Would a corporate tax cut boost productivity in Australia? So far, the evidence is unclear

The first term of the Albanese government was defined by its fight against inflation, but the second looks like it will be defined by a need to kick start Australia’s sluggish productivity growth.

Productivity is essentially the art of earning more while working less and is critical for driving our standard of living higher.

The Productivity Commission, tasked with figuring out how to get Australia’s sluggish productivity back on track, is pushing hard for corporate tax cuts as a key part of their plan for building a “dynamic and resilient economy”.

The idea? Lower taxes will attract more foreign investment, get businesses spending again and eventually boost workers’ productivity.

Commission chair, Danielle Wood, said last week while the commission wanted to create more investment opportunities, it was aware this would hit the budget bottom line:

So we’re looking at ways to spur investment while finding other ways we might be able to pick up revenue in the system.

The general company tax rate is currently 30% for large firms, and there’s a reduced rate of 25% for smaller companies with an overall turnover of less than A$50 million.

What the textbooks and other countries tell us

The Productivity Commission’s theory makes sense: if you make capital cheaper and you should get more of it flowing in.

A larger stock of capital means there is more to invest in Australian workers. This should make us more productive and help boost workers’ wages. And looking overseas, the evidence mostly backs this up.

A meta-analysis of 25 studies covering the US, UK, Japan, France, Germany, Canada, Netherlands, Sweden, Italy, Switzerland, Denmark, Portugal and Finland found every percentage point you slice off the corporate tax rate brings in about 3.3% more foreign direct investment.

Other research shows multinational companies really do move their operations to places with lower tax rates. This explains why we’re seeing this race to the bottom across Europe and North America, with countries constantly trying to undercut each other.

Research on location decisions shows how multinationals reshuffle their operations based on effective average tax rates.

Even within the United States, a US study found increases in corporate tax rates lead to big reductions in employment and wage income. However, corporate tax cuts can boost economic activity – though typically only if they are implemented during recessions.

Australia’s limited track record

Here in Australia we don’t have much local evidence to go on, and what we do have is pretty puzzling.

This matters because Australia’s corporate tax system has some unique features that may make overseas evidence less relevant. We have dividend imputation (franking credits), different treatment of capital gains, access to immediate reimbursement for some small business expenses and complex capitalisation rules that limit debt deductions for multinationals.