December 27, 2009

TAX WHAT YOU DON'T WANT, NOT WHAT YOU DO:

This stimulus is a capital idea (Alexander Calvo, 12/28/09, The Australian)

Australia has an established tradition of cutting corporate tax rates. Most recently, then treasurer Peter Costello reduced the rate from 36 per cent to 30 per cent during 2000-02. In the late 1980s Paul Keating cut the rate from 49 per cent to 39 per cent as part of the dividend imputation reforms, and he continues to regard dividend imputation and the cuts to the corporate income tax rate as an important part of his reformist program.

These tax reforms did not occur in isolation.

The corporate tax cut momentum began in the US and Britain, where these cuts are widely regarded as the key drivers of the marked economic resurgence in those countries in that era.

So there is considerable domestic and international precedent for positive results from cutting corporate tax rates.

In terms of the revenue costs of cuts to the corporate tax rate, experience has shown that the increase in productive capacity of the private sector and the consequent revenue gains to the government mean that the medium-term loss to tax revenue is ameliorated significantly.

This is because businesses have more funds available from retained earnings, and a sufficiently large reduction in the corporate tax rate will make possible some prospective investment projects that presently are not viable on an after-tax basis. That is, at the margin, the reduced rate increases investment.

Even the short-term or direct costs to government revenue of cutting corporate income taxes are not as high as some argue because those extra profits not retained but paid out as dividends are then taxed in the hands of the shareholders, which is tax-revenue neutral because of the prevailing dividend imputation regime (where the individual marginal rate paid is above the corporate rate).

Where the extra profit is reinvested in the business, these funds increase investment and the associated economic activity that in turn directly generates additional tax revenue.

And where the extra retained capital is used to pay down debt, this also ameliorates the loss to tax revenue because of the lower interest payments that will be deducted from future corporate income.

Posted by Orrin Judd at December 27, 2009 11:48 AM
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