More grist for the mill on why we should cut company tax

As Lateral Economics proposed in 2006 if you’re looking for taxes to cut to maximise growth, you can’t go past cutting company tax rates.

Now the research has been updated by this NBER working paper.

Simeon Djankov, Tim Ganser, Caralee McLiesh, Rita Ramalho, Andrei Shleifer

NBER Working Paper No. 13756
Issued in January 2008

We present new data on effective corporate income tax rates in 85 countries in 2004. The data come from a survey, conducted jointly with PricewaterhouseCoopers, of all taxes imposed on “the same” standardized mid-size domestic firm. In a cross-section of countries, our estimates of the effective corporate tax rate have a large adverse impact on aggregate investment, FDI, and entrepreneurial activity. For example, a 10 percent increase in the effective corporate tax rate reduces aggregate investment to GDP ratio by 2 percentage points. Corporate tax rates are also negatively correlated with growth, and positively correlated with the size of the informal economy. The results are robust to the inclusion of controls for other tax rates, quality of tax administration, security of property rights, level of economic development, regulation, inflation, and openness to trade.

Oh – and there isn’t much evidence that cutting top marginal rates of tax improves economic outcomes (except of course for the direct beneficiaries of such policies).

Postscript on reading further.

Personal income tax does not enter the entrepreneurship regressions (which alleviates the concern that our corporate tax rates are
wrong for entrepreneurship), enters negatively and significantly the FDI regressions (although with small coefficients), and surprisingly enters positively and significantly for aggregate investment. The last result is a fluke caused by China and Vietnam, which have both very high personal tax rates and investment rates. Without them, there is no relationship. Overall, our main findings on corporate income taxes are robust to the inclusion of any of the additional tax rates we have considered. (p. 19 of the paper)

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16 years ago

It is worth noting that that particular PwC report looks at, as literally as possible, all the taxes paid by companies and not just the income tax. In fact it produces a quite different ‘effective tax rate’ to the one in the annual report because it includes stuff like payroll tax, stamp duty, deposit tax, customs, net VAT/GST, etc and so forth for about another 45 types of ‘tax’.

I believe the report’s focus is not so much that the corporate income tax should be cut, but that taxes number 2-53 should be abolished even at the cost of increasing the corporate income tax, if necessary.

Although; of course, I agree with you and the report :)

16 years ago

The results are robust to the inclusion of controls for other tax rates

SO I am not sure what that means!

derrida derider
derrida derider
16 years ago

Why is it that every discussion of company tax in Australia that quotes international evidence studiously ignores dividend imputation? Dividend imputation makes the incidence of our company tax quite different from those of places (such as the US) that run the classical “double tax” system.

In Australia, company tax is mostly just a withholding tax on the locals (that is, it is primarily an anti-avoidance measure, and a powerful one) and a tax on returns from investment by foreigners.

Given that most of our foreign investment is in mining and real estate, the latter makes it a good resources rent tax. And our chronic current account deficit argues that we don’t exactly have a lot of trouble attracting foreign capital anyway.

So I don’t think the deadweight loss of our company tax is anything like that of the US one, and it has powerful horizontal equity advantages.

Sinclair Davidson
Sinclair Davidson
16 years ago

DD – I wrote about dividend imputation in a paper for the Association of Certified Chartered Accountants last year.

An important issue that appears to have been largely neglected in the Australian debate is the impact dividend imputation has on corporate tax revenue. In principle a tax credit is passed onto the shareholder who pays tax at their marginal rate. The taxpayer may use the imputation credit to offset their own tax liability. The corporate tax is a withholding tax only and may be claimed by an investor either in the year the corporate tax is withheld or in a later year. In other words, corporate taxation only makes a net contribution to Treasury if the final investor is unable to use the imputation credit (i.e. is a non-Australian investor). Imputation credits are distributed with dividends. Not all dividends are fully franked only those paid out of income taxed within Australia and firms do not payout all their income as a dividend. The important point is that imputation credits do not expire. Indeed, Mike Timmers has estimated that $92 billion of unused imputation credits exist. Unused imputation credits constitute a contingent liability for the Treasury. At some stage some of these unused imputation credits will be claimed against an existing income tax liability and so reduce the tax revenue flowing to Treasury. To a large extent this is already happening in the current wave of share buy-backs. Imputation credits that would otherwise accumulate are being accessed and paid out to those investors best able to reduce their tax liability.

The question of interest is how big an issue is this? Potentially if all Australian firms had 100 percent Australian ownership and all Australian firms paid out 100 percent of their earnings as a dividend the treasury would earn zero revenue from corporate income tax. Under those circumstances, the Treasury would only earn the personal tax that individuals pay on income. The first leakage from the imputation system is that non-Australian shareholders are not eligible to claim the imputation credit. According to ABS data non-Australian shareholders accounted for 32.1 percent of listed shares in 2006 (down from 40 percent in 2004). The second leakage from the imputation system is that firms do not pay out 100 percent of their earnings. Using ATO data I estimate that the franked dividend pay out ratio in 2004-05 was 45.5 percent. The answer seems to be that the Treasury should have a large contingent liability for unclaimed imputation credits. The leakage from the system in any year is small. Assuming non-Australian shareholders are unable to sell their unused imputation credits and dividends are distributed pro-rata to all shareholders, the amount of imputation credits that are lost forever in any year (based on the figures above, as being typical) would be of the order of 14 percent to 17 percent. The remainder of corporate tax revenue is used to offset personal income tax in the year, or could be paid out in future years as a dividend or could be accessed via some or other scheme (such as share buy-backs) in future years.

Neville Hathaway and Bob Officer of Capital Research Pty Ltd have undertaken a very careful analysis of the creation and usage of imputation credits. Their argument is that about 35 percent of corporate tax revenue is redeemed at the personal level as a prepayment of personal tax. Firms retain another third of imputation credits and the remainder appear to be unclaimed. This calculation implies an effective net of imputation corporate tax rate of 19 percent.

I also an ARC Discovery (joint with Prof. Richard Heaney) looking at dividend imputation and Australian corporate tax. As you quite rightly indicate little is known about how the imputation system really impacts on decision making etc.

16 years ago

Impact is dependent on share register – lots of mums and dads/super funds = v. important to pay franked dividends (banks are an example).

But institutional investors report their figures (and determine their bonuses) on a cash basis, ie pre-tax – so they tend to be either neutral or even negative on franking.

Lots of other countries, in particular I think Mediterranean ones, used to have systems where, for example, post-tax dividends are non-assessable. I believe that this is still essentially the case – I think in France dividends are taxed at about 11% (in fact a ‘social contribution’ not a ‘tax’) but I am not sure if that is in addition to income tax or separate from.