Australian Businesses Must Show They Deserve Lower Taxes

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Rio Tinto [ASX:RIO] CEO Sam Walsh has suggested Australia should follow Asia’s lead in lowering corporate taxes.

At 30%, Australian businesses pay some of the highest corporate taxes in the world. But we’re not the worst off by any means. Among major economies, we occupy a middle ground of sorts.

Both Japan and the US pay higher corporate taxes than us. As do several Western European countries. Yet Canadian, Swiss, British, Korean, and Chinese companies all pay less. Each has corporate tax rates of 25% or lower.

So it goes both ways.

Yet recently there have been growing calls to lower domestic corporate taxes. No surprise this pressure is coming mostly from corporate Australia itself. This debate over corporate tax reform isn’t clear cut. As you might expect, any battle pitting business against government will have grey areas.

So before the government does anything, we should ask ‘who benefits?’

First, here’s what Walsh said on the matter:

Australia’s tax system has fallen out of step with the rest of the world, given that in the past decade a host of countries have cut their corporate tax rates.

The public debate on reforms to the Australian economy and the tax system is therefore timely.

As a suggestion, look closer to home, to Asia, than to a theoretical OECD or European average. The average corporate tax rate in Asia is closer to 21 per cent. A worthy goal to consider and continue Australia’s pivot towards, and engagement with Asia.

Walsh can’t help but fit square pegs in round holes. It’s not enough to say that we should lower taxes because Asian companies pay less. ‘Asia has lower corporate taxes? Check. Asia is our regional neighbour? Check. What more evidence do you need that it’s the way to go…?’

Well, a lot more Mr Walsh. Corporate Australia must show it’s deserving of lower taxes. And this year, it’s done anything but.

What lower corporate taxes mean for Australia

Lowering corporate taxes would achieve two things.

For one, it’d free up cash for businesses to use as they see fit. With lower taxes, profits would be higher in most instances. Companies could then use these extra cash reserve to reinvest elsewhere. Or to return to shareholders even, as they have a habit of doing.

At the same time, lower taxes would reduce government earnings. We’re not talking about pocket change either. We must never underestimate business contribution to government coffers. Corporate Australia contributes over 22% of government tax revenues. That’s second only to personal income taxes. Yet even a 10% reduction in corporate taxes would hit government revenues hard.

When the mining boom was at its peak, tax revenues were thriving. A tax reduction might have been acceptable then. But the mining rout has already left tax revenues stretched. But the sector still pays out $21 billion in company taxes and royalties.

Using a flat tax rate of 20%, for example, would shave $7 billion off mining tax revenues. That’s too large a sum for a government looking to plug a $40 billion budget deficit.

So what’s in it for the government? Not much, in truth. Convincing the government to reduce taxes will take serious effort under these economic conditions. Mr Walsh can’t just point to Asia as a sign that taxes should be lower. Corporate Australia must show that any such move would benefit the economy in other ways.

How might it do this? Ramping up investment would be a start. Problem is, businesses aren’t showing any inclinations they’re willing to do that. I wrote about this very thing not days ago. But it’s worth repeating here again:

Businesses aren’t investing…Recent ABS figures showed third quarter business spending was down 9.2%. That was slightly better than Q2 capex, when investment fell 11.2%.

Typically, businesses have to spend to grow. As a business expands, so too do its profit margins.

Yet something doesn’t add up. Borrowing is on the rise, but investment is plunging. How? What reason does a business have in borrowing credit? If it’s investing less on average, there’s little reason to borrow more, right?

The answer is obvious when you take a cynical view of the situation.

It’s never been easier to access credit than it is now. Borrowing has never been cheaper, because rates have never been lower. Interest rates are at 2% to encourage business lending. Everyone borrows when it’s easy and cost effective to do so. That applies to corporate Australia as much as it does to everyday Aussies.

But again, we go back to the issue of capital investment. With business spending falling, it means one thing only. Businesses are growing profits by cutting spending and investment.

There’s evidence to support this. Look at wages, which grew by 1% during the quarter. Wage growth is up 2.5% from this time last year.

All that sounds fine until you realise that wages are growing at their slowest pace on record. At the same time, household purchasing power has shrunk. Wages are barely keeping up with inflation. Households are poorer, even if wage ‘growth’ suggests otherwise.

The rate of wage growth does indicate however that investment remains slack. Which throws up similar dilemmas as noted above. Businesses might be borrowing more, but they’re not spending what they borrow.

So where is all that money going? If a business borrows money and doesn’t reinvest it, where does it go? I suspect you already know the answer to that question.

The likelihood is that businesses are lavishing it on investors to curry favour. They’re embarking on stock buyback schemes. Moreover, they’re using this money to support progressive dividend yields. And investors don’t care. In fact they support anything that improves their bottom line.

In an era of low growth prospects, we should expect nothing less from businesses. In any normal circumstance, profits would account for all dividend payouts. But with revenues and profits down, companies are resorting to debt and spending cuts to achieve the same goals.’

What do borrowing levels have to do with taxes? Just substitute one for the other and you have your answer. Businesses are borrowing more, but they’re investing less. Why would it any different with taxes in that case? If businesses receive tax breaks, who’s to say they won’t hoard that extra cash?

What’s more, if big business just funnels extra profits to shareholders, there’s no reason to lower taxes. Any reduction in corporate tax rates should aim to raise investment levels. Not beef up corporate piggy banks.

Ultimately, investment is what this country needs. And it’s the only way to get the government to budge on corporate taxes. But businesses first need to show they’re willing to do that. Yet there’s no guarantee corporate Australia would spend more with lower taxes. If nothing else, it makes any corporate tax rate cut a risk not worth taking.

Mat Spasic,

Junior Analyst, The Daily Reckoning

PS: One tax reform the government could look at is the growing issue of super concessions. Addressing superannuation tax breaks could plug holes in the budget deficit. But any changes to super should come as a result of a broader review of the system.

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