the Australian chose as its front-page headline. The Treasury research suggested eight cents in the dollar would go to the states. It seems a bit of a stretch to claim that a potential $5bn in state revenue would reduce the cost to the federal government’s budget.

It also says something about how warped the economic debate is in this country that the impact of policy which everyone agrees will cause revenue to fall is described as a “boost” because some research estimates net revenue will fall only $35bn, not $65bn.

But the suggestion that this somehow means that the company tax cut will cost less than the previous estimate of $65.4bn – included in the Treasurer’s own statement made in parliament in May – is rather dopey.

Firstly, the estimate of 45 cents in the dollar return has been known for a year and a half, and secondly, budget papers don’t include second-round impacts.

You can’t say you will cut tax but then argue this will spur growth and thus the drop in revenue will not be as bad. The problem is such second-round impacts are based on a multitude of assumptions, any tweaks of which greatly change the outcomes.

Budget numbers that worked like that would become meaningless very quickly as governments would see all sorts of theoretical benefits to accrue from their policies that would create magical revenue figures.

At any rate, this new Treasury paper was not really about the cost of the plan, but more the impact of Donald Trump’s proposal to cut the company tax rate in the US from 35% to 20%. The paper suggests that if the US were to cut the company tax rate by that much, capital dollars would flow to the US from other nations (including Australia) and thus our GDP and wages would suffer as a result.

There are a few problems with suggesting this is a reason to pass our own tax cuts.

Firstly, it is hard enough to assume the economic impact of policy that might be implemented in Australia, let alone things that possibly will occur in the US. Given the corporate tax cut is not popular with US voters and unlikely to be feasible without massively increasing either the US deficit or taxes on individuals, it might be best to hold off on working out its impact until we see what legislation actually makes its way through Congress.

And secondly, the whole suggestion that a company tax cut leads to greater investment and improved wages growth is something that always looks a lot better in the economic modelling than in reality.

The UK, for example, has cut its company tax rate from 30% in 2007 to 19%, and yet real wages in the UK are lower now than they were in 2007.

And while it is nice to believe that a lower rate will bring greater investment, the issue is always what kind of investment will be attracted by a lower rate.

As the Reserve Bank assistant governor, Luci Ellis, explained to a parliamentary committee in February, we want to attract direct investment – i.e. companies setting up shop here – as that “builds new things, versus, say, purchasing of existing securities or purchasing of existing assets.”

The Paradise Papers certainly show that companies and high-worth individuals like to purchase assets and securities in a manner to avoid paying tax, but it is less of an issue for direct investment, which instead looks at labour costs and skills, location of assets, infrastructure, incentives for research and development, and the whole regulatory system.

We seem trapped in an debate in which, despite the benefits of an economy and political system which make us attractive to investors, it would appear as though all a country has going for it is its tax rate – a tax rate, which we have seen this week, is often avoided.