This Treasury modelling sets out how company tax cuts can grow the economy

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The Turnbull government’s proposed cut to company tax, costing an estimated at $48 billion over a decade, is shaping up to be one of the defining issues of the coming election campaign.

Treasurer Scott Morrison last night authorised the release of modelling which disclosed the government’s estimate of budget impact of the rate reductions, following speculation yesterday about the true cost.

However, Treasury has also released some modelling which analyses the benefits to the economy of company tax cuts which concludes that in an economy like Australia’s accrues long-term benefits in living standards from such a cut.

The research paper is complex but outlines the familiar economic argument that reducing taxes attracts more investment. It also concludes that it lifts wages and consumption. Here’s the summary (emphasis added):

For a small open economy, such as Australia, its living standards (per capita income) are determined by the level of its terms of trade, labour productivity, labour force participation and population. Australia’s terms of trade, labour force participation and population growth are expected to be flat or declining in the foreseeable future which implies any improvement in Australia’s living standards must be driven by a higher level of labour productivity. This paper shows that a company income tax cut can do that, even after allowing for increases in other taxes or cutting government spending to recover lost revenue, by lowering the before tax cost of capital. This encourages investment, which in turn increases the capital stock and labour productivity. Analysis presented here also suggests the long-term benefits accrue to workers and households via permanently higher after-tax real wages and consumption.

The model specifically looks at the economic impact of a reduction in the company tax rate from 30% to 25%, the reduction proposed by the Turnbull government, albeit over the course of 10 years with phasing of enterprise sizes qualifying for lower rates and a “glide path” slow reduction in the rate over time.

The model finds there is a 1.2% benefit to GDP – although this is highly qualified as based on “leaving all other tax rates unchanged and allowing any shortfall in revenue to be financed by a lump-sum tax increase.” The following chart sets out the long-term impact.

Source: Treasury

The authors, Michael Kouparitsas, Dinar Prihardini and Alexander Beames of Treasury’s Macroeconomic Modelling and Policy Division, explain:

On the expenditure side, roughly half of the increase in real gross domestic product (GDP) flows from higher investment. Investment increases by 2.8 per cent, and contributes around 0.6 percentage points to the overall GDP gain of 1.2 percentage points. This reflects the fact that a higher level of investment is required to maintain the expanded long-run capital stock. Consumption rises by around 0.6 per cent, and contributes around 0.3 percentage points to GDP over the long-run. As noted above, net exports must rise to stabilise the ratio of net foreign liabilities to GDP, with the contribution to GDP from net exports around 0.3 percentage points.

The authors are careful to point out that they “not provide specific estimates of the economic gains” of the tax reduction proposal in the 2016-17 federal budget.

One of its key points is the argument that a lower tax rate means that although foreigners can pay less tax, this will actually encourage them to invest in Australia, deepen the capital stock and improve productivity and living standards.

Treasury modelling isn’t exactly barbecue-stopping material but both sides of politics have been saying they will treat voters with respect. Focusing on the hard bottom-line budget cost of a company tax cut does not live up to that promise.

The full paper is available here.

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