The Tax Working Group has released their report, as you all already know. The recommendations are as expected, so its not particularly exciting in that sense.
However, there are some issues I would like to discuss – lets start with the idea that we “urgently need to cut the corporate tax rate” if Australia does.
Currently there is talk that, if Aussie cuts the corporate tax rate to 30% we need to do the same immediately. We are told this as if it is a self-evident truth, and told that if we don’t all investment will head to Australia. This is a touch over the top.
In Australia and in New Zealand there are a whole bunch of “potential investments” that offer varying rates of return. Now, New Zealand is a small open economy, so we have access to all the credit we want from overseas – as long as the rate of return on that credit (adjusted for risk) is equal to the global rate of return. So the “supply curve is perfectly elastic”.
A higher corporate tax rate in New Zealand reduces the profitability of investment, which in turn implies that the rate of return for each project is lower. As a result, a higher corporate tax rate (in a sense) shifts the demand for capital to the left.
As a result, when setting the tax what matters is the “elasticity of demand” for capital investment in New Zealand – not the tax level in Australia.
Will a higher corporate tax rate reduce investment, yes. It does so by preventing “marginal” projects from occurring – those that offer the lowest benefit.
But it must matter somehow!
The corporate tax rate overseas matters insofar as it changes the “global rate of return” on investment – so if all other countries cut their corporate tax rate, the required rate of return would be higher. As a result, foreign tax arrangements do impact on what rate of return we have to achieve to get foreign investment.
However, the welfare impact of the tax, and whether we should cut the corporate tax rate depends on the elasticity of demand for investment – it is not a fact that we should attempt match Australia’s tax rate.