Australia’s economy is dominated by powerful firms that are extracting above-normal profits from the system, and their power is growing.
They’re extracting “economic rent” from our economy, which means they’re charging higher prices and collecting higher profits from a lack of competition.
The Productivity Commission (PC) says if we want to reform our tax system we need to focus on that issue, because it will solve a whole host of problems.
Which industries are extracting economic rent from our society?
It won’t surprise you: the gas, oil, coal, and iron ore industries, the banking and financial services industry, the wholesale and retail industries, and telecommunication networks, among others.
Increase taxes on the renters
Last week, the PC published its interim recommendations to the Albanese government for how to reform Australia’s corporate tax system.
But at the heart of its recommendations was something fascinating.
Australia’s economy is not functioning fairly, Ross Garnaut says
It showed the PC has picked up the cause of economists like Ross Garnaut and others who have been calling for our tax system to be reconfigured to tax economic rents much more heavily.
Professor Garnaut spoke about these ideas in his Bannerman Lecture in May 2023 and his Henry George Commemorative Dinner address in September 2023.
And the PC has explicitly drawn from two of Garnaut’s recent journal articles to inform its recommendations.
The first article is The Economic Public Interest in a World of Oligopoly (2023). Here’s the summary of its argument:
“The Australian economy has performed well compared with comparable countries over the last three decades only if we average the excellent performance in the 1990s and the poor performance over the past decade,” Garnaut wrote.
“Real wages over the past decade have stagnated — to an extent without historical parallel.
“We cannot understand the economy’s underperformance without recognising the increasing claims of economic rents on national income.
“Correction of weaknesses requires coordination of many policy instruments including measures to reduce the prevalence of rents (competition policy and regulation of oligopoly where competition is not feasible or inefficient) and changes in taxation arrangements to shift the burden of business taxation from firms in competitive activities to firms relying heavily on economic rents.”
The second article is Replacing Corporate Income Tax with a Cash Flow Tax (2020), which Garnaut co-authored with Craig Emerson, Reuben Finighan, and Stephen Anthony.
In that article, Garnaut and his colleagues said Australia’s corporate tax system was built for the wrong century and we needed a new system to account for 21st-century realities.
What were those new realities?
We need better resource rent tax, Garnaut says
They said greater mobility of capital had given rise to an international “race to the bottom” in company tax rates to attract and retain investment, while multinationals have far more opportunities to avoid and evade taxes through transactions across international borders.
They warned that the phenomenon had contributed to the public’s growing resentment of “globalisation” and a distrust of market exchange.
They said the competitive position of national companies had declined compared to multinational corporations, due to their more limited opportunities for tax avoidance and evasion.
They said the proportion of Australia’s corporate income deriving from “economic rent” had grown, while the competitive returns on capital had declined.
And our national tax compliance culture had deteriorated.
“This paper suggests a major change in approach to taxing corporate income,” they wrote.
“It proposes changing the corporate tax base, from a conventional view of income to cash flow.
“This increases the incidence of the tax on economic rent, and reduces the incidence on competitive or ‘normal’ returns on investment.
“Our proposed cash flow tax is relatively simple to administer, applying familiar and well‐tested measurements of the taxation base.”
They also warned that a large and growing presence of economic rent in an economy tends to increase income and wealth inequality, owing to the narrow ownership of the scarce assets that attract rent.
Economic rent is growing
The PC agrees that our company tax system is inefficient.
It asked the economist Chris Murphy to investigate the prevalence of economic rents in Australia’s economy, and how a net cashflow tax could work, and it has relied on Murphy’s modelling to make its recommendations to the government.
Mr Murphy says his modelling accounts for three main types of rents: oligopoly rents, mineral rents, and land rents.
Collectively, he says economic rents account for 54 per cent of corporate tax revenue in Australia, which is up from 41 per cent in 2016-17.
The PC is very aware of what that indicates.
It says business investment has fallen significantly in Australia over the past decade, and the lack of investment has contributed to Australia’s “lacklustre productivity performance.” Meanwhile, economic rents have become a more important part of Australia’s company tax revenue by default.
There is ‘extraordinary intergenerational inequity’ in the tax system
Therefore, it says we need to consciously shift to a new tax system that specifically targets economic rents, better encourages investment, and reinvigorates competition in moribund areas of the economy that are dominated by a few large firms.
Murphy says his model of Australia’s economy has 278 industries.
He says 29 of those industries have oligopoly rents, but in practice, 85 per cent of oligopoly rents are received by just five industries: bank interest margins, wholesale margins, retail margins, bank fees, and telecommunications networks.
He says mineral resource rents are present in five industries: coal mining, crude oil, liquefied natural gas (LNG), other gas extraction, and iron ore mining.
He doesn’t provide many details about land rents.
In his modelling, Murphy discusses how taxing normal returns to capital has a “double disincentive” effect of discouraging both investment and labour supply, but location-specific economic rents are immobile, so taxing them does not diminish their local supply at all.
He says his estimate that economic rents account for 54 per cent of corporate tax revenue in Australia highlights the challenges in designing corporate tax policy.
“About one-half of revenue is collected from normal returns to capital, doing considerable economic harm through the double disincentive effect,” he writes.
“The other half is collected from economic rents, which in principle does no economic harm.”
Cut taxes on small businesses, tax economic rents
So, the PC has made the following proposal to the Albanese government, ahead of this month’s reform roundtable.
It says Australia needs a new corporate tax system.
It says we should cut our headline company income tax rate to 20 per cent (from 30 per cent or 25 per cent) for companies with revenue below $1 billion (which is the vast majority of Australian companies), but we should keep the 30 per cent tax rate for Australia’s largest companies, with turnover above $1 billion, in the short-term.
It says we should also introduce a new “net cashflow tax” of 5 per cent to be applied to company profits. It says the new tax will reward companies for capital expenditure by reducing their taxable income by the value of their investments.
Lower company tax rate, productivity agency tells Chalmers
It says such a system would encourage business investment much more than our current system, and thereby help to produce a more dynamic and resilient economy in the long run.
It says the net cashflow tax will likely increase the tax burden for companies with turnover above $1 billion.
Murphy’s modelling suggests the reforms will increase investment by $7.4 billion (1.6 per cent), GDP by $14.6 billion (0.5 per cent) and labour productivity by 0.4 per cent over the medium term.
It says the initial reforms will be revenue-neutral, so they won’t weaken the government’s budget position.
The PC says that if we tax economic rents more heavily, we can cut taxes on millions of smaller companies in Australia that are operating in more competitive environments, which will allow them to grow and challenge the big incumbents.
“In many sectors, a small number of big firms exercise market power to the detriment of consumers, while ever more complicated regulatory and tax systems impose higher costs that keep new entrants from joining in or scaling up,” it says.
“With fewer firms entering and exiting, the economy is not getting a productivity bounce from new firms challenging incumbents.
“Few grow into medium and large-sized businesses. Lower rates of business investment mean less capital per person and lower productivity growth.
“The corporate tax system is not delivering the best outcomes.”