Everyone loves investment tax breaks for business, especially small business. Politicians love handing them out. The beneficiaries love receiving them. Providers of capital equipment love them because they boost demand — think of all those giant utes on the roads subsidised by tax breaks for tradies. The business press extols their virtues, even if they only bring forward tax deductions that would have been claimed over a longer period.
But do they actually work? Do they increase investment, or prevent it from decreasing more in periods of poor economic growth or low investment?
A report from the Reserve Bank suggests only under certain circumstances — an answer that doesn’t suit anyone. Not politicians, who are likely to throw tax breaks at business in coming months as part of their election campaigns, nor business, nor the media.
The study looked at seven investment tax breaks deployed since the financial crisis and how much additional investment they produced. The first one, used by the Rudd government as part of its response to the financial crisis, increased investment significantly, but the study states there is “no substantial evidence that other policies, including those implemented during the pandemic, increased investment”.
The paper concludes, “This appears related to the existence of dividend imputation, which lessens the value of the [investment tax break] ITB to company shareholders and means that the policies mainly affect small unincorporated businesses.” The latter “appear to be more responsive to ITBs than incorporated companies”, but dividend imputation makes “ITBs less valuable for companies, particularly domestically-owned small companies”.
The GFC-era experience suggests ITBs could be an effective countercyclical tool, but in response to a shutdown of credit markets — which was characteristic of 2008 — rather than a slowing economy, such as during the pandemic, when business may see no value in additional investment. (Or because, as in 2020, capital equipment becomes harder to source due to supply chain limitations. Australian Bureau of Statistics figures show that quarterly capex spending dipped to a 13-year low of $33.7 billion in the September quarter of 2020, the lowest since 2007.)
Separately, two academics at the Queensland University of Technology in Brisbane have pointed out there is a considerable cost to the budget from these tax breaks: in the latest federal Treasury tax expenditures report, “the instant write-off tax break for small businesses is estimated to cost more than $4 billion by reducing taxes collected”.
That $4 billion might be more effective at encouraging investment if deployed elsewhere in the tax system — or used for another purpose altogether. But that would take away a favourite toy of politicians, business and the media.
The RBA study also notes there is some evidence for the impact on investment of the 2015 and 2016 reductions in the company tax rate for small business, separate from the ITBs: the data from 2015 “does suggest that the corporate tax cuts themselves may have had an impact on increased investment. There is no evidence of an effect from the 2016 tax rate change.”
Saul Eslake, an independent economist, vice-chancellor’s fellow at the University of Tasmania and national treasure — as well as a prominent sceptic of policies aimed at small business — told Crikey the RBA study was consistent with his view that “small business fetishism” is largely ineffective. “That’s not to say they have no impact — especially, as the authors point out, during economic downturns — but that, for policies that have become a permanent feature of our corporate tax system, they fall well short of constituting ‘value for money’.”
Eslake was more surprised by the link between tax cuts and an increase in investment, pointing out that the evidence from company tax cuts during Donald Trump’s first term in the US showed far more impact on share buybacks than investment. In reference to what he expects to be “a loud chorus arguing that Australia needs to emulate the corporate tax cuts that Trump is likely to implement later this year (similar to what we saw here in 2017)”, Eslake pointed out that the impact of such cuts here “would be blunted by the impact of dividend imputation”.
“Simply put, any cut in the corporate tax rate implies an offsetting increase in the tax payable on dividends by Australian shareholders (including superannuation funds). So that the only beneficiaries of cuts in the Australian corporate tax rate are foreign shareholders — and so the question is, or should be, why would you want to do that?”
He suggests there may be some benefit in lower tax on companies’ retained earnings not distributed to shareholders, which might flow through to increased investment. But he’s certainly right that the chorus for company tax cuts is going to start up again, with the Business Council already warming up. How big a role hard evidence plays in that debate remains to be seen.
