THE BLOG

Tax Cuts For Big Business Won't Stimulate The Economy

Rigorous empirical studies by the OECD and the IMF failed to find much evidence of supposed growth effects of tax cuts.

30/10/2017 9:45 AM AEDT | Updated 30/10/2017 1:40 PM AEDT
Bloomberg via Getty Images
"Mr. Fraser and the those arguing for lower taxes for corporations and the rich should be reminded: fiscal policy can make the difference in tackling inequality."

Treasury secretary John Fraser recently backed the Coalition's company tax cuts at a Senate estimates hearing. In light of similar moves across the rest of the world, he said, "I'm not going to say we don't live on an island because clearly we do, but we are obviously part of the world economy".

He further argued, "It is a cost of doing business. If Australia is to remain competitive we have to be mindful of what is happening elsewhere". He feared President Trump's proposed tax cuts "run the risk of sucking in a lot of capital flows that might have gone elsewhere".

With respect, Mr Fraser is wrong and seeing only one side of the ledger. He sees tax as simply a cost to business. But he does not mention that tax is needed to provide world-class infrastructure to support business, and first-rate educational facilities and healthcare system to ensure supply of well-trained, healthy workforce. They significantly boost productivity and lower business cost.

No wonder, therefore, rigorous empirical studies done at two premier capitalist organisations -- the OECD and the IMF -- failed to find much evidence of supposed growth effects of tax cuts.

For example, the OECD noted:

"...it is not always clear that a tax reduction is required (or is able) to attract FDI. Where a higher corporate tax burden is matched by well-developed infrastructure, public services and other host country attributes attractive to business... tax competition from relatively low-tax countries not offering similar advantages may not seriously affect location choice. Indeed, a number of large OECD countries with relatively high effective tax rates are very successful in attracting FDI."

A recent IMF modelling exercise of President Trump's proposed personal income tax cuts concluded:

"...the supply side [growth] effects are never large enough to offset the revenue loss from lower marginal tax rates." On the other hand, they "significantly worsen income polarization, even after taking into account trickle-down effects."

The IMF in its October 2017 Fiscal Monitor reported that after analysing tax rates in OECD countries between 1981 and 2015, it found no strong correlation between lower taxes and higher growth. The IMF's findings have been highlighted even by The Economist, which is well-known for its pro-business stance.

Often cited U.S. examples of Reagan or Bush tax cuts to promote lower tax rates are nothing but myths. Admitted by President Reagan's former chief economist, Martin Feldstein, the vast majority of growth during the Reagan era was due to expansionary monetary policy that slashed interest rates massively to help the economy bounce back from a severe recession in 1982.

Increased defence spending and an expanded labour force due to an influx of baby boomers also boosted the economy. In another study with Doug Elmendorf, the former Congressional Budget Office Director, Martin Feldstein found no evidence that the 1981 tax cuts got people to work more.

The 2001 and 2003 Bush tax cuts also failed to spur growth. Between 2001 and 2007 the economy grew at a lacklustre pace -- real per-capita income rose by 1.5 percent annually, compared to 2.3 percent during 1950-2001. Interestingly, the two sectors that grew noticeably were housing and finance, which did not gain from the 2001 and 2003 tax cuts.

Moreover, by 2006, prime-age males were working the same hours as in 2000 before the tax cuts, and women were working less -- both facts inconsistent with the view that lower tax rates raise labour supply.

Mr. Fraser's one-sided view about taxes and apprehension about investment fleeing to low tax countries can best be refuted again by looking at the recent tax cut experiments in several U.S. states with little obvious success.

The most infamous case is Kansas; Governor Sam Brownback promised that a moderate tax cut for individuals and a big tax cut for businesses would be "like a shot of adrenaline into the heart of the Kansas economy".

Unfortunately, however, despite the 2012 tax cuts, the Kansas economy remained moribund, while the neighbouring states surged ahead. In the process, the Kansas state's budget has been in tatters. The Republican-led state legislature reversed much of Brownback's tax cuts earlier this year in the face of poor growth and spending needs.

If tax cuts boost growth, tax increases should stall the economy. But, President Clinton's tax increase in 1993 tells a different story. It didn't stall growth; instead, it shows that higher taxes on high-income households need not hamper faster economic growth.

Mr. Fraser is either genuinely ignorant of these overwhelming facts, or is deliberately blinded by some defunct ideology and regards them as 'fake'.

The race to the bottom tax competition simply cannot make an economy stronger and resilient. Like competitive devaluation of exchange rates in the hope of boosting exports, this 'beggar thy neighbour' policy, instead harms the country itself. It not only damages its productive capacity, but also worsens income distribution, a significant factor behind the rise of populism.

Mr. Fraser and the those arguing for lower taxes for corporations and the rich should be reminded of what the IMF has tried to persuade in its October 2017 Fiscal Monitor: fiscal policy can make the difference in tackling inequality; and that efficiency and equity must go hand-in-hand.

More On This Topic