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Oct 25, 2012

Forget business tax cuts, focus on electricity reform

While attempts to wangle a cut to business tax rates fail, there's more to gain from repairing our energy regulation framework instead, write Bernard Keane and Glenn Dyer.

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The failure of the Business Tax Working Group to recommend a revenue-neutral way to lower the corporate tax rate hasn’t surprised too many people: it was always going to be hard to identify a way to broaden the tax base sufficiently in a way that ensured a small number of losers and sufficient winners. But another reason why the working group threw the towel in is worth noting:

“The economic benefits from a reduction in the company tax rate from the current rate are likely to be smaller than when the rate was much higher in the 1980s and 1990s, notwithstanding that capital may have become more mobile since then. The working group considers that a cut of two to three percentage points would be required to drive a significant investment response.”

That is, the benefits of a corporate tax cut, supposedly necessary because Australia has one of the highest corporate tax rates in the developed world, might have been overhyped.

A 2% cut in the corporate tax rate would, if not offset by base-broadening measures, cost $2-3 billion a year, according to the government’s figures given when the Coalition and the Greens blocked Labor’s tax cut. Treasury modelling for the working group suggests a 1% cut in company tax not offset by base-broadening would increase both GDP and real wages by 0.2% — but over an extended period, between seven and 20 years. That’s worth around $3 billion of GDP currently.

While the working group was throwing its hands up, Rod Sims of the Australian Competition and Consumer Commission was making a not unrelated point: that Australians, including business, were paying $3 billion too much for electricity courtesy of the flaws in the way we regulate electricity pricing.

While most of the media focus is on the consumer impacts of electricity price rises, business suffer much worse, because electricity is, for many businesses and especially manufacturers and retailers, a far higher component of their costs than electricity is in household budgets. But consumer costs are also significant because they feed into inflation, potentially limiting the RBA’s capacity to reduce interest rates, as we again saw in the September quarter CPI which revealed electricity prices rose 15% (and gas and other household fuels were up more than 11%).

Some of this was due to the carbon price, but economists suggested the carbon price contributed around 0.4% to the CPI in the quarter (remember Treasury estimated a 0.7% impact on the CPI from the tax), meaning that other cost rises, such as vegetables and fruit (more than 10%), played a big part, as well as the impact of power charges and costs.

Sims is only the latest in a succession of independent authorities to identify the huge cost of a flawed regulatory model for electricity pricing that allows power companies to use investment to game the system to gouge consumers. Ross Garnaut was the first prominent figure to call for a fundamental overhaul of electricity regulation when he updated his climate change reports in 2011 and identified market, government ownership of power companies and regulatory flaws as a key reason behind rising power bills.

The Australian Energy Regulator itself argued it lacked the power to prevent companies from overcharging. The Productivity Commissions’ draft report on electricity regulation last week showed how a more efficient, better regulated electricity network could “potentially save billions of dollars”. Now Sims has quantified how much.

Poor regulation of power, gas and water in this country and the seemingly cost-plus way of handing out price increases (it’s not as simple as that, but seems that way), with little attempt to wring offsetting benefits from the producers of power, gas or water, plus the distributors and retailers, is not helping improve productivity.

Better regulation of power company prices, particularly around investment and rates of return, and privatisation of state-owned suppliers and distributors would deliver as much or more for business than any corporate tax cut offset by base-broadening measures.

In fact the impact on productivity of poor regulation bears examining by the Productivity Commission. It should be an issue business hops on and prosecutes because higher power, gas and water costs are adding to the cost of doing business in this country (and hurting consumer finances and consumer spending and therefore retailers). Multi-factor productivity (that is labor productivity plus the business contributions of capital, innovation etc) is imprecise and much harder to measure than labour productivity which seems to be in an upturn (according to the March and June quarter national accounts) as employment growth slow and output is maintained.

Federal Treasury and others have already pointed out that multi-factor productivity growth in Australia is weak at best, partly due to inadequate management. To that you could add the adverse financial impact of regulatory failure of the sort we are seeing in electricity, but also in gas and water. But don’t tell the business media and their friends in the lobby groups.

If an incoming Coalition government is serious about reform it should prioritise the wholesale rewriting of the regulatory regime covering electricity, gas, water and other natural monopolies in this country (such as Sydney Airport) and the about-to-be sold off NSW government-owned ports ahead of another tax inquiry or even a financial services inquiry. The current regulatory situation for electricity in particular is clearly inadequate and starting to produce cost distortions on business and consumers that will retard growth across the economy, as well as impact employment and demand. It is a situation all governments and parties have had a hand in producing over the last two decades. It was the Keating government that began the establishment of the national electricity market and the Howard government that completed it.

It has been a hugely successful microeconomic reform but power companies have long since identified the weak spots in the framework established by the Commonwealth and the states for regulating prices, and gamed them. Both sides of politics in NSW and Queensland have failed to privatise power assets and used them as ATMs to prop up budgets. Like the disastrous telecommunications reforms of the Hawke government that were exacerbated by the Howard government’s sale of Telstra, there’s plenty of blame to go around in this.

There’s accordingly a pressing need for some policy leadership from Canberra to break out of the current regulatory impasse costing Australian businesses and consumers plenty.

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