Gavin R. Putland,  BE PhD

Wednesday, August 07, 2013 (Comment)

The price of eliminating ‘company tax’

The Business Council of Australia is seeking feedback on its “Action Plan for Enduring Prosperity”. Here's my contribution (slightly edited). I publish it in response to the Coalition's promise to cut company tax by 1.5 pathetic percentage points.

How can we cut labour costs without reducing take-home pay? How can we replace personal income tax by GST without raising prices of Australian goods and services? How can we get get rid of FBT? How can we cut Federal expenditure without a political backlash?

All four questions have the same answer.

How can we replace company tax by GST without raising prices of Australian goods and services? By recognizing the limits of the answer.

The “answer” is: Replace the PAYG component of personal income tax in the hands of employers. The employees continue to receive credit for the withheld PAYG tax on their “grossed up” wages, so there's no reduction in their after-tax wages, and no widening of after-tax wage inequalities. But employers, instead of forwarding the withheld PAYG tax to the ATO, pay a higher GST. In the aggregate, the withheld PAYG tax covers the additional GST, with no need for employers to raise prices.

(Why does conventional wisdom say that replacing personal income tax with GST would raise prices? Because conventional wisdom assumes that the forgone PAYG income tax would be paid out in wages and salaries, in which case the extra business income needed to pay the GST must come from elsewhere. That is not what I am proposing here; rather, I am proposing that the forgone PAYG income tax be retained by employers.)

Because employers keep the income tax on money wages/salaries, they have nothing to gain by paying employees more in kind and less in money, so there's no need for FBT (although there is a need to stop sole traders from minimizing tax by hiring themselves as employees on inflated salaries).

While employees' take-home pay remains intact, PAYG personal income tax ceases to be part of the marginal cost of labour as seen by employers. That creates more jobs, hence more domestic demand for Australian products. And because the GST, unlike the cost of labour, doesn't feed into export prices, there's also more foreign demand for Australian products. Of course the extra jobs automatically reduce welfare expenditure. Hence not all the lost revenue from PAYG tax needs to be replaced by GST. Moreover, the abolition of FBT reduces compliance costs that feed into prices. So, in the aggregate, domestic retail prices of domestic products not only don't rise; they fall.

Thus all four questions are answered.

The only downside for consumers is that the higher GST on imports would not be compensated by any reduction in foreign labour taxes embedded in prices of imports, and would be only partly compensated by the ensuing currency appreciation. That's a price worth paying for better job opportunities and lower prices of domestic products. The only people who might need compensation are those outside the workforce.

The reduction in the marginal cost of labour for employers, the gain in competitiveness of exports, the expansion of employment, and the consequent reduction in welfare expenditure would be all the greater if the GST were high enough to replace not only PAYG personal income tax but also the superannuation guarantee. A Federally mandated, employer-funded 9.25% super contribution is equivalent to a Federally funded 9.25% contribution paid for by a 9.25% Federal payroll tax. If it were instead paid for by GST, employees would not lose any take-home pay or super contributions; and employers in the aggregate would not need to find any additional business income, so prices of Australian products would still not need to rise.

Is the untaxing of exports a beggar-thy-neighbour policy? Not at all. The GST effectively zero-rates not only exports, but also capital investment. If all countries adopt the policy, the result is more investment. Not all countries can be net exporters, but all can be net investors. That is not to deny that there is a first-mover advantage which Australia should be keen to claim.

Compliance costs, hence prices, would be further reduced if the GST were replaced by a simple, border-adjusted cash-flow tax (CFT), as suggested in Chapter D of the Henry Report.

What about company tax? A GST or CFT taxes value added, including value added by labour (wages) and value added by capital (profit), and is therefore equivalent to a labour tax (PAYG personal income tax and the super guarantee) plus a profit tax (company tax), except that it's border-adjusted. So, if a GST or CFT replaces both labour taxes and profit taxes, it need not raise prices of Australian products. Why take years reducing company tax to 25% “as and when fiscal circumstances permit” when you can replace it with an expanded consumption tax in one hit?

If a GST or CFT replaces both labour taxes and profit taxes, it replaces the personal income tax of sole traders, albeit only in their capacity as sole traders (not in their capacity as employees if they have jobs “on the side”).

But there's a caveat. Profit is “value added” only in so far as it represents the necessary return on capital. The rest of it, including “capital gains” on non-replicable assets, is a surplus. This then is what I mean by “the limits of the answer”: if we don't want to raise prices of Australian products, a consumption tax can replace a profit tax, but it can't replace excess-profit taxes; on the contrary, it requires a more consistent excess-profit tax, possibly along the lines of the PRRT (among other options). That, I submit, is a small and politically inescapable price to pay for the elimination of company tax as we know it.

Together, the above reforms would restore full employment without a Keynesian spending spree, and turn Australia into a tax haven for exporters without hurting workers or consumers.

[Last modified 8 August 2013.]

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