TAXING TIMES
The Productivity Commission advises the Australian Government to go hard on company tax reform. But why?
“We recommend … reducing the statutory corporate tax rate to 20% while introducing a net cashflow tax of 5% ... [but] that companies earning above $1 billion in revenue remain on the current 30% corporate income tax.” Productivity Commission, 2025.
I was surprised that the Commission chose company tax as their main battleground to lift Australian productivity. All of the other draft recommendations in their ongoing review of Australian productivity, spread across five volumes, are well-considered policy reforms that are modest in scope. And while the Commission clearly has the skill as economic policy advisors to contribute a view on company tax, they have no institutional history in this policy theatre. No track record, no standing with stakeholders, no skin in the game. So why did the Commission choose to throw most of its eggs into the company tax reform basket, of all the baskets that were open to it?
Regardless, in my opinion, the Commission’s company tax proposal is dead in the water for three reasons that I step through below.
• The policy recommendation is complicated
• The modelling the Commission published obfuscates the issues
• There is no political path to implementation
The recommended policy is not a simple tweak
The idea of a cash flow tax is straightforward. Currently, companies invest and the estimated depreciation on those investments each year is used to reduce a their taxable earnings. This is a ‘classical’ company tax.
A cash flow tax instead allows companies to deduct the entire cost of investment from their taxable income in the year the investment occurs. That is, the cash flow tax allows companies to bring forward the depreciation that occurs over a number of years into the current year for tax purposes.
Economist’s hope a cash flow tax will boost investment by lowering the cost of capital that companies consider in deciding whether to undertake an investment. Depreciation deductions spread over many years are worth less to a company, the time value of money being what it is, than taking deductions immediately.
Cash flow taxes have very rarely been attempted. Even Ken Henry’s highly-ambitious review of Australia’s taxation system published in 2009 merely noted that a cash flow tax deserves further consideration in the long term.
Stacking a cash flow tax on top of a classical company tax scheme, as the Commission recommends, is a new-to-the-world innovation. It requires a single investment in a single asset to be treated in two different ways so that company tax can be assessed at two different rates on two different measures of taxable income.
Are you confused? The recommendation is best illustrated by reproducing a table from the Commission’s report.
Table 1: How the Commission’s recommendation would work
Source: Reproduced from Productivity Commission, 2025, p.15, Table 1.1.
The Commission points out that its proposal will not result in any change in company reporting requirements to the Australian Taxation Office. A cashflow tax would rely on data already reported. This is a worthwhile point to make and I agree with the Commission’s assessment: there will be no increase in paperwork.
Yet, the stated purpose of the Commission’s recommendation is to boost economic dynamism and resilience by spurring greater business investment. That requires businesses to change their behaviour and make investments they would not have made. Changing business behaviour requires businesses to understand company tax policy, not merely to submit paperwork.
The modelling is inconsistent
Every high school student knows the theory of gravity is useless. Everything falls under gravity with the same acceleration in a vacuum, but the only place you will find a vacuum is in space, where there is no gravity. If all the science you apply is the theory of gravity, then your answer to the question of whether a bowling ball or a feather falls faster when dropped from the Tower of Pisa will be incorrect. Air resistance matters a good deal and cannot be ignored.
So it is with modelling company tax. Understanding the effect of company tax policy on required rates of return to investment is, like gravity, important. But two other key forces — location-specific rents and the ability of businesses to shift profits to low tax jurisdictions —are also important.
Chris Murphy summarises the issues as follows, amended by the author for brevity.
“Location-specific Economic rents
By definition, location-specific economic rents are immobile, so taxing them does not diminish their local supply. Hence, if we could separate the corporate income tax base into two components, one component for normal returns to capital and for firm-specific rents, and the other component for location-specific economic rents, we would tax the second component but not the first component.
International Profit Shifting
The application of a relatively high corporate tax rate to the income of multinational corporations encourages them … to use various financial manipulations, including transfer pricing, the relocation of the ownership of intangibles, and the use of loan reallocations that facilitate interest stripping, to shift revenues to relatively low tax countries and deductions to relatively high-tax countries. There is considerable empirical evidence of income shifting that a relatively high statutory corporate tax rate encourages income shifting.
Besides eroding local tax revenue, international profit shifting (IPS) involves unproductive tax avoidance activity that is a drain on national income.”
Chris Murphy is a serious tax policy modeler with a strong track record. His model explicitly takes account of rents and profit shifting. It provides a strong, scientific basis for analysing company tax changes and, in my opinion, should form the basis of future refinements in the lead up to the Commission’s final report.
To my reading, the CoPS model is irrelevant because it takes no account of these forces. If it does, there is no discussion in their report.
Modelling is both science and art. The art comes from the choice of economic parameters within the model. Often there is limited prior research to inform these choices and they can have profound effects on modelling outcomes, including on whether a policy proposal is good or bad for the welfare of Australians. Is the elasticity of substitution between labour and capital 0.4 or 0.8, for example? How large are location-specific rents? This can be addressed by illustrating sensitivity analyses and open debate with other interested economists.
The politics: where is the love?
Gaining social license for tax reform is difficult. In this case, the public debate is starting from zero — to my knowledge, nobody is calling for a cash flow tax — and the complexity of the proposal will make it very difficult to garner support. My predictions are:
• Many small businesses won’t understand it
• Medium size businesses may be happy if it were introduced, but are unlikely to campaign for it
• Large businesses will oppose it ferociously because it will lower their profits significantly
It is worth recalling that the Rudd Government’s campaign to introduce a similar tax to the minerals industry, to the clear benefit of almost all voters in the middle of the mining boom, the Minerals Council of Australia defeated it in part because it was too complicated to explain. Similarly, the Gillard Government’s carbon price was rolled back despite extensive modelling.
One final embuggerance
Company tax is a backstop to personal income tax ensuring integrity of the tax system overall. Small business owners can retain profits in a company, paying taxes at the company rate when their marginal personal income tax rate may be much higher. That is, company structures allow high income earners to time-shift the realisation of personal income tax, much like negative gearing on investment properties, and pay less tax over the course of their lives. The greater the difference between the top marginal personal income tax rate and the company tax rate, the greater the problem.
It is traditional in analysis of company tax in Australia for the analyst to wave their hands about this being an important issue, then move on. The astute reader will observe that I, too, have taken this approach.
Summing up
I welcome the Commission bringing its transparent, whole-of-economy approach to consideration of tax policy. If it continues to resource research in this field then over time it may have an influential voice. Chris Murphy’s model provides a sound basis for sensitivity analysis around different parameter choices. The Commission’s proposal to stack a cashflow tax on top of a classical company tax system – even if it were shown to be economically desirable, of which I am skeptical – most likely will never be implemented.
What if we all stop paying taxes?
Links
Creating a More Dynamic and Resilient Economy, Productivity Commission 2025, https://www.pc.gov.au/inquiries/current/resilient-economy#report
Corporate Tax Reform Modelling Scenarios: First Stage Report, Chris Murphy 2025, https://www.pc.gov.au/inquiries/current/resilient-economy/interim/tax-reform-modelling-murphy.pdf
Broad vs Targeted Company Tax Reforms: A CGE Analysis of Ten Percentage Point Reductions in Australia, Victoria University Centre of Policy Studies (CoPS) 2025, https://www.pc.gov.au/inquiries/current/resilient-economy/interim/tax-reform-modelling-nassios.pdf
Australia’s Future Tax System, Australian Government 2010, https://treasury.gov.au/sites/default/files/2019-10/afts_final_report_part_2_vol_1_consolidated.pdf
Experiences with Cash-Flow Taxation and Prospects, Ernst and Young 2015, https://taxation-customs.ec.europa.eu/system/files/2016-09/taxation_paper_55.pdf