On the face of it, the idea that you can increase employment and pump up economic activity by reducing corporate taxation sounds straight forward and uncontroversial. After all, the less company revenue that goes to the tax man, the more should be on hand for things like hiring more staff, buying new equipment and the like.
Ultimately, the thinking goes, the boost to employment and growth will make everyone a winner.
It is the deceptively simple idea that lies at the heart of the Coalition’s economic plan to boost jobs and growth by implementing $48 billion worth of business tax cuts over the next 10 years.
It also happens to be wrong.
Many have already pointed out that the benefits of stronger growth and increasingly profitable businesses don’t necessarily “trickle down” through more and better-paid jobs, as some naively believe.
The widening gulf between a small group of high-income “haves” and the rest of society is evidence of that. In Australia in 2013-14, 62 per cent of all household wealth was concentrated in the top 20 per cent, while the bottom 20 per cent held just 1 per cent of all wealth. Ten years earlier, the wealthiest 20 per cent owned 59 per cent of all wealth.
As The Economist reported this week, the proportion of working poor in the UK is increasing – 10 years ago about 40 per cent of those in absolute poverty (income less than 60 per cent of the national median, after housing costs) lived in households where people were in some sort of employment. Today, that proportion has risen to more than 50 per cent.
Try telling workers whose wages have yet to recover to pre-GFC levels even while house prices soar, and it is little wonder that an election pitch centred on business tax cuts is a hard political sell job.
But added to well-founded scepticism about who will actually benefit from business tax cuts is an even deeper problem that makes them a poor prescription for jobs and growth.
The searing experience of the GFC and its aftermath has provide a wealth of information to digest about what works and what doesn’t in trying to support economic activity and employment at times of low or stagnant growth.
Among those who have taken a close look at the effectiveness of government stimulus measures is Princeton University economist Alan Blinder.
Blinder, who is a former Vice Chairman of the US Federal Reserve’s Board of Governors and served on Bill Clinton’s Council of Economic Advisers, has run the ruler over the various actions taken by the US Government in the wake of the Lehman Brothers collapse, from welfare handouts and the Cash for Clunkers program to infrastructure and defence spending and business tax cuts.
His findings (http://www.hamiltonproject.org/papers/fiscal_policy_reconsidered) will hearten Keynesians and should give those who spruik business tax relief as the first and best policy response to a downturn pause for thought.
What Blinder found was that the most effective action taken by the US Government was to target temporary handouts to low income households through the Supplemental Nutrition Assistance Program (formerly known as food stamps).
In the first three months of 2009, for every $1 directed by the government through SNAP, $1.74 worth of economic activity was generated.
Extending unemployment insurance benefits had a 1.61 multiplier effect over the same period, while a temporary boost to work-share programs had a 1.69 multiplier effect.
Even increasing infrastructure spending was found to have a significant multiplier effect, though Blinder said the time lags involved in commissioning and undertaking capital projects meant that it was a stimulus measure more appropriate for prolonged downturns rather than shorter ones.
But, effective as some of these spending measures proved to be, there was great clamour from more conservative members of Congress for tax cuts as the tonic the ailing economy needed.
Here, Blinder found the evidence was mixed.
While temporary tax cuts and credits targeted at “liquidity constrained” (read, hand-to-mouth) households had appreciable multiplier effects (like Child Tax Credits, 1.38 times; Earned Income Tax Credits, 1.24 times), permanent tax cuts were much less impressive in their effectiveness.
The multiplier effect of permanent cuts to dividend and capital gains taxes was 0.39, and for a permanent cut in the corporate tax rate, it was just 0.32.
Not only were corporate tax cuts much less impressive as a stimulus measure, but they were prone to getting hijacked by the business lobby and turned into something whose prime purpose was to plump profits rather than fuel economic activity.
As evidence, Blinder cites the experience of an accelerated (“bonus”) depreciation measure included in a 2002 tax cut bill.
The change, which had the effect of putting investment goods “on sale” for a limited period of time, was originally due to expire after 18 months. This short duration was considered key to its effectiveness as a stimulus measure.
Instead, business lobbied hard to have the bonus depreciation extended…and extended… and extended…so much so that last year legislation was passed to keep it going until 2019.
“Ironically, we may have destroyed the usefulness of bonus depreciation as a countercyclical tool by making it permanent,” Blinder says, and advances what he calls a general theorem of political economy: “Business tax cuts artfully designed by economists for maximum bang for the buck will be altered by lobbyists to achieve maximum revenue loss instead”.
The reason is that “business lobbyists don’t care about ‘bang’, but care deeply about getting more ‘bucks’ for their clients, and lobbying almost always overpowers economic logic”.
The lesson, says Blinder, is to be wary of using investment incentives as a stimulus measure.
Many might object that American business and politics is a lot different to that in Australia and, anyway, we are a long way from the dire economic circumstances that confronted policymakers in late 2008 and early 2009, so Blinder’s analysis has little to tell us.
But the real question is, is a company tax rate of 30 per cent stifling activity, and would cutting it to 25 per cent over the next 10 years unleash a wave of investment and jobs growth?
The evidence suggests the answer to both questions is no.
As the Reserve Bank of Australia has observed, what has been holding growth down in Australia has been the plunge in global commodity prices and the fall in resources investment.
This has been partially offset by the effects of low interest rates and a weaker currency, which has encouraged growth in services exports and housing investment – both oif which have helped support an improvement in consumption to around its decade-long average of 3 per cent.
Arguably, what has been weighing on hiring and non-mining investment for the last few years has been soft demand and uncertainty about the outlook.
A $48 billion company tax cut might help firms capitalise on the improvement in consumption, but it is hard to see how it would drive it. Unless there is a compelling reason to hire and invest (read: an opportunity to make money), businesses are unlikely to make an outlay, regardless of whether the tax rate is 30 per cent or 25 per cent.
Instead, much of it could find its way into the bank accounts of lawyers and bankers devising M&A activities or pumping up shareholder dividends.