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Economics References Committee
26/04/2018
Commitment to the Senate issued by the Business Council of Australia

DIXON, Dr Janine, Private capacity

Committee met at 09:00

CHAIR ( Senator Ketter ): I declare open this hearing of the Senate Economics References Committee for the inquiry into the commitment to the Senate issued by the Business Council of Australia. The Senate referred this inquiry to the committee on 26 March 2018 for report by 31 May 2018. The committee has received 15 submissions so far, which are available on the committee's website. This is a public hearing and a Hansard transcript of the proceedings is being made, although the committee may determine or agree to a request to have evidence heard in camera.

I remind all witnesses that in giving evidence to the committee they are protected by parliamentary privilege. It is unlawful for anyone to threaten or disadvantage a witness on account of evidence given to a committee, and such action may be treated by the Senate as contempt. It is also contempt to give false or misleading evidence to a committee. If a witness objects to answering a question, the witness should state the ground upon which the objection is taken, and the committee will determine whether it will insist on an answer. If the committee determines to insist on an answer, a witness may request that the answer be given in camera. Such a request may also be made at any other time. I ask photographers and cameramen to follow the established media guidelines and the instructions of the committee secretariat. Please ensure that senators' and witnesses' laptops and personal papers are not filmed.

I now welcome Dr Janine Dixon. Thank you for appearing before the committee this morning. I invite you to make a brief opening statement, should you wish to do so.

Dr Dixon : Thank you for the opportunity to talk to you today. I'm an economist working at the Centre of Policy Studies at Victoria University. In one guise or another the Centre of Policy Studies has been using detailed, economy-wide general equilibrium models to assist policymakers now for over 40 years. This began with the development of the ORANI model by Professor Peter Dixon and others in the late 1970s at the IMPACT Project in the then Industries Assistance Commission. Centre of Policy Studies models, including ORANI, MONASH, MMRF and, now, the VU model, have since played a continuous role in the Australian policy debate on a wide range of topics. As such, our models have evolved to reflect what is important to policymakers: detailed representation of industries, of regions, of jobs, of taxation—both state and federal—of trade and the balance of payments, and of adjustment costs. Some of these factors have been very important in our modelling of company tax, which I produced jointly with my colleague, Dr Jason Nassios. I'd like to talk first about our modelling, because it really sets the scene for what I'll say after that about the BCA's commitment to the Senate.

You don't need to be a very radical economist to conclude that the economics of a cut to the company tax rate are not sound. There are those who will argue that a tax cut won't stimulate investment any more than low interest rates have, that Australia is awash with oligopolies and rent seekers, and that rich foreign investors will simply trouser the tax cut and give us nothing in return. But you don't actually need to subscribe to that point of view to come to the conclusion that the cut to the tax rate from 30 per cent to 25 per cent for Australia's largest businesses will leave us worse off.

We agree with the government and the BCA that a cut to company tax will stimulate investment and wages. These effects will be modest, derived from investments that are profitable at a 25 per cent tax rate but not at a 30 per cent tax rate. New investment will need workers. To attract these workers away from their existing jobs, wages will grow. Wage growth is great for workers, obviously, but it will also quickly curtail any sought after investment boom. An investment that looks profitable at 25 per cent tax under today's wages will not necessarily be profitable as wages go up. Our estimation is that the potential new investment opportunities that open up under the lower tax rate are quite limited, facilitating a small positive stimulus to economic growth.

But some growth is better than none, right? Wrong. Even though economic growth will be stimulated, gross national income—the measure that really matters—will be reduced, because foreign investors will contribute less to the nation's income through taxation. Immediately when taxes are cut, as a nation, we will lose a chunk of tax revenue that we otherwise would have collected from foreign investors. This has a negative impact not only on government revenue but on our income as a nation. Over time, some but not all of this loss to the nation will be offset by higher wages, but we'll never catch up. National income will remain permanently lower than it would have been without the tax cut.

At this stage I should mention the modelling done for the government in-house at Treasury and by independent consultant economist Chris Murphy. Like us, these modellers conclude that GDP and wages will be larger as a result of a company tax cut. But, unlike us, they also find that gross national income will be larger, although to a lesser extent than GDP. Why the difference? Let me give you three reasons.

First, these results—that is, the Treasury's results—are based on long-run, comparative static modelling. That is modelling that simply asks: how would the economy look if the company tax rate were five per cent lower? It ignores the transition costs of getting there. We already have a large foreign investment presence in Australia which has voted with its feet for the 30 per cent tax rate. A tax cut is a gift to these investors. For the policy to be a success, the investment expansion has to beat this initial giveaway. The Treasury modelling correctly accounts for the repatriation of profits earned on new investment but does not account for the initial windfall gain to foreign owners of existing investments.

Second, Murphy's modelling takes into account a gain that he attributes to reduced profit-shifting. His argument is that, with a lower tax rate, companies are less motivated to incur the costs and risks associated with reducing taxes by shifting profits to tax havens. I won't go as far as to say that this doesn't happen, but I didn't take it into account in my modelling of the tax cut because I didn't think it relevant with taxes in the range of 25 to 30 per cent. The committee might not be aware that, in earlier versions of his modelling, the basis of the spectacular estimate of $2.39 consumer benefit for every $1 of tax revenue forgone, the reduced profit-shifting accounted for a significant proportion of that benefit. This estimate has since been revised downwards.

Third, parameter assumptions in models are important. We need to have some idea of how much additional capital can be absorbed by a labour force of a particular size. This determines how quickly wage growth chokes off the investment possibilities that open up under a company tax cut. The government modellers have chosen to use a top-of-the-range parameter value, meaning that they conclude that a relatively large amount of capital is absorbed before wage growth chokes it off. These technical concerns may not be of great interest, but they do illustrate that, although the case for a company tax cut carries the imprimatur of government-appointed economic modellers, varying just a few assumptions can turn the outcome from positive to negative.

Let's talk more about wage growth. Remember, we're comparing two states of the world here: enterprise tax plan 1 and enterprise tax plan 2. Although the small businesses receive a tax cut in enterprise tax plan 2, they get it in enterprise tax plan 1 anyway, so we are really expecting the big, foreign owned businesses to drive wage growth. These are the companies that receive the biggest benefit from the tax cut. The other employers—the unincorporated businesses, the Australian owned companies paying fully franked dividends, and the government—will face higher wage costs and no compensation on their tax bill.

This brings me to my point about the BCA's commitment. I find the commitment itself to be quite plausible. These businesses will be the beneficiaries of a generous tax cut, and we may see a few new Kmarts or Coles going up as a result. But no economist, including any at Treasury, has said that the company tax cuts will lead to long-term, significant increase in employment. Wages? Yes. But not employment. So, if the BCA businesses expand, they would do so by drawing resources—employment—away from the rest of the economy. Faced with higher wage costs, some small businesses will cease to operate; others may never come into being. This is not a policy that cares about small business.

But won't the workers benefit from wage growth? It sounds good, but it's an illusion. We've shown that national income will be lower, so there is no way that all Australians can be better off. If no attempt is made to recoup the lost taxation revenue, then government spending on essential services will be less than it otherwise could have been. If attempts are made to recoup the lost taxation revenue through bracket creep or a higher GST, then post-tax wage gains to employees will be eliminated.

In conclusion, I'd like to point out that I can say there is no way of tweaking this package to make it better. The policy leaves us worse off, whether we start from a position of budget deficit or surplus. Any move to compensate industry, and small business in particular, for the deleterious effects of enterprise tax plan 2, such as better funding for apprenticeships or improvements in the electricity market, doesn't need to be connected to company tax cuts and should be considered on its own merits. Sometimes we implement policies and accept the economic cost because we're trying to achieve other aims. The carbon tax could have been an example of this. But the very aim of enterprise tax plan 2 is surely to improve domestic incomes and, in this, it will not succeed.

CHAIR: Thank you very much, Dr Dixon, for your opening statement. In what you've said, you have covered a number of my questions, but I do think the central premise of what you're putting to us is about the impact on gross national income from the tax cut. I would be interested if you could elaborate on that a bit further. It seems apparent that this relates to the forgone tax revenue going to overseas investors and reducing our overall national income. I'd like you to explain why that hasn't really been picked up by the government's modelling?

Dr Dixon : The key reason that it hasn't really been picked up is that they don't have the framework in which to pick it up because they go directly to the long term. They basically ask: if company taxes are lower, how much capital would there be in the economy? And they certainly conclude that there would be more capital in the economy, but they don't look at the immediate effect—the morning-after effect—of just cutting company taxes. At that point the capital hasn't entered the economy yet, so we're just making a loss on revenue, and the offsetting gains will take time to come in. Without a dynamic year-to-year, short-run and long-run type of framework, they're not really set up to consider that.

CHAIR: What do you think the impact on gross national income is in the long term?

Dr Dixon : I find it's around about a quarter of a percent—so an increase in GDP but a reduction in gross national income. GDP is a measure, as you know, of all the things that are produced here, but we correct gross national income for income earned here by foreigners. Because this tax cut works at the margin—really on foreign investment—that income to foreign investors is the strongest component of the tax cut, and, when you remove it, what you're left with here is actually less.

CHAIR: I note in your submission you talked about how not all Australians can be better off as a result of this change to the company tax cut. Can you elaborate on what you meant by that? What does that mean?

Dr Dixon : At the very most basic level, the pie for Australians will be smaller. Maybe the way it will be distributed will be better for some, but, if it's smaller to begin with, it cannot possibly be better for all. I think the clear losers from this policy are the businesses that don't receive the tax cut and that are employers, because they're going to have to face a higher wage bill, which they're going to have to deal with one way or another. So I think they're the clear losers from the policy. The next loser from the policy is government revenue itself—collecting less government revenue. From that point of view, the distribution of the loss will then depend on other government policies. If it's the case that revenue is picked up from higher taxes on wages then workers would be the losers. If it is picked up by cutting spending then some of the most vulnerable members of our society would be the losers.

CHAIR: From your research, it is important to look at how the tax cuts are going to be funded, particularly if it is by increases in personal income tax?

Dr Dixon : Indeed. I doubt you would need high increases in personal income tax to cover it. I think bracket creep would probably be sufficient.

CHAIR: This cut will boost returns to foreign investors and lower capital returns for domestic investors?

Dr Dixon : Yes.

CHAIR: You say that unincorporated businesses don't get the benefit of this tax cut. It is a detrimental effect. Is that primarily through higher wage costs?

Dr Dixon : It's through wage costs. It's primarily wage costs, but any other costs as well.

CHAIR: Most people look at GDP growth as being a proxy for the national wealth. People always consider that to be an important indicator to see whether a particular decision is good or bad. You're encouraging us to look at a different index. Why hasn't this issue come up before, do you think?

Dr Dixon : Most times you would expect income and GDP to move together, but, in this case, because the expansion in GDP is driven by an increase in foreign activity, it is important to look at the two separately. We initially ran this modelling back in early 2016, and at that point all that was in the public domain from Treasury were GDP estimates. After we essentially agreed with Treasury on GDP but pointed out that gross national income would fall, Treasury started to put out those national income estimates too.

CHAIR: So you've had an impact on the information that Treasury is releasing to the public?

Dr Dixon : It could have been coincidental.

CHAIR: Could it? That's very interesting. I know that Senator Keneally has one question.

Senator KENEALLY: Thank you, Dr Dixon, for your time today. Could you just return to the idea with regard to reducing profit-shifting. Is this the same thing that some people argue is the morality dividend—

Dr Dixon : It is.

Senator KENEALLY: that is, that companies will choose to pay more tax or choose to stop profit-shifting because of the lower tax rate. You cited a figure there, and I just wanted to make sure that I had it clear. The Treasury estimates showed that for every dollar cut of tax there would be—what was it?—$2—

Dr Dixon : $2.39. This was an estimate from economist Chris Murphy, who built the profit-shifting into his modelling. It was very complementary to the policy, so it did get a lot of—

Senator KENEALLY: So the idea would be that, for every dollar the government cuts in the corporate tax rate, somehow companies are going pay $2.39—

Dr Dixon : Benefits will be $2.39, meaning mostly the expansion of the economy that comes as a result—

Senator KENEALLY: So that would be the benefit, not the amount—

Dr Dixon : Yes, it drives additional benefit.

Senator KENEALLY: And part of that is the so-called morality dividend.

Dr Dixon : A lot of it is the morality dividend.

CHAIR: You've indicated that there are some losers out of this proposed tax cut in the business community. Based on that, do you think that the Small Business Association should be advocating support of a cut on tax for big businesses?

Dr Dixon : I don't think so, no.

CHAIR: How do you respond to their proposition that small businesses who supply to big businesses stand to benefit from the cuts?

Dr Dixon : They may stand to benefit there. There is a give and a take, though. I think they stand to lose more from higher wages.

Senator PATERSON: So we shouldn't cut company taxes until we increase wages?

Dr Dixon : Correct.

Senator PATERSON: Right!

Senator HUME: We've just spent months arguing in the Senate that lowering company taxes will increase wages, because the opposition suggests that it won't.

Dr Dixon : You have to be two-handed as an economist.

Senator PATERSON: I am sure the voters of Australia would hate the idea of higher wages as a result of company tax cuts.

Senator KENEALLY: I think they hate the idea of bracket creep.

Dr Dixon : They probably hate the idea of lower income overall.

CHAIR: Can you elaborate on your analysis that the tax cuts are a windfall for past investment, particularly for foreign investors.

Dr Dixon : If you think there are a whole lot of investment opportunities out there and they're all different, some of them are more profitable than others. For those that are profitable enough to cover a 30 per cent tax rate, we don't need to cut the tax rate for them; we've got them. Those investments are in place already. When we cut the tax rate, what we're doing is opening up the possibility of potential projects that are profitable enough to cover a 25 a per cent tax rate, but not 30. It is those ones. With the companies that are okay with 30 per cent, if we give them a tax cut, that is just a windfall gain for those investments. Most times when you wish to cut a tax or implement a subsidy, there will be a bit of giveaway to the things that would have happened anyway. So you must weigh that up against the things that you're going to induce to occur—the extra things that will be given the incentive.

CHAIR: What are the other policy options that could be considered to boost investment?

Dr Dixon : Let's just start at the start. A company tax cut doesn't actually beat just doing nothing, just leaving the company tax rate where it is. If you're looking for policy options to increase investment, it's true that a company tax cut will increase investment, but you must look more widely at the impacts before giving it the tick. What other policy impacts could induce investment? I think we can look more directly at policies to increase investment. The company tax cut is a little indirect in that it is a policy to encourage profits, and to make more profits you should invest. So it's a little bit indirect. You must make those steps. So policy to increase investment along the lines of an investment allowance, instant deductions—those types of policies—based on modelling that I have done more recently, an investment allowance would be more effective. It suffers the same problem in that investments that would have taken place anyway now get a little free kick, but we think that loss is less relative to the gain that you would get.

CHAIR: When you say it's more effective, do you mean that for every dollar of forgone tax revenue that the impact on the economy is greater?

Dr Dixon : Yes.

Senator HUME: Dr Dixon, was the modelling that you did actually on the company tax cut proposed by the government or was it on a company tax cut generally? Was it on the government's policy?

Dr Dixon : I have models of the government's policy but the modelling that is in the public domain, such as in a paper on our website, is an earlier version of a policy to cut company taxes. It was in fact a policy proposed some time ago by the Business Council and it involved deeper cuts than what the government ended up with.

Senator HUME: So the modelling that you're talking about today reflects deeper cuts than the government is proposing?

Dr Dixon : No. The modelling I'm talking about today is modelling of enterprise tax plan 2, relative to enterprise tax plan 1.

Senator HUME: The modelling you're talking about today includes a stepped program—the full company tax cut comes in stages?

Dr Dixon : Yes.

Senator HUME: How do you then account for the transition costs? I would've thought that the transition would happen over quite a long period of time.

Dr Dixon : Yes, it does. The modelling is a year-to-year exercise, so in a sense the companies don't act ahead of the tax cut; they wait until the tax cut comes in. I have tried—

Senator HUME: You're suggesting that companies don't make investment decisions in anticipation of forecasts?

Dr Dixon : In anticipation of that forecast tax cut.

Senator HUME: But surely companies model into the future what they intend to do, particularly with investment decisions.

Dr Dixon : Sure, to some extent they would.

Senator HUME: They would include a tax cut in their modelling, surely. It's a cost of business that wouldn't apply.

Dr Dixon : They look at their investments today and think, 'In 10 years time I'll have a tax cut,' and assess their investment on that basis—it may be so. It gets a bit speculative at that point, but I have run models, not published, where I've said, 'A little bit of investment takes place ahead of the tax cut'—to pick up on this anticipation that you're talking about—'and puts us ahead of where we otherwise would have been when the tax cut comes in,' but it's not enough. It's just not enough. If you want to collect 30c, at the moment, from a foreign company, they need to make $1 of profit. If you want to collect 30c, if the tax rate's at 25 per cent, they need to make $1.20.

Senator HUME: Has the modelling that you've done included a 25 per cent tax rate for companies with turnovers of less than $50 million?

Dr Dixon : Yes, but that's in the business-as-usual and the policy simulation.

Senator HUME: I'm just making sure that the modelling that you're talking about today is reflective of the policy that we have proposed.

Dr Dixon : Yes.

Senator HUME: So you have said that the policy we have proposed will increase GDP and will increase wages?

Dr Dixon : Indeed.

Senator HUME: Talk to me about the reasons that the company tax cut will draw resources away from the rest of the economy—I think that was the phrase that you used. You were talking about how it would essentially shift the employment dynamic.

Dr Dixon : Because the company tax cut isn't really implemented across the board. The headline rate may appear to be, but you have all sorts of businesses that don't really pay it. In particular, we have dividend imputation. If you're an Australian owner of a small or medium enterprise, if—

Senator HUME: A shareholder?

Dr Dixon : Yes, a shareholder—you might be the sole shareholder operating it or you might be a shareholder in a listed company. It doesn't really matter what the company tax rate is because you'll take a franking credit with your dividend and you'll get that back through your personal income tax. From the point of view of those decision-makers, those shareholders, a company tax cut doesn't really make a difference. This company tax cut, when you take into account that dividend imputation exists, is very skewed towards just particular types of businesses. Because foreign shareholders, as you know, can't use the franking credit; it has no value to them.

Senator HUME: You're suggesting that increased amounts of foreign investment is not a good thing?

Dr Dixon : No, I'm not suggesting that at all.

Senator HUME: But surely that's what a reduced company tax rate would do. It would attract more foreign investment.

Dr Dixon : But it would also give away more revenue. You must be two-handed about this.

Senator HUME: Give away more revenue to who?

Dr Dixon : To the foreign owners of investment that's already installed here.

Senator HUME: But surely, if people are going to make more money, they're more likely to invest more. Isn't that the most basic of Economics 101?

Dr Dixon : Yes, and I've taken that into account—that they will invest in projects that are profitable at 25 per cent but not 30.

Senator HUME: Yes, and that's a bad thing?

Dr Dixon : But projects that are already profitable at 30 per cent—we don't need to give them a tax cut.

Senator HUME: But wouldn't there be more projects that more people would invest in if the return was going to be higher?

Dr Dixon : I would think they're already being invested in. If they're profitable at 30, they'll be invested in.

Senator HUME: We heard another academic talking the other day about the effect of company tax on the capital asset pricing model, which is the cost of capital. If the cost of capital is lower, you're more likely to invest, are you not?

Dr Dixon : Sure. But we've taken that into account. If the returns on capital were higher for other reasons—suppose we had strong terms of trade, suppose there were improvements to the level of education in Australia or suppose Australia ran an advertising campaign to attract investment—that would be great. Foreign investment is good—we want it—but not at a cost to tax revenue, when the cost to tax revenue is large and up-front.

Senator HUME: But it's not large and it's not up-front, because it's being staggered in over time.

Dr Dixon : It's too large to justify the gains.

Senator HUME: That's just an opinion, isn't it, more than anything else?

Dr Dixon : Well, it's an informed opinion.

Senator HUME: That's a somewhat subjective opinion, I'd imagine, as opposed to an objective one. Surely the aim of the game is to grow the pie over time?

Dr Dixon : It's an informed opinion based on an economic modelling framework. You could equally say that any modelling based on Treasury or based on what you're saying is also an opinion.

Senator HUME: We seem to be going in circles here. Do you think that maintaining the status quo, a two-tier corporate system, will lead to a disincentive for businesses to expand and therefore potentially stifle economic growth?

Dr Dixon : I do think that a two-tier system creates distortions around the threshold. There may be businesses that are taking revenue of $49 million, and the two-tier system may prevent them from wanting to expand.

Senator HUME: Are you suggesting that we maintain the two-tier system or that we dismantle it?

Dr Dixon : I'm only suggesting that enterprise tax plan 2 is detrimental relative to tax plan 1.

Senator HUME: You have two choices; you can't be half pregnant. You can either have a two-tier system, which is what we have now, or you can implement tax plan 2 and have—

Dr Dixon : Implementing tax plan 2 has its benefits, including removing the two-tier system, but it's too costly.

Senator HUME: Which is more important, having the costly system that you're suggesting—

Dr Dixon : It's more important to maintain a good revenue base from foreign investment in Australia.

Senator HUME: Are you suggesting that we dismantle the existing company tax cuts, the two-tier system?

Dr Dixon : No.

Senator STORER: Dr Dixon, I want to return to the assumptions discussion on the Chris Murphy modelling and the Treasury modelling. You spoke about profit shifting. I think on Tuesday we had a paper from the IPA which downplayed the amount of profit shifting occurring to date, yet you've made the point that you think that this is a significant part of the benefit coming from the Chris Murphy modelling and Treasury modelling. I want to hear a bit more about your viewpoint on that assumption.

Dr Dixon : The modelling I was referring to that arrived at the $2.39 benefit for every dollar lost, from my reading of it, derived a gain to consumer welfare of around $5 billion if you cut the company tax rate, of which I believe $3.9 billion was attributed to that profit-shifting estimate.

Senator STORER: You mentioned a second assumption. Could you remind me of your comments?

Dr Dixon : I mentioned moving directly to the long run; there was that assumption. The other assumption was the amount of capital that can be absorbed by a labour force of a particular size. There are a range of parameter values you could use to estimate that. There are various studies supporting a range of values, and Treasury has used a pretty high value there.

Senator STORER: We also heard about the difference in the modelling in terms of the lump sum, which is the notional modelling—because there is no lump-sum countermeasure in the policy. If it's funded by bracket creep, as in the second example given in the modelling, whilst the GDP decreases slightly, from 0.93 to 0.72, the employment goes from 0.2 to -0.02, so slightly minus. Also, real after-tax labour income—well, wages decreased significantly. Surely the change has to be paid for. Is your modelling indicating how it's paid for, and that's how you may be getting a GNI—

Dr Dixon : The most generous way you can model a policy like this is with the notional lump-sum transfer. A different method of paying for it, such as income tax, creates a disincentive effect on labour, and that's where he's getting those estimates. Once you implement an income tax increase to pay for the tax cut, your post-tax wages are down and so the incentive to supply labour is down, and that's why he gets that slightly negative impact on employment. In the modelling I'm talking about at the moment, I didn't do that. Although I've said that pre-tax wages will go up and I've pointed out that, in the context of national income falling, there's no way that this can be made out to be a good thing, in the modelling I'm talking about you find a very slight increase in employment. That modelling is in fact a little bit generous to the case of the company tax cut. If, as it plays out, we get a bit of income tax increase—which I suppose will be by stealth, through bracket creep—the result on national income could actually be worse than what I'm saying, and I'm already saying negative.

Senator STORER: Can you repeat why?

Dr Dixon : Because of the large loss of tax revenue that is paid by foreign investors. If we lose tax revenue to the household sector—suppose we cut the GST—it still stays with us. The household sector is bigger and the government sector is smaller, but in this case, because this is tax revenue that's being collected from foreign investors, it's gone. Gradually, as investment opportunities pick up as a result of a lower tax rate, some of that will come back to us through higher wages, but on balance not enough.

Senator PATERSON: Dr Dixon, thank you for acknowledging that the government's policy will lead to an increase in investment and an increase in wages. When even the critics of the government's policy acknowledge two of its strongest recommendations, I think we're making good progress. I want to return to the discussion you were having with my colleague Senator Hume about Australian incorporated businesses and how they won't benefit, due to dividend imputation. Didn't you leave out a fairly significant factor in that conversation?

Dr Dixon : Which was?

Senator PATERSON: Retained earnings for investment.

Dr Dixon : That's taken into account in the modelling.

Senator PATERSON: Right. But in your exchange with Senator Hume you didn't note that, for example, companies will be able to retain more earnings for investment, which would lower the corporate tax rate.

Dr Dixon : Sure they will, but she didn't asked directly about it. The point is—

Senator PATERSON: I'm asking directly about it, so let's have a discussion about it.

Dr Dixon : The point is that dividend imputation exists and that local investors can take advantage of it and foreign investors cannot. The tax cut—even though it sounds the same, 30 down to 25—for foreign investors will effectively be larger. That puts them at an advantage. It puts them in a place where they can offer higher wages and be compensated for that through the tax cut, and everybody else has to pay those higher wages and is compensated less.

Senator PATERSON: I'm going to quote from your submission to the committee here. Under the bullet point 'Australian-owned incorporated companies' you said:

As such, these business owners receive no benefit from a cut to the rate of company tax.

Is that a full statement? Is that an accurate statement? Does that take into account retained earnings?

Dr Dixon : It takes into account retained earnings and wage growth. It takes both into account.

Senator PATERSON: It doesn't mention retained earnings anywhere. I can't see it anywhere. Correct me if I'm wrong.

Dr Dixon : Forgive me for not putting it into the statement, but it's certainly taken into account in the modelling.

Senator PATERSON: But because of retained earnings for investment, they will in fact receive a benefit. You might argue that it's not a net benefit, but it's certainly a benefit.

Dr Dixon : It's not a net benefit, and I think that's what we should be concerned with.

Senator PATERSON: So you've modelled the effect of retained earnings against increased wages and found that an increased wage bill is going to be greater than the benefit for retained earnings?

Dr Dixon : Correct.

Senator PATERSON: Whereabouts in your modelling is that?

Dr Dixon : It's in the share of the franking credits that are actually claimed. If we were to say that all franking credits were claimed we'd be essentially saying that there was no cut to company tax for Australian incorporated businesses because franking credits were 100 per cent claimed. We know they're not, so that's taken into account in the modelling.

Senator PATERSON: But one of the things that's not taken into account in your modelling—correct me if I'm wrong—is the indirect effects for small- and medium-sized businesses. For example, do you take into account the increased investment that they might receive from the larger businesses as a result of company tax cuts?

Dr Dixon : We separately model local and foreign-owned businesses and we can see the expansion in the two sectors, and we can see that the expansion in the foreign-owned sector outweighs or kind of mops up a little bit of the domestic-owned sector. You get an overall expansion, but you get a bigger expansion in the foreign sector and a slight contraction in the domestic sector.

Senator PATERSON: So overall it will get us an increased level of investment. The $550 billion a year of business transacted between small and large businesses would increase.

Dr Dixon : GDP increases overall, which—all other things being equal—would be good for small businesses as well.

Senator PATERSON: It sounds good to me. Certainly if I were a small business and one of my customers were a large business that was going to get a tax cut and as a result can invest more in their business, I'd be pretty happy about that, wouldn't I?

Dr Dixon : In that specific example, perhaps.

Senator PATERSON: I just want to turn to one final issue, and that's the relative reliance of the Australian economy and government revenues on company taxes. Is that something that concerns you?

Dr Dixon : Not as such, no.

Senator PATERSON: In the OECD we're the fourth-most reliant in terms of company tax as a percentage of GDP—4.3 per cent comes from company tax. If you break that down to a proportion of company tax as a percentage of tax revenue it's 15.3 per cent, and we're the most reliant in the OECD. Does that sound sustainable to you going forward?

Dr Dixon : Company tax is company tax. A lot of it is immediately offset by dividend imputation.

Senator PATERSON: That doesn't really answer my question, though. Given the risks to government revenue going forward, if our rate of company tax for large businesses stays at 30 per cent and we are already the country in the OECD most reliant on company tax revenue, does that sound like a sustainable footing for future tax revenue?

Dr Dixon : In the context of Australia's tax system, I believe so.

Senator PATERSON: I'm not just asking about Australia; I'm talking about Australia relative to the world. We're in a competitive environment for global capital. A lot of businesses can locate their intellectual property anywhere in the world they like. They're choosing to do so in low-tax jurisdictions—shock-horror. Is that going to be a danger to Australia? Is the kind of profit shifting that senators are concerned about going to occur more often, and is that going to be a problem for Australia, given we're so reliant on company taxes?

Dr Dixon : Potentially, yes, but it's not a problem that would be solved by cutting the company tax rate.

Senator PATERSON: Why not?

Dr Dixon : Because you can still do that. You can still put your profits or your intellectual property offshore. We're not talking about going down to 15 per cent.

Senator PATERSON: But your economic incentive to do so is reduced, isn't it?

Dr Dixon : Somewhat, but we're talking about going from 30 to 25. We're talking about putting profits offshore in places where the tax rate is 15 or 12.

Senator PATERSON: So you're advocating an even bigger company tax cut than the government is proposing.

Dr Dixon : No, I'm not.

Senator PATERSON: But at the margin we know every single percentage point of company tax is a point of incentive for a company to profit shift, isn't it?

Dr Dixon : At the margin it is, but I don't think this is—

Senator PATERSON: Well, that's where decisions are made, isn't it?

Dr Dixon : It is, but I don't think this is a big problem when moving from 30 to 25.

Senator PATRICK: Thank you, Dr Dixon, for appearing. In relation to the modelling, it's a bit confusing to me. Your submission doesn't actually include any real description of the modelling. It relates back to what Senator Hume was saying. Is it possible for you to provide the committee with modelling that actually reflects the tax cuts in the bill, and, secondly—noting that the assumptions are so important—a modelling report that provides the committee with some understanding of what assumptions were, in fact, used in the modelling?

Dr Dixon : That will be possible. The report that I've published at the moment is from a couple of years ago, and since then I've certainly refined and updated the modelling, particularly given the amount of public forums I've been to to discuss it and so forth. So I haven't got a report I can just hand straight to you, but I can certainly provide such a thing.

Senator HUME: So your submission is based on the updates, or your submission is based on the original—

Dr Dixon : Indeed—updates, yes, and more generally. Whether it was the enterprise tax plan itself or the original proposal from the business council that we modelled at first, the economic mechanisms are the same.

Senator PATRICK: But you would appreciate that modelling is always very sensitive; a change in one input can make a big difference to the output.

Dr Dixon : Yes, I think that's right—as I've shown in the comparison of our modelling with the Treasury modelling.

Senator PATRICK: Sure. That comes back to the fact that if you get 10 economists in a room you'll get 14 different answers! I say that with a bit of humour, but that's the reality of it. Unless you have a detailed look at what assumptions are used—and Senator Storer is also asking questions about that—it makes it very difficult. My understanding is that Treasury has put out its modelling and a modelling report, hasn't it?

Dr Dixon : Yes, Treasury has.

Senator PATRICK: And that allows you to offer constructive criticism as to the way in which they've come to their results, and so it is, in some sense, only fair that you would perhaps do the same thing and expose yourself to—

Dr Dixon : I can't disagree with you there.

Senator PATRICK: So, if you were able to do that, it would be helpful. One of the things you are concentrating on—and I'm in furious agreement with you—is that it's very important to maintain that gross national income, such that we don't end up seeing cuts to services. That's the basic concern you have, I presume?

Dr Dixon : Yes.

Senator PATRICK: This comes back to the Henry review, which talked about other mechanisms for simplifying tax but also for broadening the tax base. One of those mechanisms for broadening the tax base was PRRT adjustments, for example. There was the Callaghan review; the government is yet to respond to that. But if, for example, the government were to come out with a package that said, 'We're going to deal with problems in taxing some of our resources,' presumably that would put you at ease in respect of that gross national income?

Dr Dixon : I can't answer, as I haven't modelled that as such, but I will note that the Henry review recommended a cut to the company tax rate from 30 to 25, as we're looking at, and, in the same dot point, they said 'in addition to the minerals resource rent tax'—or something along those lines. It wasn't even a separate recommendation; it was the one recommendation. And here we are with just half of it.

Senator PATRICK: I'll put on the record that, from our side, we have a concern that this legislation, viewed in isolation, is very problematic. But say there were other bits of the puzzle such as a change to PRRT or an alternative. It's now on the public record that I have had some conversations with the tax commissioner about anti-avoidance. There's a significant amount of revenue that's being restored, or recovered, as a result of some of those measures. Would you agree that would all be helpful—noting that you haven't seen it—in addressing your concern?

Dr Dixon : I do agree it would be helpful, but I suppose it's not the concern we're trying to address today. Anti-avoidance, in terms of tax office actions, is helpful. Anti-avoidance, in terms of saying, 'You can have some of it anyway,' cutting the rate from 30 per cent to 25 per cent, is less helpful.

Senator PATRICK: If you saw the numbers—and I don't know what is in the public domain—they're in the billions of dollars. Your modelling says, 'We're going to lose a fair amount of income as a result of a tax cut,' but if it's put in play at the same time as some of these anti-avoidance measures—perhaps a change in the PRRT or perhaps some other mechanisms; I'm not privy to what's in the budget—would that address your concerns?

Dr Dixon : Potentially.

Senator PATRICK: I think you agree that this will help with foreign capital investment. How important is that to the economy? Obviously, a whole bunch of business activity takes place nationally and only some comes from foreign investment. Can you talk about the quantum and the importance?

Dr Dixon : Yes. We think foreign investment accounts for around 20 per cent of all investment in Australia, but what we really need to look at, though, is at the margin. Foreign investment is much more important at the margin, not least because Australian investment is constrained by the size of the Australian economy and the Australian savings rate. Even though investment is divvied up as 80 per cent domestic and 20 per cent foreign, the next dollar of investment is much more likely to be sourced from foreign investment.

Senator PATRICK: I share a great concern about some of the smaller businesses. I like the idea that you help the small guys because it keeps the big guys more competitive. You state a concern about the effect of the tax cuts on smaller businesses. Once again, if there were measures in place—and, once again, I'm not privy to any of them—that gave some encouragement or boost to the smaller businesses, would that also allay some of your fears?

Dr Dixon : Any such measures would need to be funded. I don't think it would allay my fear of the fairly large up-front loss in tax revenue.

Senator PATRICK: I agree with your assessment, but, if presented as a total package, could they be framed up? Could you sit down and work out a way to do this where we attract foreign investment and don't have to deal with the downsides that you have clearly talked about? Have you looked at how you might do that at all?

Dr Dixon : I suppose indirectly. If you look at the big source of negativity towards the tax cut, it's the loss of revenue on capital that would have been installed here anyway—that is, capital that's already installed on the day that the tax cut takes place. Is there a way of insulating that revenue—that is, insulating the businesses that were happy to pay 30 per cent, which we justify on the basis that they are here and they're paying 30 per cent? Is there a way of shoring up that revenue stream from those businesses whilst still offering the tax cut to new investment in order to attract the new investment? To me, that started to sound awfully like an investment allowance.

Senator PATRICK: That's your proposition to deal with that part of the problem.

Dr Dixon : Yes.

Senator PATRICK: I wonder whether you've looked at others? I presume that the Treasury would look at this holistically when they're doing their work. The other question I have is—and this comes down to the 10 economists and 14 answers in the room—it seems to me that a whole bunch of nations are taking the option of reducing this revenue base. I'm not suggesting we just blindly follow countries off the cliff, which might be the case in the US, but there are other countries that are doing similar things, and Treasury would say that's to deal with competitiveness between nations. Do you have any view on (a) why they're doing it and (b) the effect of their reductions, which are real, versus us not changing?

Dr Dixon : When considering the reductions that they're making, what we need to do is revisit the starting point for our modelling, which is an economy in which around 20 per cent of capital is foreign owned. The point is that if other countries reduce their tax rates to the extent that it changes the starting point for us then that could have an impact. If it turned out that the other countries reduced their tax rates and we found ourselves in a situation where foreign-owned capital is perhaps only 15 per cent or 10 per cent of our total capital stock then the loss that we'd make on existing investments would be smaller because there'd be less of it to begin with. And that would improve the case for a company tax cut in Australia. But, at this juncture, I don't think that's a reality for us.

Senator PATRICK: Clearly, other countries are doing this. I think most people probably at least accept the argument in isolation that we are therefore less attractive to that capital. Once again, if we had a package that dealt with the downsides that you are clearly articulating and which are arguable—whether or not such a cut would be acceptable or in fact good for the nation, if we had a range of other mechanisms in place, would you at least accept that you could construct something that dealt with the cons?

Dr Dixon : The basis of such a thing would have to be to protect the revenue stream on the investments that we were getting anyway. That would have to be the basis for it. On the matter of competitiveness, it's a strange thing that we look at our tax rate and say it's uncompetitive, and then we say, 'We'll cut the tax rate, and our wages will go up,' and we never talk about competitiveness again. High wages will also make us uncompetitive in the same way.

Senator PATRICK: Sure, that's all those different levers in the model, however, which is why I think it's important to get the assumption on the table.

Senator PATERSON: Chair, I just have one clarifying question, if that's okay?

CHAIR: Yes, but then Senator Keneally has some questions.

Senator PATERSON: Dr Dixon, I want to clarify some earlier evidence from you about the fact that Treasury wasn't modelling GNI, or at least wasn't modelling it until recently—did I hear you correctly?

Dr Dixon : An early report from Treasury reported and focused on GDP rather than GNI. I wouldn't like to say they never modelled it.

Senator PATERSON: Do you remember how early that report was that measured GDP but not GNI?

Dr Dixon : Possibly 2015.

Senator PATERSON: Because I'm looking at their May 2016 modelling. On page 17 they do model GNI and they estimate that the impact of the company tax cut is a 0.8 per cent increase in GNI in the long run. That obviously differs from your analysis. Why do you think that is?

Dr Dixon : Chiefly because they left out the short run and also because of parameter settings in their models which assume that a labour force of a certain size can absorb quite a lot of extra capital.

Senator PATERSON: Okay, thank you.

Senator KENEALLY: I'll be brief. I want to pick up on some of the questions that Senator Patrick was asking. We heard in testimony on Tuesday from the Business Council of Australia that they opposed a previous attempt in 2011 to cut the corporate tax rate, because it was funded by changes to the mining tax. It was suggested that how a corporate tax cut is paid for really does matter. It matters to business; by your testimony today, it matters to wage earners; and it matters to people who rely on government services. So, coming to this question, could we just be very clear one more time? With this particular enterprise tax plan, the government contends that funding for it is in the budget. Treasury seems to argue, or at least Treasury modelling seems to suggest, it is funded through bracket creep, the morality dividend and, I presume, some sort of savings. Have I missed anything there? Is there any other way they're going to pay for this corporate tax cut?

Dr Dixon : No, I don't think you've missed anything. I think the fundamental point, though, is that, no matter whether we start from a position of surplus or deficit, this tax cut leaves us worse off than we would have been without it.

Senator KENEALLY: I also want to ask about the notion of introducing differential thresholds. We also have some differential thresholds. As you've pointed out and as we all know, up to $50 million has passed the Senate. We heard testimony on Tuesday from the Business Council that they would not support introducing thresholds of, say, $100 million or $500 million. They argue that this corporate tax rate must be applied across all businesses in order to get the effect. Could you comment on your view of their usefulness to the economy? I understand that you don't support the corporate tax cut at all, but what if there was a proposal to cap at, say, $500 million?

Dr Dixon : Firstly, I think it'd be quite a lot less effective in picking up the gains that you want to pick up, because the system of dividend imputation blunts the positive effect of the corporate tax cut. The really big foreign owned businesses are where you'd expect to see a gain, and they'll be above that threshold, so they'll be left out. In general, I think thresholds create distortions, and they're not ideal. You get to a point where you're just below the threshold and you're no further motivated to expand.

Senator HUME: Disincentives, as opposed to—

Dr Dixon : Yes, disincentives. So I don't think thresholds are a great idea.

Senator STOKER: Dr Dixon, you've talked about a 'windfall' to companies that have already invested on the basis of this 30 per cent rate and the need to insulate that potential revenue from becoming such a windfall. Does a program of staggering the implementation of a reduced tax rate have the effect of reducing that impact?

Dr Dixon : I think it does, but not to a large enough extent, though.

Senator STOKER: Does it also provide a signal to the market to encourage new investment?

Dr Dixon : It does.

Senator STOKER: Nothing further, Chair.

CHAIR: Thanks for appearing before us, Dr Dixon.