What Was the Industrial Revolution? Robert E. Lucas Jr.

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Brexit will lower company tax rates everywhere

Brexit will turn the British Isles into one great big offshore tax haven. The post-referendum plans for a 15% company tax rate (and the Australian plans for a 25% company tax rate) will put pressure on New Zealand to follow suit.

A common argument against a much lower company tax in New Zealand is the clipping of the ticket argument. A lower company tax rate in New Zealand is said to mean no more than the higher after-tax dividends are taxed at a higher tax rate in the home country of the foreign investor. Less company tax is paid in New Zealand but more tax is paid back home for no net gain to the investor.

The 12 ½% Irish company tax rate attracted investment

The strongest evidence against this is the Irish were relentlessly bullied by the rest of the European Union over its 12 ½% company tax. The other EU finance ministers rightly feared a loss of investment to Ireland. This 12.5% rate applied initially to exports, then manufacturing and then trading profits. The fiscal bounty of the Celtic Tiger years allowed the Irish to finesse these complaints based on EU laws about fiscal discrimination by phasing their 32% general company tax rate down to 12 ½ %.

Our Minister of Finance certainly would not welcome the plans (Senate permitting) for a 25% company tax rate in Australia by 2026. Rather than rubbing his hands in anticipation of more tax revenues on dividends repatriated from New Zealand subsidiaries in Australia, Mr. English will worry about loss of domestic and offshore investment to a more competitive neighbouring tax jurisdiction.

Source: OECD Stat.

The first big country low company tax rate

The British already have the lowest company tax of any major economy with the 20% company tax rate that started on 1 April 2016 (see graphic). This rate will fall to 19% on 1 April 2017, and 17% on 1 April 2020. Brexit will take that rate down to 15% at a date to be determined.

No Minister of Finance welcomes the prospect of a leading world economy and Europe’s key financial centre having by far the 2nd lowest company tax rate of any developed economy by 2020. They will worry about lost investment rather than expect a higher local tax take.

High company tax rates lower wages

Too many people mistakenly believe that company taxes are paid by shareholders through lower dividends. With capital highly mobile across borders, countries with high company tax rates attract less investment because of the lower after-tax returns relative to competing destinations.

This capital flight means lower wages in high company tax jurisdictions because their workers have less capital to work with. A lower company tax means higher wages because of more investment.

Even the USA is under pressure

The US got away with a very much above average company tax rate (38%) because its economy is so large relative to the rest of the world but it too is under pressure from footloose capital and corporate inversions. The US company tax system is so full of holes that if all tax loopholes were closed, its federal company tax rate could be cut from 35% to 9% with no net loss of revenue.

Leading US tax economist Laurence Kotlikoff estimated that this tax reform would increase wages by 8%, output by 6%, and the amount of capital invested by 17%. Australian Treasury modelling found that a 10-percentage point cut in their company tax rate would increase wages by 1.4% to 3%.

The race is on

The British company tax rate is now well below anywhere else bar one. That will force other countries, other big economies, to reconsider their position. New Zealand should not be left behind in harvesting the large wage increases that flow from a much lower company tax rate.

Why is the reduction in GDP levels so small? @GreenpeaceNZ @Oxfamnz

The global reduction in the level of GDP between now and 2060 is estimated to range between 0.6% and 4.4% is nothing is done. In the case of developing countries undergoing growth miracles, we are all talking about 6 months GDP growth! Russia and Canada will be overrun by tourists in the event of runaway climate change.

Source: The Economic Consequences of Climate Change The damages from selected climate change impacts to 2060 DOI:http://dx.doi.org/10.1787/9789264235410-5-en

Debt repayment does not rule out tax cuts

The case for a tax cut is a distinct issue from repaying the recent large budget deficits and balancing the budget over the business cycle.

Ministers of Finance should pay more attention to the concept of tax smoothing. Unless something special is happening, income tax rates should be similar from one year to another. We should keep tax rates fairly smooth by borrowing during recessions and emergencies.

Instead, the Government not indexing the income tax thresholds for inflation collected $2.1 billion in extra revenue since 2008 according to Parliamentary Library calculations. Raising the income tax rate thresholds is becoming more pressing. Income growth is starting to push many ordinary taxpayers uncomfortably close to the next threshold and a much higher marginal tax rate. For example, 30% rather than the 17.5% income tax rate many taxpayers face.

New Zealand is already left behind on company tax rates; ours is currently 28%. The Australian company tax rate may drop to 25%; the British company tax rate is going down to 17% by 2020.

Large public deficits have their place

Prudent public debt management dictates that governments run temporary budget deficits in recessions and other emergencies such as the Canterbury earthquake and repay that debt as better times return. Recessions and natural disasters are infrequent so this extra debt should be paid down at a measured speed, not a frantic pace at the expense of other tax policy goals.

An increase in the budget deficit smooths over these bad times and avoids taxes going up and down like a Jack-in-the-Box over the business cycle. Who raises taxes in a recession?

Beware of foul-weather fiscal conservatives

After the start of the recession in 2009, foul weather fiscal conservatives wanted to do just that. The same usual suspects who always advocate bigger government argued for higher taxes rather than running a larger budget deficit, which New Zealand did. Imagine the massive income tax rises required every recession and in the last recession in particular if the large budget deficits were not run?

The large public debt from the temporary budget deficits that smoothed over the last recession is no special or additional reason to postpone income tax cuts. A sound long-term fiscal strategy has tax rates at levels that make up on the deficits in bad times with surpluses in the good times. Slowly repaying debts accumulated in a recession is a routine part of prudent public debt management.

There is room for tax cuts

Every budget allocates about $1.5 billion for new policy proposals that can be adopted without the Treasury thinking that they might harm long-term fiscal stability.

New Zealand budget allows for up to $1.5 billion on new policies every year. If this new spending was justified despite the large public debt from the recent recession, some tax cuts are too. They could start with raising the income tax rate thresholds to make up for past inflation.