For as long as the galahs in the petshop have been incanting the slogans of economic reform, the idea of “alignment” between the top personal marginal tax rate and the company rate has been a holy grail of tax reform.

It seems so logical — as assorted know-alls argue — “why pay 45% tax when you can incorporate and pay 30%?” There are some tax deferment issues, but properly administered, companies needn’t present substantial tax avoidance opportunities. You can’t enjoy a company’s money without it being paid to you as dividends — and when it is guess what? You pay tax on it.

Meanwhile, the economies which have posted the fastest growth in the last couple of decades have some of the largest gaps between their company tax and top marginal rate. Ireland’s economic acceleration has been supercharged by a company tax rate of 12.5%. It’s top personal rate? 42%.

Things are changing. I’m hoping we’ll finally twig that the quest for the holy grail finally comes to be seen as the wild goose chase it is — an arduous, uncertain and costly exercise which, if we’re unlucky enough to be successful will yield us, well, a goose!

A week or so ago the government sensibly abandoned its aspirational goal of removing the top marginal rate. And now Treasury Secretary Ken Henry has indicated he’s keen to cut capital taxes.

Economic theory since the 1970s has shown that taxes on investment have very high costs because their incentive effects on saving and investment compound heavily over time. This is the literature which Henry (implicitly) cites. I’m less convinced by it than him. A substantial part of the effect relies on people being implausibly far-sighted. And simply cutting taxes on capital is strongly regressive.

But I’d argue that the case for cutting company tax is, if anything, stronger than Henry lets on. That’s because another kind of “alignment” — that between low levels of company tax rates and high levels of economic growth — is one of the few really robust policy implications of cross country studies.

Henry also hinted that one source of funding for lower company tax could be more direct taxation of the resources rents that have arisen from the resources boom. We said something similar in the Review of Australia’s National Innovation System released in September. And we proposed another way of funding lower company tax.

There is strong evidence that [dividend] imputation credits are not fully valued by the market. Further, because foreign buyers of Australian shares are the marginal investor and so dominate the price setting process, as Cannavan, Finn, and Gray suggest, “in a small open economy such as Australia, the company’s cost of capital is not affected by the introduction of a dividend imputation system”.

That last sentence may not say much to you so let me translate. Dividend imputation foregoes more than $20 billion per year (no, that’s not a misprint) and yet it doesn’t lower the cost of capital to our firms and so it’s a simple “windfall” transfer to domestic shareholders.

Abolishing dividend imputation could fund a wholesale cut in company tax from 30% to somewhere around 19%! Then some additional resource rent taxation and some anti-avoidance measures like some of the ones we abolished when we briefly managed alignment in 1987 could see us lowering company tax towards Irish levels.

Oh, and it would make our domestic tax arrangements less, not more regressive.

Count me in.

Peter Fray

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