When the Greens proposed an extra super-profits tax on the excessive part of really excessive profits last week, business and the government acted as if the sky was about to fall in.
It would make Australia one of the “worst places in the world to run a business”, said the Business Council. It would “force up prices on everyday essentials”.
The idea that large profits were “unjustifiably extracted” was false, said the head of the Commonwealth Bank, and so on.
Labor was the same. The Greens were making up numbers, the super-profits tax was “designed to get attention,” according to Treasurer Jim Chalmers.
But the principle behind the idea is a good one – as Labor and the Business Council should know better than anyone.
An idea of interest to Labor and business
Back in 2011, then Labor Treasurer Wayne Swan asked his business tax working group to consider it. Guess who was Swan’s chief of staff at the time? Today’s treasurer, Jim Chalmers.
And before that, the Business Council of Australia itself put forward the idea in 2009 – known as an allowance for corporate equity – in its submission to the Henry Tax Review.
The council said the idea had “the potential to deliver significant benefits”.
Two tiers of company tax
At the heart of the Greens’ idea, as well as the idea put forward by the Business Council 15 years ago, is a two-tier system of company tax.
Ordinary profits would get taxed at a standard rate.
And here’s where the current Greens and the Business Council’s earlier idea start to diverge.
Under the Business Council proposal, the standard rate have been a rate of zero. Under the Green’s proposal this would be the present company tax rate. “Above normal returns” would get taxed at a higher rate.
What’s a normal return? Researchers at the ANU’s Tax and Transfer Institute, drawing on the experience of the countries that have done this, suggest using the 10-year government bond rate, which at the moment is close to 4%.
It would mean any annual profit in excess of (say) 4% of shareholders’ equity would be taxed at the higher rate, and the profit below that taxed at the lower rate.
The threshold proposed by the Greens is more generous. It’s that any profit in excess of the bond rate plus 5% would be taxed at the higher rate, meaning (at the moment) any profit in excess of 9% of shareholders’ equity.
Today’s super-profits suggest something’s wrong
The thinking behind the idea is that in a hypothetical perfectly competitive market, high returns on equity wouldn’t endure.
As soon as one firm worked out how to earn a good deal more than the cost of borrowing, other firms would borrow to enter the market and undercut it, whittling away the excess profit.
For most businesses, especially most small businesses, that’s exactly what happens. Continuing large profits are rare.
But for some businesses in some industries, outsized returns are the norm. Among them are the big four banks, where the returns on equity exceed 10%.
For big mining companies such as Rio and BHP, those returns on equity approach 20%. With Coles and Woolworths, they exceed 25%.
In each, the profits aren’t whittled away by new entrants because it’s hard for new entrants to gain a foothold.
Australians are weirdly reluctant to move away from the big four banks. As for Coles and Woolworths, they have invested so much in distribution at scale they are almost impossible to challenge.
And as for mining companies, they get continuing access to the good sites without having to periodically rebid for them.
So why not tax away just some of the well-above-normal profits that they’re earning in the absence of proper competition?
It’s an argument Swan used arguing for a resource super profits tax in 2010.
The funds raised could be used to cut the tax rate for the bulk of companies not making super-profits, perhaps even to zero (as the Australian National University’s Tax and Transfer Policy Institute suggests). Doing that would help many more Australian businesses become profitable.
There’s a case for taxing ordinary profits at zero
There would also be a technical advantage if we moved to a zero tax rate for ordinary business profits – and it’s one beloved by economic theoreticians.
The system we’ve got at the moment pushes firms into debt. If they try to raise money from shareholders, they are made to pay tax on the returns they pay out as dividends, whereas if they borrow, their interest payments are tax deductable.
An allowance for corporate equity, which is what the Greens are calling their proposal, would treat debt and equity the same for all firms other than those collecting super-profits.
But only if the tax rate on ordinary profits was zero. And that certainly isn’t what the Greens are proposing.
We could certainly cut ordinary company tax
Given the large number of firms that make ordinary profits, Australia probably couldn’t afford to reduce the company tax rate to zero. But it could afford to cut it somewhat, providing some but not all of the benefits of the scheme the Business Council was attracted to 15 years ago.
There are all manner of two-tier allowance for corporate equity tax systems around the world, many in Europe, including in Italy, Belgium, Poland and Portugal, as well as in Brazil. Dating back to the 1990s, they are no longer novel.
The treasurer is right to say that Greens’ primary task is to “put out press releases”. The Greens aren’t in office and have no prospect of governing in their own right.
But that doesn’t mean their ideas shouldn’t be taken seriously. Within the treasury, within the treasurer’s own office, among tax specialists, and within the Business Council, this particular idea has been taken seriously for some time.
Peter Martin is Economics Editor of The Conversation.
This article was originally published on The Conversation. Read the original article.
