Net cash flow tax would benefit smaller, high-investment firms, economist says

In a bid to boost economic dynamism and productivity, the Productivity Commission (PC) has proposed that Australia’s corporate income tax (CIT) system should be replaced with a hybrid system including a CIT and net cash flow tax (NCFT).

Under the proposal, the CIT would be cut to 20 per cent for businesses with annual turnover below $1 billion, and to 28 per cent for larger businesses. An additional 5 per cent NCFT would be introduced on company profits, with allowances to deduct capital expenditure costs up front.

Jason Nassios, an associate professor at Victoria University’s Centre of Policy Studies, said the biggest winners of the proposed CIT-NCFT hybrid system would be businesses with annual turnover between $50 million and $1 billion.

The hybrid system would see these firms’ CIT reduced from 30 per cent to 20 per cent, leaving them with an overall tax rate of 25 per cent, including the 5 per cent NCFT.

“If you're a firm between $50 million and $1 billion, you're getting a very big tax deduction. You're going from 30 per cent down to 20 per cent CIT, plus a 5 per cent CFT. So, overall, you're getting a 5 per cent tax reduction. That's real value to you, whether you like the CFT or not,” he said.

High-investment firms with annual turnover below $50 million would also benefit from the hybrid system due to the front-loaded tax deductions available under the NCFT, Nassios said. In contrast, small firms that didn’t invest much would likely be indifferent to the hybrid system, as their total tax rate would largely stay put at 25 per cent.

The biggest losers would be the top end of town, Nassios noted. Firms with turnover above $1 billion would see a modest CIT cut, from 30 per cent to 28 per cent. However, the 5 per cent NCFT would push up their overall tax rate from 30 per cent to 33 per cent.

“If you're a big firm, above a billion in turnover, you're probably not going to like this system,” he said.

Nassios said these firms would have to be “investing pretty heavily” to reap any benefits from the NCFT’s allowances for up-front tax deductions. He added that this factor likely explained some of the pushback against the tax by industry bodies representing the interests of large firms, such as the Business Council of Australia (BCA).

“You've got a system where big businesses will pay a bit more to keep it revenue neutral. So that's the pushback from the BCA and subscribers to those big firms. And that's completely understandable,” he noted.

He also acknowledged that the hybrid CIT-NCFT system would bring on additional compliance costs as firms and agencies adapted to the new system.

“I understand the complexity angle,” Nassios said.

“I think without almost any doubt, when you introduce a new tax and you have new ways that you have to report income and understand your tax liability, that pushes more work onto either the existing worker, forcing them to work longer, or you have to make your teams a little bit bigger.”

But what about the economy? Nassios said his modelling suggested that investment would rise under the PC’s proposed system, as companies that invested heavily would be able to deduct the costs of their investments up-front under the NCFT.

He added that the NCFT was attractive from an economic efficiency angle, as it wouldn’t distort investment decisions.

“The net cash flow tax is attractive from that perspective because it doesn't … alter economic incentives,” he said.

“I'm an investor sitting there looking to invest $100, and I have to pay a certain level of tax on it. I've got a post-tax rate of return, which is my income less my tax liability, but the government, under a cash flow tax, gives me a tax offset on the full amount of my investment upfront.”

The PC’s proposal has come at a time when policymakers are sounding alarms about Australia’s stagnating productivity, with stark implications for living standards. The Reserve Bank also warned that Australia’s sluggish productivity growth could limit the economy’s ability to grow without spurring inflation.

Nassios said the hybrid CIT-NCFT system would boost competition and investment by tilting the playing field towards smaller, investment-intensive firms.

“The idea at the core of this big deduction for these small to medium firms is to try to improve their competitiveness, try to give them an edge through the tax system to compete with some of our larger existing domestically owned firms or multinationals.”

Overall, Nassios predicted that the proposal would lead to higher investment and productivity over the longer term, while costing the budget less than standalone corporate tax cuts.

“Our modelling of the package suggests investment will rise.”

“In the long run, more investment gives us more capital. That means capital per worker goes up. So if capital per worker goes up, by and large our economy will be a little bit more productive.”