Foreign investors, not Australians, are likely to benefit from corporate tax cuts

The following insightful piece is authored by Anis Chowdhury, a former Director at one of the UN agencies and currently Adjunct Professor, University of Western Sydney and Australian Defence Force Academy. 

 

The Coalition Government has based its argument on the proposed corporate tax cuts on the recent cuts in America. In my previous Australia Institute blog (January 20, 2018), I have debunked Treasurer Scott Morrison’s scare tactics that if we do not follow the US move, investors will abandon Australia. Drawing from research findings on past US experiences of tax cuts, I have also debunked the argument that tax cuts generate more jobs and higher income.

In a recent paper, the prestigious US research organization, Brookings Institution, has demonstrated that the latest corporate tax cuts of the Trump administration will benefit mostly the foreign investors; not the ordinary Americans or businesses. It cites recent estimates from the Congressional Budget Office (CBO) to support its conclusion. The CBO analysis shows that the Tax Cut and Jobs Act (TCJA) effectively will have no impact on US incomes after 10 years. While foreign investors will end up receiving much of the gains, the net income available to Americans will rise barely, if at all.

According to the Brookings paper, this outcome results from different estimated impacts of corporate tax cuts on Gross Domestic Product (GDP), Gross National Product (GNP) and Net National Product (NNP). GDP is the estimate of output produced within a country (e.g. Australia) regardless of who produces it – domestic or foreign companies/workers. GNP is the estimate of output by domestic workers and domestically-owned capital. It is derived by subtracting incomes (profit, interest, wages, etc.) paid to the foreign nationals/entities and adding income received by nationals/entities from overseas. NNP is GNP minus depreciation of capital goods—the wear and tear of machines and other facilities. NNP comes closest of the three measures to incomes of the people and businesses of a country.

The CBO estimates that TCJA will increase US GDP by 0.5% in 2028. This happens as lower tax rates on capital income—such as the 21% rate on corporate profits—increases the after-tax rate of return which in turn should boost investment and hence the stock of productive capital such as computers or factories. But the CBO finds that most of that additional capital will be financed by foreigners. As a result, net payments of profits, dividends, and interest to foreigners also will also rise. The CBO projects that after subtracting those net payments to foreigners from GDP, the tax cuts will boost GNP by just 0.1% in 2028.

However, since the increase in output results mostly from additional investment in capital goods, the nation’s capital stock will be higher relative to output. That is good as it can raise worker productivity and wages, on average. But to maintain that larger capital stock a larger share of output must be devoted to offsetting depreciation, i.e. for wear and tear of those additional machines and factory buildings.

The CBO estimates that the rise in depreciation will be about 0.1% of output in 2028—enough to erase the already paltry boost to GNP. This means long-run incomes for Americans as measured by NNP will be more or less unchanged by the TCJA.

Thus, one can safely conclude that the Coalition Government’s proposed corporate tax cuts, modeled after the US, is unlikely to create much prosperity and jobs for Australians as is argued. Contrary to the claim, the direct benefits from tax cuts on incomes of Australian workers and businesses will be almost non-existent in the long-run.

Then consider the negative effects of tax cuts at the high end: Worsening income inequality, less revenue to finance government services and benefits, and higher Commonwealth debt, it is hard to make a case for Mr. Morrison’s proposed tax cuts for corporations and high-income earners.

 

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