Election 2016: Trickle-down economics is the rising tide that lifts all boats

Bookmark and Share Economics & Deregulation | Sinclair Davidson
Australian Financial Review 1st July, 2016

One of the biggest fallacies in economics is the zero sum game - the notion that any gain is someone else's loss. Nothing could be further from the reality of economists explaining the gains from trade and how benefits of economic growth are shared across the economy. At this election there has been a lot of scepticism about so-called trickle-down economics, but this reflects more political opportunism than a sober assessment of the phenomenal explosion in living standards over the past few decades.

The fact is that a rising tide raises all boats. A strong and growing economy is in everyone's best interests. Profitable businesses reinvesting back into the economy create value for shareholders, employment opportunities for the unemployed, job mobility and higher wages for the already employed and greater tax revenue for the government. Everyone wins.

Surprisingly, however, the Turnbull government proposal to cut company income tax is being widely pooh-poohed. This policy is squarely aimed at promoting greater business investment in Australia, leading to a virtuous cycle of economic prosperity. In this sense it is little different to the 2010 ALP policy that proposed much the same policy. Yet somehow, now that the ALP is out of office, it has become a poor policy option.

So observers have pointed to Australia's dividend imputation system as being one reason why cutting company tax rates won't benefit the domestic economy. Australian tax residents are indifferent to the company tax rate - they are taxed on company income at their own personal marginal tax rate. In a very precise and narrow sense this is quite right - yet the criticism misses the point. In a zero sum game, a company tax rate cut would benefit foreign investors more than Australian shareholders.

Tax cuts are not about redistribution and the politics of envy but rather about expanding economic opportunity. In any event, shareholders are also workers, and employers, and parents of unemployed youth, and so on. Even if Australian shareholders don't immediately benefit financially from a company tax rate cut (an assumption in itself), they will benefit in a myriad other ways.

But what of the basic assumption that Australian shareholders won't financially benefit from a company tax cut? This country operates in a globally integrated financial market. Domestic shareholders are very unlikely to be the "marginal shareholder" who sets the cost of capital for large Australian firms. For those large public firms that invest billions of dollars in our economy and underpin our national prosperity, the cost of capital is set in international markets and the (increasingly) high Australian company tax rate represents an actual hurdle and not merely an internal transfer between the government and taxpayers.

In the first instance, the government expects to collect $50 billion less in revenue over 10 years. Much has been made of this "loss". The fact is this is a trivial sum of money for a policy that aims to dramatically realign Australian company tax rates with international norms. To put that figure into context, the former Rudd government committed $52.4 billion of actual spending to its two stimulus packages between October 2008 and February 2009 - a mere five months.

Prejudice against foreign investors

It is also important to address another misconception. The US government taxes its companies on the difference between their own (high) domestic company tax rate and foreign company tax rates. Lowering our company tax rate could simply mean that the US Treasury gets more revenue at our expense. Well, no. Two points need to be made. The US isn't the only source of foreign capital into Australia. More importantly, the US only taxes foreign earnings when those earnings are actually repatriated to the US. If the past is any guide, most profits earned here by large businesses and multinationals will be reinvested in Australia.

In the past few years there has been a massive surge in anti-business sentiment. This has manifested itself in the widespread, yet fallacious, view that business is not paying its fair share of taxation. The notion that foreign investors exploit this country to our disadvantage is especially problematic. Our savings are insufficient to finance the investment and economic prosperity that we enjoy. In any event, the Australian company tax raises the second-highest level of company tax revenue in the OECD. At the same time, however, our company tax rate is becoming increasingly uncompetitive in a world where OECD standards are not enough to attract investment capital. Even after 10 years our company tax rate will still be higher than the average OECD company tax rate is now.

While the dividend imputation system is good domestic tax policy, it does not prevent Australian business from having to compete for international capital at international prices, including internationally competitive tax rates.