Company tax rates are a hot international topic, with PM Turnbull arguing Australia should follow the US’s example to remain competitive. The article below, written by Tim Farrelly an Australian asset allocation consultant, argues Australian taxpayers will be the main losers while investors will gain almost nothing in the longer run.
Why we don’t need a corporate tax cut
If the US company tax cuts get through, there will be renewed calls for tax cuts in Australia. The Business Council of Australia will again claim that without the tax cut, Australia won’t be competitive in attracting much needed foreign capital investment.
Will a tax cut attract foreign investment?
Unfortunately the answer appears to be ‘no’.
There are three different types of foreign investors: direct investors who come to Australia to build facilities to export products and services to the rest of the world; direct investors who bring their products and services to Australia to sell to Australians; and passive investors who buy shares in Australian companies.
The first group are virtually non-existent. Australia’s wage/cost structure will still be too high and, unless they eliminate company tax entirely, there will still be other countries that are much more attractive.
The second group are here in abundance – Microsoft, Apple and McDonalds all do roaring businesses in Australia. Would a lower tax rate attract more of them? Not likely, as most of them pay minimal taxes already. It’s hard to beat a tax rate of close to zero! Quite rightly, the ATO is trying to ensure these companies all pay a fairer rate of tax.
Finally, there are the passive foreign share investors who, by definition, don’t make capital investment decisions here. Local managements do.
It is really hard to see a lower tax rate making a difference to foreign sourced capital investment.
Who would be the winners and losers?
Australian shareholders would gain almost nothing. In the long run, the value of shares is determined by the dividends they pay. Dividends would rise by around 12% if the tax rate was cut to 20% – however, under the dividend imputation system, the after-tax value of those dividends would be identical to Australian investors. Cash dividends would be up, but imputation credits would fall by an identical amount. In the short-term, share prices would rise a little – by, say, 5% or 6%. Over time, expect this gain to be frittered away.
So who are the winners?
First and foremost on the winners list are company executives. Higher after-tax profits deliver higher bonuses and – executives hope – higher share prices and therefore stock option valuations.
The second group of winners are foreign passive investors. A reduction in the company tax rate from 30% to 20% would deliver 12% higher dividends and higher share prices, in the short-term at least.
The main losers in all of this are Australian tax payers. A reduction in corporate tax would, based on data published by the Australian Treasury, gift around $8 billion to $10 billion per annum to foreign passive investors.
In return, Australian taxpayers would get nothing. If the arguments advanced here are even close to being correct, we’d get precious little in the way of new investment, nothing in the way of higher equity returns, and a much bigger budget deficit. How much bigger? In the 2016-17 financial year, the Australian budget deficit was $33 billion. A loss of $8 billion to $10 billion represents a really significant setback on the way to getting the budget back into surplus. Where will the money come from? We can only guess. Removing imputation credits? Reducing pension payments? A higher GST? Who knows, but wherever it comes from, it would hurt Australian investors.
When would a cut to corporate tax rates make sense?
Easy! When the budget is in a surplus. Then we can afford to cut all tax rates, both personal and corporate. Now is not the time.
If you agree, let your local MP know.
Principal farrelly’s Investment Strategy
This information is of a general nature only and nothing on this site should be taken as personal financial or investment advice, or a recommendation to buy or sell a particular product.