The provision of special tax exemptions and deductions for investment options where a market failure can be argued is a different story. This case is illustrated by the 40% extra allowance for expenditure on R&D (items B105 and B106). Much R&D by the investing firm provides spillover benefits to other firms, but other firms do not pay the investing firm for these benefits.
The tax concession or subsidy is a crude way of providing compensation for the spillover benefits, and it encourages firms to increase investment in R&D to a level consistent with the best use of national resources. But one might argue whether other policy interventions such as direct subsidies – or a different tax concession rate – are more appropriate.
A more comprehensive tax base with less special exemptions and deductions provides a second set of benefits through the lower tax rate that it will fund. In the context of Australia as a net importer of international capital in a small open economy, a lower tax rate on business investment in Australia initially increases the after-tax return to overseas investors.
Seeking the best after-tax return across the globe, international investors shift more funds to Australia until the extra investment drives down the pre-tax return to restore the initial after-tax return. The increase in capital means more and better machines, buildings and technology per Australian worker, and higher labour productivity.
But the reality is that multinational companies have opportunities to shift their taxable revenues to lower tax rate countries and to shift many of their debt, overhead and intellectual property expenses to higher tax rate countries. Further, tax authorities are always playing a catch-up game to minimise these profit-shifting strategies. A lower Australian business tax rate increases the incentive of multinationals to record their profits in Australia, and to shift their tax payments from overseas to Australia.
A lower Australian business tax rate has additional gains for the Australian economy. The lower rate reduces the current tax favoured treatment of debt investment over equity investment by international investors. In turn, the lower gearing ratio would increase the ability of firms to ride cyclical, seasonal and other business shocks.
Ultimately, as argued by Australia’s Future Tax System report of 2010 and the Mirrlees Report of 2010 in the UK, with supporting econometric evidence, most of the benefits of a lower Australian business tax rate are passed on to employees as higher wages. But this will take some years of decision changes and adjustment.
John Freebairn is a professor, Department of Economics, at University of Melbourne.
This article first appeared at The Conversation.
