Australia's Future Tax System

Final Report: Detailed Analysis

Chapter B: Investment and entity taxation

B1. Company and other investment taxes

B1–2 Australia relies heavily on company income tax

At the international level, Australia's tax system stands out for its relatively high reliance on company income tax.

From 1982 to 2007, the OECD average (unweighted) corporate tax to GDP ratio increased from around 2.5 per cent to 3.7 per cent (see Chart B1–1). This increase may reflect a number of factors, including increasing profitability and structural changes (for example, a decline in the agricultural sector and an increase in the finance sector's share of the economy).

The increase in the corporate tax to GDP ratio has been more pronounced in Australia. After following the average OECD trend in the early 1980s, the company income tax to GDP ratio increased from around 2.7 per cent in 1985 to 5.9 per cent in 2005. Many of the explanations applying to other countries are also likely to explain the growth in the company income tax to GDP ratio for Australia. For example, the factor share of the corporate sector (the ratio of GOS to GDP) increased from 16.6 per cent in 1980–81 to 23.9 per cent in 2005–06 (Clark, Pridmore & Stoney 2007).

Chart B1–1: Corporate tax revenues in the OECD 1982–2005

Chart B1–1: Corporate tax revenues in the OECD 1982–2005

Source: Loretz (2008), with additional data from author.

Australia's company income tax revenue as a proportion of GDP (5.9 per cent) is the fourth highest in the OECD and much higher than the OECD average (3.7 per cent). This reflects a number of factors including:

  • Australia's company income tax revenue, as measured for these purposes, includes taxes on superannuation funds levied on contributions and earnings (which are effectively taxes on individuals' savings) and petroleum resource rent tax revenue.
  • Levels of incorporation differ across countries, and the classification of income from companies may differ. For example, tax revenue from 'S corporations' in the United States appears as a tax on individuals.
  • Levels of corporate sector profitability differ across countries. For example, the profitability of Australia's corporate sector is typically high because it includes economic rents arising from Australia's natural resources.
  • There may also be an incentive for domestically-owned companies to pay tax in Australia in order to pay fully franked dividends under Australia's imputation system (see Section B2 The treatment of business entities and their owners).
  • Australia has a relatively broad based company income tax, with limited concessional write-off arrangements compared to many OECD countries.

Finding

Australia has a relatively high reliance on company income tax compared to other OECD economies. This reflects, in part, classification differences in disaggregating company income taxes and Australia's abundance of natural resources, a high level of incorporation, the corporate sector's high level of profitability, the dividend imputation system, and a relatively broad company income tax base.

Company income tax rates have been falling worldwide

Company income tax rates have fallen across the OECD over the past 30 years (Chart B1–2). The fall in the average statutory corporate tax rate across the OECD has been fairly continuous. The unweighted average company income tax rate fell from around 47 per cent in 1982 to around 28 per cent in 2007. The weighted average (which is heavily influenced by the United States, Japan and the United Kingdom) has fallen to a lesser extent, from around 50 per cent in 1982 to 36 per cent in 2006.

The unweighted average tax rate has been falling faster than the weighted average because smaller economies have been reducing rates faster than larger economies. This is unsurprising as larger economies such as the United States have more scope to set their corporate tax rate based on domestic considerations.

Australia has, until recently, followed this trend, with the company income tax rate falling from 49 per cent in the mid-1980s to its current rate of 30 per cent in 2001.

Chart B1–2: Statutory corporate tax rates in the OECD 1982–2007

Chart B1–2: Statutory corporate tax rates in the OECD 1982–2007

Source: Loretz (2008), with additional data from author.

Unlike Australia's company income tax rate, the unweighted average rate has continued to fall. In 2001, when Australia reduced its statutory company income tax rate to 30 per cent, it had the ninth lowest rate in the OECD. Australia now has one of the highest corporate rates among small to medium OECD countries, and at 30 per cent is well above the average for small to medium OECD countries (around 25 per cent) (see Chart B1–3).

Chart B1–3: Statutory corporate tax rates, OECD countries 2009

Chart B1–3: Statutory corporate tax rates, OECD countries 2009

Source: OECD (2009d).

Australia's company income tax rate is also relatively high compared to other countries in our region (see Chart B1–4). Australia's current company income tax rate is significantly higher than Hong Kong (16.5 per cent) and Singapore (18 per cent) and marginally higher that the average for the Asia-Pacific region (27.5 per cent).

Chart B1–4: Statutory company income tax rates, Asia-Pacific countries 2009

Chart B1–4: Statutory company income tax rates, Asia-Pacific countries 2009

Source: KPMG (2009).

While reductions in company income tax rates have been characterised as a 'race to the bottom' among OECD countries, reforms to company income tax have often also involved structural improvements to those tax systems.

For example, the decline in statutory company income tax rates across the OECD over the past 30 years has been accompanied by a broadening of the company income tax base. Australia has followed this trend, most notably by including capital gains (1985–86) and income from the life insurance and gold mining industries (1990–91). At the same time, Australia abolished the general investment allowance (1988–89) and the accelerated depreciation regime (1999–2000).

If reducing rates and broadening bases has reached or is reaching a natural limit, further rate reductions would have a significant cost. While this raises some uncertainty over the likely future path of company income tax rates internationally, it could be expected that continued pressure to attract mobile capital will lead to further reductions in rates over the longer-term.

That said, given the fiscal pressures arising in most developed countries from the global financial crisis, the ability for many countries to significantly reduce their company income tax rate may be limited, at least in the medium term.

Effective company income tax rates have also been falling

While base broadening has, to some degree, offset the cuts in statutory corporate income tax rates, measures of the effective marginal tax rate and effective average tax rates, which take into account the statutory rate as well as elements of the tax base for a hypothetical project, have declined.4

Charts B1–5 and B1–6 present the trends in effective marginal tax rates and effective average tax rates respectively. Both measures have followed a similar downward trend, suggesting the broadening of the tax base did not fully offset the fall in statutory tax rates. The fall in effective marginal tax rates is less pronounced than the fall in statutory rates and effective average tax rates, indicating that countries may have reduced effective average tax rates to attract more profitable businesses (Devereux et al. 2002).

Australia has followed this trend with both marginal and average effective tax rates falling over the past 25 years.

Chart B1–5: Effective marginal tax rates in the OECD 1982–2007

Chart B1–5: Effective marginal tax rates in the OECD 1982–2007

Source: Loretz (2008), with additional data from author.

Chart B1–6: Effective average tax rates in the OECD 1982–2007

Chart B1–6: Effective average tax rates in the OECD 1982–2007

Source: Loretz (2008), with additional data from author.

Finding

Australia's company income tax rate, which currently stands at 30 per cent, is high relative to other comparably sized OECD countries. The average rate for small to medium OECD economies is currently around 25 per cent.


4 The effective marginal tax rate measures the tax burden on an investment just earning the same return as an alternative investment; the effective average tax rate measures the tax burden for an inframarginal investment with an economic rent.