Tax of wishful thinking

Image Credit: Alan Cleaver (Flickr: Creative Commons)

We are seeing a global trend to lower corporate tax rates. Governments say they are doing this to increase employment, wages, capital investment and economic growth. But tax cuts don’t have conditions placed on them. The government does not cut the corporate tax rate on the condition companies increase wages and employment. So, are they just hoping for the best?

The current global average corporate tax rate has gradually declined since the Reagan administration in the 1980s and now sits at 22.96%. On average, countries have continued to lower their rates post-GFC in an effort to attract companies, and thereby try to increase their tax base, employment and wage levels.

The USA just cut theirs from 35% to 21%, both France and Belgium will be reducing theirs to 25% from 33% and 29% respectively by 2022, and Australia is intending to reduce theirs from 30% to 25% by 2026-27. They justify giving up billions in tax revenue now for more jobs and higher wages in the future… they hope.

The theory behind this fiscal bet says that a reduction in corporate taxes provides companies additional funds for them to reinvest in the form of higher wages, increased employment, business expansion, etc. This reinvestment will grow the economy and thereby increase the actual amount of tax revenue raised by the government despite the lower tax rate.

This assertion is hotly contested among economists and the language used to debate these economic theorems is often myopic and ad hominem. The argument is over whether the connection between corporate tax cuts and wage hikes and increased employment is “plain logic” as asserted by the Australian Finance Minister, Mathias Cormann.

The answer is: sometimes and not as effectively as governments claim.

It must be remembered that companies are for-profit entities and have no obligation to spend the tax break how the government wants. Therefore, it is necessary to understand that the tax savings will only be used on higher wages and increased employment if there is not a more profitable alternative. What makes corporate tax cut trickle-down economics so hit-and-miss is that the conditions for it to work must be just right.

One condition is the company would need to be in an industry where there is potential to grow or else the tax base will not expand. That growth is also contingent on a labour-intensive division of the company or else employment will not significantly rise. And then there are the tempting alternatives. The continuing average rise in global corporate debt means companies have legitimate reasons for spending that tax break on debt servicing but this does not equal increased wages and employment. Publicly listed companies may also decide to buy back stocks and pay/increase dividends. These are some of the many alternatives to government wishes.

But, perhaps companies recognise these opportunities and still do what the government requests. That is both wishful thinking and the philosophy behind these government corporate tax cuts.

Australia reduced their corporate tax rate in 2015 but only 22% of those savings were spent on wage growth (3%) and new hiring (19%). Put another way, 78% of the tax cut didn’t go where the government hoped it would. It technically fulfilled the International Monetary Fund's and Australian Government’s prediction that it would increase wages and employment, but it is hardly cost-effective.

The ineffectiveness is more stark in the US. Only 9% of the tax savings are being passed on by the 402 of the 5.9 million US employers giving wage hikes or one-off bonuses. Economists thus far are seeing little benefit from President Trump’s corporate tax cut.

If governments’ intention truly is to increase wages and employment, surely there is a more cost-effective way?

One way may be wage subsidies. They have been used globally for more than 30 years, and more than 22 jurisdictions adopted them during the GFC to great effect. World Bank studies show they increase wages and employment, and are more effective than corporate tax cuts. They increased employment levels by up to 31% when coupled with non-dismissal clauses and effective administration by the funding agency. One such example is the Australian Government’s “JobActive Program.”

Another way could be through personal income tax cuts. The reduction in tax payment would increase individuals’ disposable income and therefore mimic higher wages. Five of the G20 have recently adopted this and Australia is considering it.

Governments need a more cost-effective means of raising wages and employment. Failure to change policy can only mean one of two things. One, governments’ are content with 9-22% cost-effectiveness. Two, they don’t care because they prioritise company profit over people’s standard of living. Whichever it is, claims this is effective governance is wishful thinking.

Nicholas Filer is a Brisbane based project manager with honours degrees in Law and International Relations.