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Economics References Committee
Commitment to the Senate issued by the Business Council of Australia

COWAN, Mr Simon, Research Manager, The Centre for Independent Studies

O'DONNELL, Mr Matthew, Senior Research Fellow, The Centre for Independent Studies


CHAIR: Thank you for appearing before the committee today. I invite you to make a brief opening statement should you wish to do so.

Mr Cowan : On behalf of The Centre for Independent Studies, I want to thank the committee for the opportunity to speak today. The CIS is a non-partisan think tank, but one which believes in free markets and smaller government. It is on that basis that The CIS supports lowering taxes, including, but not limited to, corporate taxes.

Company tax is one of the most hurtful economic taxes that exist and, in global terms, Australia is more dependent on company tax than many other comparable countries. Countries around the world and in our region have either cut rates or already have substantially lower rates than Australia does. We hope that by coming here today and participating in this inquiry we can dispel some of the pernicious myths surrounding this debate. While we would be happy to debate the general merits of company tax cuts, and no doubt we'll touch on these issues in our submissions, the substance of our brief opening remarks will be on two elements arising from the terms of reference. The first relates to the principle of requiring the BCA or any individual company to give a commitment to increase investment, employment or wages in order to pass a company tax cut, and the second relates to the desirability or otherwise of implementing a system for monitoring compliance with that commitment. In our view, both the concept of the commitment and the system to monitor performance are damaging to economic freedom and, with respect, suggest a misunderstanding of how company tax cuts will affect the economy.

If the BCA or any individual company wish to make voluntary commitments for what are essentially political purposes, that is up to them. It is another matter altogether for legislators to make such a commitment a precondition or binding requirement of company tax cuts. Tax cuts reduce the disincentives put in the way of companies and individuals, allowing them greater economic freedom and allowing them to create economic growth. Conditional cuts, on the other hand, are another form of regulation and central planning based on the notion that it is only government that can ensure businesses will do the right thing and invest more.

There are legitimate questions that should be asked before passing any tax cuts, including whether or not the budget can afford them. But whether the government needs to coerce companies for the benefits to 'trickle down' is not such a question. The benefits of company tax do not flow to wage-earners on the basis of a commitment by companies to use the proceeds to boost wages or hire staff, though no doubt some companies may do this. It does not require charity or a social contract with business. In no sense are the benefits reliant on a trickle-down effect. By contrast, it is the market that will drive this increased investment, particularly by foreigners who receive a higher rate of return than they would have done so previously. It is this self-interested increase in investment that will increase labour productivity, employment and, ultimately, wages.

However, the fact that a commitment by business is not necessary for a company tax cut to be a good policy is not the only reason why a system of measurement for such compliance is not a good idea. One reason, and an important one, is that the company tax rate is only one of many factors that determine whether a company chooses to invest. In observing movements in investment, wages, productivity and employment in the years following a company tax cut, it will be impossible to separate the effects of the cut from movements in the general economy. This is especially the case for a tax cut phased in over a number of years. Evidence of wage growth at companies making this commitment would not necessarily be associated with a company tax cut, nor would any increases in investment necessarily be caused by that commitment. Both could be the result of external effects in the economy. Importantly, the counterfactual in this analysis is not the current levels of investment, wages or employment. The global market for capital is dynamic, and by standing still Australia risks losing investment to other countries. Investment may have declined in Australia in the absence of a cut. So there is no way to know, even if no change in investment was evidence of a company tax cut failure.

A third relevant point is that part of the response to company tax cuts will take the form of new foreign investors coming to Australia and new companies being formed here, whereas any commitments can only come from the existing companies operating in Australia. That is why it is necessary to rely on aggregate modelling to determine the expected effect of a company tax cut, and most of the modelling performed indicates that company tax cuts will have a positive effect on investment, growth and wages.

In short, the case for company tax cuts rises or falls on its merits. It does not rely on BCA members or other large companies being good corporate citizens who pay their taxes or commit to deal with the proceeds of the cut. We'd be happy to take any questions.

CHAIR: Thank you very much. In your opening statement you talk about the BCA's commitment being given for political purposes. I take it from everything you said in your opening statement that you might agree with Professor Swan—I think you heard his evidence—that the BCA's commitment is a pile of rubbish and not worth the paper it's written on. Would you agree with that?

Mr Cowan : No, I would not. I think the commitment they've made is actually correct and specifically that a corporate tax cut is likely to lead to them investing more in Australia. The point that I'm making about it being political is that the reason they're giving—the idea that they would need to deal with a cut in a certain way—is driven primarily by the political debate around company tax cuts, not the economic effect of those cuts.

CHAIR: But in real terms what is the effect of their commitment? If you say these beneficial outcomes are going to occur anyway if the tax cuts go ahead, what is the effect of the commitment?

Mr Cowan : Very little.

CHAIR: Very little?

Mr Cowan : Yes. The commitment is worth very little. The economic effects that underlie the company tax cut are worth a lot more, which is why it's important that the tax cut happens. It's not important that the commitment is received or that the commitment is measured or assessed in years going forward.

CHAIR: Well, I'm focused on the commitment.

Mr Cowan : I'm happy to do so.

CHAIR: You've said it's worth very little; I've said it's not worth the paper that it's written on. There doesn't seem to be much between us on that issue.

Mr Cowan : I don't want to get into the semantics of that point. Basically the point I'm making is not that there's anything in that commitment that I think is economically incorrect; it's that I don't think that the commitment has any economic effect with respect to company tax cuts.

CHAIR: So, if you were in the shoes of the BCA, you wouldn't have made that commitment, would you?

Mr Cowan : I understand why they did it, but the purpose of doing so was to move forward the debate on company tax cuts rather than try and lock in any sort of economic gain. We've seen in the US, for example, where Donald Trump passed substantial tax cuts, that he secured commitments from companies that they would treat the proceeds in a certain way. That impact, however welcome it may be, is not the primary economic mechanism by which company tax cuts work.

CHAIR: But, having weighed into the debate for political purposes, as you say, you don't think it's relevant for the Senate to want to inquire into the level of the commitment, what it actually means? We're talking about $65 billion worth of forgone tax revenue. You don't think the public has an interest in whether or not there are better ways for those funds to be allocated?

Mr Cowan : Absolutely. As I said, I think there are a number of important questions with respect to a company tax cut, but the mechanisms to measure any commitment or performance by particular companies in the economy are not a strong indicator of whether or not company tax cuts are a good policy or indeed whether or not the tax cuts are a success or failure, both from the perspective that the economic impacts are separate to the commitment and in terms of attempting to measure the commitment. It will be very difficult, if not impossible, to separate out the global economic impacts and all of the other factors that are at play here in addition to the factors that would have occurred had the company tax cut not happened. So there's no counterfactual to assess this against, and there's no way to be certain that any positive benefits from investment or wages come from company tax cuts or, indeed, that, if there are no changes, the company tax cut didn't provide a benefit that we would not have otherwise received.

CHAIR: How do you respond to earlier testimony that even optimistic modelling in support of these tax cuts shows only very modest gains if the cuts are paid for by bracket creep?

Mr Cowan : I think bracket creep is also quite a pernicious tax, and we've campaigned long and hard on the government's need to move against bracket creep. I think you see more benefits if we see a reduction in inefficient government spending. One of the things we've advocated for in our TARGET 30 program is that the government should substantially cut assistance that it provides to businesses to distort particular investment decisions, and that, if they were to do so and use those proceeds to fund the company tax cut, you would probably see greater benefits.

CHAIR: What about evidence that the corporate tax rate is still quite competitive at 30 per cent, given the impact of dividend imputation?

Mr Cowan : There's no question that dividend imputation has an effect on this debate and on these issues. But when we're talking about company tax cuts, the relevant issue is: who is the marginal investor? Where does the extra dollar come from with respect to investment as a result of this cut? I think there's fairly good evidence that the marginal investor is a foreign investor who does feel the impact of company tax cuts and, therefore, will be responsive to changes. Australia does have a company tax rate that is higher than competing countries. There are a lot of different corporate tax systems in the world, but I do think there is evidence to suggest that, if Australia had a lower company tax rate, that would secure additional investment from foreign investors.

CHAIR: So you would agree that most of the benefits of the tax cuts go to foreign investors and that there are windfalls for existing investments to a much greater degree than incentivising of new investment?

Mr Cowan : I think we need in that respect to separate out short-term and long-term benefits. In the short term, there's a benefit to foreign investors. That benefit is what secures additional investment in the country. As that additional investment comes in, as a result of what is effectively a higher rate of return, that investment then competes away that additional rate of return back towards the global expected average rate of return for investment. As that happens, the benefits to foreigners diminish and what we see is that investment then translates to capital deepening, an increase in productivity as a result of that and then through to wages. That's why modelling by the Treasury and others has found that the bulk of the incidence of company tax rates is actually borne by workers and the bulk of the benefits of a company tax rate cut would also flow through, in the longer term, to workers.

Senator HUME: I have a very brief line of questioning on the impact of a company tax cut in the CIS's opinion. If economic growth leads to employment growth—and, obviously, there's been a lot of talk about wages stagnation recently—can you explain how potential increased employment from a company tax cut would affect wages?

Mr O'Donnell : Basically, the more you invest, the more opportunities there are out there to hire more workers at the end of the day. The whole point of an economy is to serve the consumer, and businesses are always looking for ways to serve the consumer. One of the main ways to serve the consumer is to provide new products, and you need people to actually produce those products.

Mr Cowan : And, of course, adding to what my colleague Matthew is saying, by increasing the demand for employment, you are effectively increasing the demand for employees to a relatively fixed pool. As that happens, employees can demand higher wages. We've seen in recent years a stagnation of wages, but, across a longer period of time in Australia particularly, we have seen a significant growth in wages at all levels, and, particularly, if you look at the effects of, say, the mining boom that Howard and Costello saw, we saw a very significant growth of wages as a result of that combined with a falling rate of unemployment. So the economic transition mechanism is there. The difficulty is assessing whether or not that fall or increase is caused by the company tax cut or other effects in the economy. The most obvious example of that is, if you were to compare employment between 2008 and 2012 and 2013 and 2017 and ignore the impact of the GFC, you would come to a very skewed analysis.

Mr O'Donnell : And to add to that, all new investment in machinery et cetera makes workers more productive, and, when the workers are more productive, they can ask for higher wages.

Senator HUME: So an increase in employment, which is most likely to come from a company tax cut, leads to an increase in wages; is that correct?

Mr O'Donnell : It's not just employment. It's employment and investment.

Senator HUME: And investment.

Mr Cowan : And productivity.

Senator HUME: Will that impact be immediate or do you think it will take some time?

Mr O'Donnell : It always takes time. Some things will happen straightaway because companies front-run. When companies are looking for investments, they're looking into the future, so there are certain investments they may make today or would make today if they knew that there was a tax cut in the future, but a lot of the impact is going to take time.

Mr Cowan : Indeed, one of the things that companies are looking for in that respect is certainty. If they're certain that the company tax rate will be a certain percentage in the future, then that will impact their decision-making. If they're not certain what that rate will be, it may not have as great an impact.

Senator HUME: It's fair for the companies that signed the BCA's letter to say that they are considering investment within their own organisations in response to a company tax cut?

Mr O'Donnell : Absolutely.

Mr Cowan : Yes.

Senator RHIANNON: Mr Cowan, you said earlier in your evidence that you understand why BCA did it, but, when you were speaking, I didn't hear you actually explain that. You've talked about your opinion of the commitment but not actually the reasons why they did it. Could you say why you believe they did it?

Mr Cowan : I think there are probably two main motivating factors here. The first is that, obviously, there's a self-interest element. A company tax cut would be good for the BCA members. It will benefit them, so they have an interest in that policy being pursued by government. I think they also believe that a company tax cut would be good for the country as a whole. It would result in higher wages and higher economic growth. So, on that basis, they're seeking to advance the debate to try and reassure senators and others that the mechanisms by which this occurred—the benefits translate from a tax cut from an economic perspective. I think they're trying to convince people that they'll actually occur. I don't think that it's necessary for them to make that commitment for those benefits to occur, but I think they're doing so to try and encourage people to accept that they will.

Senator RHIANNON: You spoke earlier about the political aspect of this. Let's remember, in the context of when this happened, that the government didn't have the numbers, and the government has said that this is a foundation of their economic plans, their political plans et cetera. So the BCA has come in to try and win those numbers over. Wasn't it just an attempt to win votes? Isn't that purely what it was all about?

Mr Cowan : I think it's primarily a political tool. I think it is aimed at convincing people who are wavering on this issue. I would expect that the BCA would also support an investment guarantee for very similar reasons and with similar motivations.

Senator RHIANNON: You'd be aware that the original BCA statement was much stronger, and then they couldn't get the agreement of many of their members, and they watered it down to a much more wishy-washy statement. Doesn't that really underline how political it was? It was about winning votes, and, at the end of the day, self-interest rules?

Mr Cowan : I've seen what purports to be a draft of the original commitment. I think the commitment that they made in the end reflects better the economic realities and what is within their control. I think some of the things that were in the original document—and I must stress that I have no idea if what's been reported on is actually a draft that was circulated amongst BCA members, but I would suggest that the commitment they gave better reflects the economic circumstances of a company tax cut.

Senator RHIANNON: That final document was widely described as being less accountable. Would you agree with that? Had it gone in that direction?

Mr Cowan : Less accountable? I think the accountability has very little weight as to whether or not a company tax cut is a good policy. From the perspective of policy, I'm not sure that whether or not it's more or less accountable is important. I think that, as I said, the commitment they made in the end better reflects the economic circumstances that they have control over.

Senator RHIANNON: When we're discussing this, it's worth remembering what was in that original document. It's been reported that it promised to put business—and these are BCA's original words—in a stronger position to avoid offshoring jobs, invest more in remote and rural Australia and be able to increase wages when the conditions are right. That was all dropped.

Mr Cowan : I think there's reason to think that some of the commitments that are in the original statement would come to pass, but I think it would be a stretch to say that there's strong evidence to suggest that they would be in a stronger position to avoid the offshoring of jobs per se. As I said, I think there are a lot of other factors that are at play with respect to this. That is why I think that a short commitment better reflects the economic circumstances. There is certainly a suggestion that jobs may well be created in cities, suburbs, towns and bush, but I don't think that they can necessarily control whether or not that occurs.

Senator STOKER: In your submissions you referred to the US experience of granting company tax cuts as a comparative example. Can you explain to us what some of the economic benefits have been in the US and, in particular, explain how that has affected wages growth?

Mr Cowan : The US company tax cuts have only occurred very recently. As to the longer term effects that we are talking about in our submission, in terms of increased wages across the economy, I think it's too early to see the benefits. What we have seen is that some US companies in particular have taken the proceeds of that tax cut and used that to boost wages or to provide benefits to employees. Some of them have no doubt also distributed that to their shareholders and to other investors. That's the sort of behaviour that you would expect to see. In the short term there is likely to be anecdotal situations where wages increase in particular companies and employment potentially goes down. Whether or not that effect is big enough to measure across the company, I think is an open question. But I think the primary benefits that you would see from a company tax cut take longer to be seen. What we've seen in the US are steps in the right direction rather than evidence that the full benefits of the tax cuts have already been passed on.

Senator STOKER: Based on your understanding of that experience, what do you expect to be the short-, medium- and long-term implications of tax cuts for companies in Australia?

Mr Cowan : The US experience is somewhat different due to the fact that they have quite a large budget deficit and they've massively reduced revenue into a deficit. Their situation is a little bit different to ours and there's obviously that element of it. There is also the fact that the US economy is quite different to Australia. It's a large economy. It's not as dependent on capital inflows as Australia is. It's not as responsive to global economic conditions. But what we would expect to see—and what modelling from Treasury and others shows—is that initially there will be an increase in foreign investment, chasing that additional return. That increase in foreign investment will lead to, say, new companies setting up here and existing companies investing more. That capital deepening will translate to additional employment opportunities and additional productivity gains and that will then lead to wages growth over time. That would be expected to be seen in the medium to long term rather than in the short term.

Senator KENEALLY: Thank you for your evidence and your time today. Following the questions about the tax cuts in the United States, you would be aware that President Trump's Tax Cuts and Jobs Act also contained significant provisions regarding tax depreciation.

Mr Cowan : There are a lot of specifics in the plan. I must confess that I am not an expert on the US tax cuts, but I am aware of the general position with respect to those tax cuts. Obviously the US have a very different situation to Australia's in a number of ways. They do not have an imputation system. They've also transitioned to a source based revenue. So they will actually see less benefit from the company tax cuts than they might have otherwise. In particular, US investors would see a greater impact from company tax cuts from Australia.

Senator KENEALLY: I will come back to the point about depreciation but, since you have brought up some of the differences between the United States and Australia, is it also the case that 44 states in the US levy a form of corporate income tax?

Mr O'Donnell : Yes.

Mr Cowan : I'm sure that's correct. As I said, the US system is quite different to the Australian system in a number of respects.

Senator KENEALLY: I'm sure we'll explore that point later on with other witnesses, but that's not the point that I wanted to explore with you. Back to the issue around depreciation: according to the Reserve Bank, non-mining investment in Australia is at a 58-year low, at just nine per cent of GDP. Given that, what would be the best way for Australia to overcome what some commentators have observed is our greatest weakness—that non-mining investment is at this 58-year low? Should we lower company tax, or should we increase investment allowances, accelerated depreciation and research deductions?

Mr Cowan : That's a good question, and, to be honest with you, I think we're quite concerned about the level of investment. We've published, for a number of years, on the problem that Australia is basically seeing a level of company investment that we haven't seen since we've been in a serious recession. So we definitely need to do things to boost the level of investment, and for a number of different reasons. We think that the investment deductions policy is also a good one. We think that there are benefits that would accrue from that policy in addition to company tax cuts. I think the better position in the longer term is to go with a company tax cut rather than an investment allowance, for a couple of reasons. The first is—and this is what I've seen reported from Grattan and others—that the investment allowances that are being proposed don't cover all the investment in the economy, so that may distort some of the choices that are being made. In the longer term, there is also the possibility that government will then intervene and interfere with that investment allowance to direct it towards particular types of investment, and we have seen that in the past, where government has chosen or preferred particular investments over others for political reasons. So we would prefer that that was not the case. But absolutely we think that there's a lot of merit and benefit in investment deductions and allowances, and we think that that is a good way of boosting investment in the country.

Senator KENEALLY: Orica chief executive Alberto Calderon recently said that the best way to boost desperately-needed investment was to boost investment allowances, not lower company taxes. So you would say he's wrong in that assertion?

Mr O'Donnell : That's his particular opinion, but the economy is an incredibly complex thing, and every entrepreneur and every individual has a different view on what's right and wrong, and the market system is driven by people making those decisions with their own money and getting it right or wrong. So why we like a company tax cut is because it's even—it treats everybody the same—whereas, with these investment allowances, it picks winners. Even if it's inadvertent, it's still picking winners, and it's much better to allow individuals to make the decisions rather than having it done by government fiat.

Mr Cowan : I would add: certainly, having an investment allowance would be better than the current situation; it would definitely be an improvement.

Senator KENEALLY: Robert Gottliebsen in The Australian said that handing our biggest taxpayers, banks, miners and retailers, a fistful of cash when, in the case of Australian-owned companies, shareholders will demand higher dividends, is not an efficient way to boost investment. Isn't that the point—that if we provide this company tax cut, in the short term, particularly, shareholders are going to demand higher dividends?

Mr O'Donnell : What matters is not increasing investment; what matters is increasing GDP. And what people decide to do with their own money is fine, provided that the policy change is improving the economy. If people don't want to invest, that's fine, because they're going to use that money—they'll consume something—and then that will create an opportunity for more jobs to be made in a different market. But to say that a company tax cut is all about investment is incorrect; it's about allowing individuals to make their own decisions and maximise the size of the economy.

Senator KENEALLY: In that case, then, you do seem to be at odds with the BCA, whose commitment to the Senate is that, if the company tax rate is cut, there will be more investment. And that is all they said; they didn't talk about anything else in their commitment.

Mr O'Donnell : It is highly likely that there will be more investment, but that's not the reason you have a company tax cut. You have a company tax cut because you want to maximise the size of the economy and you want to allow individuals to make decisions for themselves.

CHAIR: The commitment that the BCA has given goes directly from the tax cut all the way through to wage rises. But you, in your submission, have made, I think, the correct point, which is that there is no direct line from company tax cuts to higher wages.

Mr Cowan : Yes; it depends on the other conditions in the economy, amongst other things. So if everything else was equal, we would expect to see an increase in wages as a result of company tax cuts. There are a lot of other factors that impact here and that's why I think the best that you could say is that it's likely, perhaps even very likely, that you will see an increase in wages as a result of company tax cuts, but you can't give certainty that is the case. There's no guarantee that will occur.

CHAIR: Some economists would argue that a precursor to wage rises is improved productivity. Would you agree with that?

Mr Cowan : Yes, I certainly would.

Mr O'Donnell : Yes. If the company tax cuts allow businesses to make more investments, particularly capital investments, then productivity will rise and that will create more opportunities for workers to get wage rises.

CHAIR: How do you explain the fact that productivity seems to have been rising since 2000 and yet real wage increases have been stagnant?

Mr O'Donnell : Real wages have increased—there's no doubt about that—and I agree they haven't increased to the same level as productivity, but a whole host of things occur in an economy. Things don't move in lockstep. There are other periods of time when wages rise significantly faster than productivity. There's always a balance between what's going on.

Mr Cowan : One of the things that we saw during that period was a significant increase in very technical and specific types of capital, with the mining boom. The level of investment that we saw was very strongly directed in that particular direction. We didn't see a general increase in investment in the way you might expect from a company tax cut; we saw a very specific boost in the initial stage. The other point that is relevant with respect to mining is that there is a lag from the level of investment to the increase in productivity, because you need a very significant up-front capital investment. You then see a gain as the mine comes online in the longer term.

Mr O'Donnell : The other thing to add is that measuring productivity is one of the hardest things to do for the ABS. Trying to work out exactly what productivity is at any point in time is very difficult. You could have some significant measurement issues which could be driving some of that difference.

CHAIR: Mr Cowan, all this goes back to your point that this commitment's worth very little to the BCA.

Mr Cowan : I think the commitment is primarily political rather than economic. I don't think the fact that the commitment matters little necessarily translates to company tax cuts not been good policy or that the company tax cut itself is not a substantial or significant thing to pursue.

Senator STOKER: Chair, before we go too much further, may I just correct something? The witnesses were asked to proceed on a factual basis, which was that there had been no growth in non-mining investment in recent years. In fact, it rose by 12 per cent in 2017.

Senator KENEALLY: I cited the Reserve Bank, which said it had grown by nine per cent. I didn't say 'no growth'.

Mr Cowan : It had fallen substantially in the years before that. We've seen an uptick in recent times. It's not yet clear whether that's a sustained increase.

Senator STOKER: Just for clarity—and I take what Senator Keneally said—the minutes of 3 April 2018 show that private non-mining business investment increased by more than 12 per cent over 2017.

Senator KENEALLY: And I said that non-mining investment in Australia is at a 58-year low, at just nine per cent of GDP. I don't think we're in contradiction, Senator.

Senator STOKER: That's fine. Thank you.

CHAIR: Thank you very much for appearing before us today.

Mr Cowan : Thank you very much.