An analogue budget meets the digital world

Budgets are a matter of light and shade. You have to get the balance right. And so having spent the weekend talking about its wonderful childcare plans, yesterday the Government paraded Treasurer Joe Hockey in front of cameras toformally announce some of the budget’s so-called “tax integrity measures”.

Yes, tax integrity measures. Treasury’s spinners would have worked hard on that little catchphrase. Funny how measures to strengthen the integrity of a tax system always seem to deliver more tax to the government.

First, the Government plans to adjust anti-avoidance laws to crack down on multinationals shifting their profits to lower taxing jurisdictions. Second, the Government is going to introduce a Netflix tax – that is, try to impose the GST on digital downloads like books, music, videos and so on.

These two are linked, and in an important way that perhaps even Hockey does not realise. Analogue tax system, meet digital world.

Let’s start with profit shifting. I’ve tackled the claims that multinationals are evading taxation by shifting their profits across borders on The Drum before. Long story short: it’s a beat up. But the Government wants a budget that sounds fair and nothing sounds fairer than beating up on big companies. The corporate tax is a diffuse and confusing tax. It’s designed that way.

We are told Australian Taxation Officers have been “embedded” in 30 different multinational companies. We’re not told which companies. And at the press conference yesterday the treasurer didn’t want to tell us how much revenue the new anti-avoidance measures might raise. “It’s billions of dollars, obviously.”

This should be a red flag. It’s true that Treasury doesn’t have a good track record for estimating how much money new taxes will raise – recall the embarrassingly low take from the mining tax. But this looks less like prudence and more like a lack of confidence. Running a media or political campaign against corporate tax avoidance is easy. Trying to reverse engineer the tax accounting of the world’s biggest firms is hard.

The Government’s crackdown has a certain Sisyphean quality. In a world where much value is tied up in intangible intellectual property, it is borderline nonsensical for politicians to command that economic activity occurs in this jurisdiction or that jurisdiction.

It used to be the case that big firms had capital assets you could see and touch. Factories, vehicles, equipment, land. What mattered to firms were things like location, infrastructure, access to markets, the price and skills of the labour force and so on. But now the assets of the biggest firms can be placed anywhere in the world instantaneously. So they tend to be clustered in low tax jurisdictions with established and reliable legal systems. Like Ireland and Singapore.

What isn’t obvious is why this is a bad thing. Yes, higher tax countries like Australia would prefer that firms book their intellectual property here so Treasury could skim some cash off the top. But treating big firms to a publicity focused “crackdown” only harms what we should be trying to improve: the Australian investment environment. Firms should want to put their assets here. Implicitly, the Government’s profit shifting claims suggest they do not.

There is almost exactly the same issue with the Netflix tax. Once again, the Government is trying to shoehorn a national tax better suited for an analogue era into the age of digital globalisation.

“It is plainly unfair that a supplier of digital products into Australia is not charging the GST whilst someone locally has to charge the GST,” Hockey said at the press conference on Monday.

But why? The GST is a tax that the Australian government has chosen to place on Australian businesses. If there is an unfairness here it is an unfairness imposed by the government when it chose to introduce the GST. It is not “unfair” that other countries do not charge the Australian GST.

When we import goods from other countries – real or intangible – they are priced free of the burden of the many taxes and regulatory costs imposed by the Australian government. This does not make international trade unfair. In fact, all those institutional, regulatory and geographic differences between different trading partners are why international trade is so beneficial.

And – as with the profit shifting debate – the Government’s rhetoric is running far ahead of its capabilities. It is absolute fantasy that Hockey and the Australian Treasury will be able to impose our taxes on international digital goods providers in any meaningful way.

Yes, they might be able to convince a few of the big firms to play ball. But many already are playing ball. Apple, for instance, already charges GST. Those online firms with no Australian base and few Australian interests are unlikely to sign up to this new impost. What’s the Government going to do? Censor them?

It was reported last week that the Abbott Government has scotched many of the tax increases on the table in order to free itself to attack Bill Shorten for wanting to increase tax. That’s good, as far as it goes.

But it would be better if they opposed tax increases because they find increasing tax inherently objectionable.

Ultimately, the tax “integrity measures” announced yesterday have to be seen in the context of a Government that thinks the only viable way back to surplus is more revenue.

Conservative Voters Blindsided By Coalition Tax Increases

What exactly is the point of a Coalition government if it offers the same sort of tax increases as voters expect from Labor and the Greens?

It’s disturbing how quickly the Abbott government has turned its attention to boosting government revenue rather than reducing government spending. It’s only been in power 18 months.

First, there’s the planned deposit tax, a levy imposed on all our bank accounts purportedly to pay for the deposit insurance introduced by Labor during the global financial crisis.

When Kevin Rudd proposed the deposit tax in August 2013, Joe Hockey, then shadow treasurer, said it showed how “Australians end up paying for Labor’s waste and mismanagement”. So what does it say now the tax is being mooted by the Coalition?

Then there are all the possible changes to the GST. The GST-free import threshold of $1000 might be lowered. The government is drawing up legislation to impose GST on digital downloads – the so-called Netflix tax. There’s even been discussion of broadening the GST base to include things like fresh food, health and education.

There’s also a Google tax on the horizon. Hockey said last month companies that do not pay the “legitimate level” of tax are “thieves”. But tax minimisation is perfectly lawful. We all do it when we fill out our tax forms. In fact, firms have an obligation to their shareholders to minimise tax.

To change corporate tax law as Hockey wants wouldn’t be recouping money that is rightfully the Treasury’s. It would be increasing the corporate tax burden, and increasing investment uncertainty while it’s at it.

Likewise, the government wants to tackle what is described as the superannuation tax “concession”. Here it is on a virtual unity ticket with Labor.

Don’t be fooled by the word concession. It is a euphemism. The issue here is that while income is taxed progressively – rich people pay proportionally more than poor – superannuation is taxed at a flat rate of 15 per cent. The government thinks wealthy people are putting too much money into super, avoiding high marginal income tax rates, and depriving Treasury of money. Let’s be blunt: to eliminate superannuation concessions would be just another tax increase.

But there is a more fundamental point. Superannuation is taxed at a lower rate to counterbalance the income tax system’s bias against savers. All those so-called loopholes and thresholds and concessions exist for a reason. Many of them exist to prevent perverse and unfair taxation, to treat different assets equally, to avoid double taxation, to encourage saving. And all of them were instituted as part of a democratic bargaining process. Eliminating a loophole is the same as raising a tax.

The Coalition should know this instinctively. Liberal parliamentarians campaigned under the slogan “Our Plan: Lower Taxes”. When he became leader Tony Abbott declared “there will not be any new taxes as part of the Coalition’s policies”. Now his team are lining up alongside Bill Shorten and Christine Milne to push for new and higher taxes. Let’s hope they’re embarrassed.

I haven’t even mentioned bracket creep, the process whereby inflation slowly pushes wage-earners into a higher tax bracket without making them wealthier.

The tax system is full of little revenue-scrounging tricks like that, tricks of language and mathematics and perspective that hide who pays and how much.

Funny how those tricks always work in Treasury’s favour. Bracket creep could be done away with once and for all by indexing income tax to inflation. Malcolm Fraser’s government experimented with such a policy, but abandoned it. It is in the government’s political interest to let bracket creep work its subtle expropriating magic.

The government’s problem is spending, not revenue. The public spat this month between Hockey and Peter Costello was revealing. If you missed it, Costello criticised Hockey’s desire to raise tax. Hockey responded that he wished he had the sort of revenue Costello enjoyed in government.

But hold on: Hockey does have that sort of revenue. If we adjust the figures for inflation, Hockey has $18.6 billion more revenue than Costello received in his last budget. (The most recent reported figures appear in the December Mid-Year Economic and Fiscal Outlook.)

The government’s other budget excuse – that the iron-ore price is bottoming out – isn’t convincing either. Yes, iron ore could go as low as $US36 ($46) a tonne. It was nearly $US200 a few years ago. But that was under Labor. Costello hadn’t been so lucky. Iron ore only lurched above $36 after the Howard government left office.

Hockey said he was kicking off a national conversation about tax and efficiency when he launched his tax discussion paper last month. Economists – particularly the sort of economists that populate treasury departments – spend a lot of time thinking about what is the most efficient tax system. The discussion paper reflects a lot of that thought. It judges taxes on how much they distort our incentives to work and produce.

However, efficiency isn’t the only thing we want in a tax system. Too often politicians use the word efficiency as a synonym for ingenious. The 17th-century French finance minister Jean Baptiste Colbert famously described the art of taxation as “plucking the goose as to get the most feathers with the least hissing”. You can understand his view. For a treasurer the most important thing is maximising revenue.

But it’s not obvious why we should be pleased the government wants to pluck more of our feathers. A Coalition government, no less.

Moral Panic Overlooks Real Company Tax Problem

with Sinclair Davidson

The corporate tax profit shifting debate is a classic example of moral panic. First, it’s incredibly complicated. How many Australians could explain how company tax is calculated, let alone what business practices a “double Irish Dutch sandwich” refers to?

Second, it’s driven by hyperbolic and simplistic reports of companies paying little to no tax. These stories pivot on even more complicated scandals, such as “Lux Leaks”, and the technicalities of foreign tax systems.

And third, it’s wildly overstated. The best current estimates of how much corporate tax is shifted across borders is in the realm of 2 per cent to 4 per cent of total corporate tax.

It’s true that earlier estimates in the 1990s were much more than that. It was those high estimates that got the Organisation for Economic Co-operation and Development interested in the issue. But the firm- and affiliate-level evidence is better now. It’s pointless to scrutinise a moral panic for the clarity of its claims. But the corporate tax debate is missing the point.

As a society we don’t value firms for the money the government extracts from them. We value firms because they produce goods and offer services that make us richer, our lives easier, more convenient and more enjoyable, and our standards of living higher.

We ought to design our tax system to encourage foreign firms operating and doing business on Australian shores, bringing investment and jobs. Any attempt to tackle profit shifting that raises uncertainty or lowers Australia’s investment climate would be a disaster.

The corporate tax is not a good tax. As a recent Treasury paper pointed out, it is one of the most inefficient taxes levied by Australian governments. The burden of the corporate tax is scattered and obscure.

Greens leader Christine Milne has been running around this week accusing companies of not paying their “fair share”. But that fair share is always and inevitably passed on to someone else. The literature on the incidence of corporate taxation suggests the burden of corporate tax is worn in the short term by investors, and in the long run by a combination of investors and workers. Of course, under our superannuation system every worker is an investor as well.

Few of the standard justifications for the existence of corporate tax – particularly in a small, open economy – are compelling. One fear is that company owners might divert their personal income into the company. But they’d still have to pay capital gains tax on the way out again. Another argument is that corporate tax is an easy way to get money out of multinationals. Absurd, we know.

That’s why there are academic tax papers with titles such as “Why is there corporate taxation in a small open economy?” and “Can capital income taxes survive? And should they?”

For the political class, the corporate tax has one great advantage: it’s unclear who ultimately pays. It’s easy and comfortable to beat up on corporations, just as long as you stay mum about who actually ends up paying corporate tax. The whole system rests on this clever one-two trick. Who could sympathise with big bad business?

But even if the government wishes to keep the corporate tax fiscal illusion going, there’s hope. For all the handwringing about the double Irish Dutch sandwich, one point often missed is that Ireland has been very clever. That country’s low corporate tax rates have brought in multinationals, and with them jobs and investment.

It’s not obvious those low rates have come at a cost to the Irish budget. Corporate tax revenue as a percentage of total revenue in Ireland is almost exactly the OECD average. There’s no reason we couldn’t copy the Irish example – get in on the Irish-Dutch sandwich ourselves. The Irish make their own luck. So should we.

This Small Business Fetish Has Gone Too Far

As part of its back to basics campaign, the Abbott Government has telegraphed a small business tax package for the 2015 budget.

The plan, as far as we know, is that small business will get a tax cut of about 1.5 per cent. Big business will be left paying the standard rate of 30 per cent.

The Coalition has long had a romantic attachment to small business as a sort of moral heart of Australian private enterprise, but this policy is the worst sort of small business fetishism.

It threatens to further undermine an already complicated corporate tax system, confuses the sources of economic growth, and will distract policymakers from the much more fundamental task of opening protected areas of the economy up to competition.

Let’s take these one at a time.

It beggars belief that while the political class is banging on about the convoluted the tax code, “unfair” tax concessions, and clever corporate tax minimisation, the Government is planning to increase the complexity of the corporate tax system.

How long before we see the first exposé in Fairfax business pages about large corporates rearranging themselves to take advantage of the concessional small business rates?

The proposed small business tax cut would make the Australian corporate tax system explicitly progressive. Just as we pay a higher rate of income tax according to our wealth, firms would pay a higher rate of corporate tax depending on their size. The United States has a progressive corporate tax. Ours is flat – 30 per cent no matter what.

Now, in practice, firms don’t pay the same 30 per cent rate. As my Institute of Public Affairs colleague Sinclair Davidson has documented, all those deductions, offsets and credits mean the effective tax rate – that is, the amount of tax paid – hovers about 25 per cent. On top of this, small businesses tend to have much more variable profitability, so they tend to pay less than big business already.

Even with this caveat in mind, progressive corporate taxes are a terrible idea.

Corporate taxes are very different from income taxes. Income taxes are ultimately paid by the people whom the tax is levied upon. The money comes out of the pocket of the person who fills in the tax return. I’d prefer our income tax to be flat. But progressivity for income tax at least has its own internal logic.

Corporate taxes are very different. The cost of corporate tax is ultimately paid by someone other than the corporation – passed on to consumers through higher prices, or to shareholders, or even to the company’s employees.

After all, companies don’t pay corporate tax, people do.

It’s not at all clear why we would want to tax people who buy products from large firms more than those who buy from small firms. Unless, of course, the small business tax cut is a form of primitive industry policy to prop up small business and make it artificially competitive.

Large firms exist for a reason: to take advantage of economies of scale. Large scale manufacturing is more efficient than small scale manufacturing. Big is beautiful. All else being equal those big multinationals that everyone hates have given us cheaper products and higher living standards.

This hints at a much deeper confusion underlying the Government’s small business fetishism.Joe Hockey likes to describe small business as the “engine room of the economy”. Funnily enough Wayne Swan used to say the same thing.

Of course, no single sector is the engine room of the economy. That’s just rhetoric. (Anyway, what happened to mining?)

But the Government seems to be attributing the economic characteristics of entrepreneurship onto small business. Entrepreneurs bring new products to market, put competitive pressure on existing firms to do better, undercut monopolies, and keep not just the economy going but our living standards improving.

All those giant firms that dominate the 21st century economy – Google, Apple, Microsoft, etc – were originally garage start-ups. Why would we want to penalise the next Google for growing by taxing them at a higher rate?

Obviously by definition entrepreneurs start as small business owners. But not all small businesses are equally entrepreneurial. The defining characteristic of an entrepreneur is that they do something new. They are driven by an idea. We hear from Canberra that big business is a threat to small business. Well, entrepreneurs are a threat to big business. Paper beats rock.

If the Government wants to help entrepreneurs, it shouldn’t be looking first at the tax code. It should be looking at the sorts of things raised by the Harper review into competition policy last week. That is, the regulatory restrictions on entering markets, like the taxi or retail pharmacy markets, which hold back entrepreneurs from exerting competitive pressure on incumbent businesses.

It’s true that the small business tax cut is a lot less objectionable than the tax increases being proposed, like the bank deposit tax and an increase in the GST. Maybe it’s churlish to criticise a tax cut when the real risk is tax increases.

But the Abbott Government says it understands the importance of free enterprise and the market economy. It should want to reduce corporate tax on all firms – not just small ones.

A Submission to the Senate Inquiry into Corporate Tax Avoidance

With Sinclair Davidson

Introduction: In October 2014 the Australian Senate agreed to an inquiry into corporate tax avoidance. This comes after a wave of media comment about apparent tax “minimisation” strategies practiced by large multinational firms, particularly firms operating in the technology space.

The debate over company tax avoidance at home and abroad is a highly politically charged one, but the evidence suggests it offers far more heat than light.

The debate has exposed that the mechanics of Australia’s company tax is poorly understood. Even basic aspects of the company tax – such as the distinction between accounting profit and taxable profit – have been misinterpreted and those misinterpretations repeated.

Such misunderstandings and confusions multiply when the debate turns to the interrelation between company tax in different countries and the international corporate tax regime. Further complications are the growing significance of intellectual property and “border-less” commerce in the digital age. This makes the existence of confusion about the company tax burden understandable. But that confusion is no basis on which to alter the structure of the tax system, nor impose new regulatory controls or privacy-limiting information sharing policies, which could undermine the value of Australia as a business friendly economy.

Furthermore, the overarching public policy goal for Parliament must be the ultimate health of the economy, and the prosperity of the Australian people. We value multinational activity in Australia not because they provide revenue for the government budget, but because they create economic activity: provide jobs, services, and enhance our wellbeing.

Parliament must avoid introducing policy settings which purport to protect the stability of public revenue but at the same time cool the investment climate and push multinational economic activity outside of Australia.

The debate over corporate tax avoidance resembles another controversial and complex tax debate in recent years – that surrounding the mining tax. As we argued in The Australian in in January 2015:

The government should tread carefully. This obsession with multinationals and corporate tax looks like the Rudd government’s mining tax debacle. In 2010, Wayne Swan said foreign-owned mining companies were paying only 13 per cent tax in Australia. Tax office data told a different story but the government ploughed ahead. As we learned, populism made for poor policy …

There’s another reason for [the government] to be careful. When all the dust had settled from Swan’s tax crusade, the mining tax raised almost no money anyway.

Available in PDF here.

When Is Tax ‘Reform’ Actually Just A Tax Grab?

The worst thing about the Abbott Government’s newfound interest in reforming the GST is that it makes Kevin Rudd right.

During the 2013 campaign one of Rudd’s biggest attacks on the Coalition was that Tony Abbott was desperate to increase the GST.

The sole hook for this claim was the fact that the Coalition had promised a tax review that, unlike Rudd’s Henry Review, was supposed to scrutinise the GST alongside everything else.

On that basis any attempt to study Australia’s tax mix could be assumed as a plan to increase any and every tax.

Rudd’s GST attack was deliberate, disingenuous fearmongering – based on virtually nothing, used to fill out a campaign desperate for anything.

Yet now here we are, in 2015, and the Coalition can’t help itself talking about changing the GST.

Rudd would be feeling pretty good about his ability to predict the future. The great sage of Griffith.

There are apparently two proposals on the cards. The first is lowering the threshold at which consumers can import goods without paying GST. The idea is that local retail doesn’t compete on a level playing field against foreign websites.

The second is the perennial one of broadening the base. The GST should be applied to things like fresh food – things that were specifically excluded when the tax was first introduced by the Howard government at the turn of the century.

Both interesting ideas. It’s nice to chat about policy.

Incidentally, these proposals will raise the government quite a bit of money.

It’s painfully obvious that the main reason we’re talking about the changing the GST is because of the Government’s dire budget and political situation.

There’s a big difference between tax reform and tax grabs. The sudden interest in the GST looks everything like a tax grab.

But there’s another reason for the GST gabfest: the Coalition’s search for a “narrative” that will push them through to the next election.

Folk political memory recalls how John Howard won his first re-election on the GST – the same new tax that had sunk John Hewson just a few years before. Even more impressively, Howard pulled off this trick after an unfortunate and unhappy first term.

So you can understand why trying to replicate the master’s 1998 success might have some appeal.

But the GST was a grand program, not a technical adjustment. When Howard and Peter Costello announced the GST they described it as “not a new tax, a new tax system”.

The idea was not that the GST would simply replace the sales tax but would reduce taxes across the board. Howard claimed “the heart” of the system was “the largest personal income tax cut in Australia’s history”. And the GST was supposed to allow states to abolish stamp duties and transaction taxes, and a host of other inefficient taxes.

Despite some superficial similarities, Howard was in a very different political space to Abbott. Howard had much more political capital. Budget repair was on track. There was a sense in the late 1990s that we had prosperity in our future – a sense somewhat lacking today.

And, most of all, Howard’s “non-core” promises did nowhere near as much damage as Abbott’s policy backflips have done.

One of the most credibility damaging moves this Government made was its introduction of the deficit levy on high income earners in the 2014 budget.

Not only did it destroy the promise that “taxes (will) always be lower under the Coalition”, but it raised the marginal tax rate on high income earners to 49 per cent – just under that morally dubious rate where more marginal income goes to the government than to the earner.

The Abbott Government’s approach to taxation thus far has been almost exactly the same Labor’s. They’ve been trying to quietly bump up taxes and tax rates at the edges without causing a stir. In August last year the indexation of the fuel excise resumed. In April the Fringe Benefit Tax rate is going to be bumped up as well.

Then of course there’s bracket creep, which steadily and inexorably raises everybody’s tax rate without the Government having to lift a finger.

You might object that possible changes to the GST should be treated on their own merits. They’re either good ideas or bad ones, regardless of what else is going on in the broader economic or political sphere.

As my IPA colleague Mikayla Novak has pointed out, lowering the import threshold is in the not-a-good-idea category. It won’t fix the problems of the retail sector, and it would be prohibitively expensive to impose.

And as for broadening the base? Well, a broad tax is better than a narrow one. But unless this change is matched by wider reform, imposing the GST on food would be simply soaking the poor.

But the Government isn’t thinking about efficiency, or fairness. It’s thinking about politics. Let’s hope parliament doesn’t use the GST for a short-term budget fix.

Beware Google Tax Grabs

with Sinclair Davidson

Last month, Treasurer Joe Hockey ­announced the government had “embedded” auditors in 10 ­unnamed multinational corporations to ensure they pay tax on profits earned in Australia. And the government is “contemplating additional legislative action” to ensure multinationals pay their “fair share”.

The government should tread carefully. This obsession with multinationals and corporate tax looks like the Rudd government’s mining tax debacle. In 2010, Wayne Swan said foreign-owned mining companies were paying only 13 per cent tax in Australia. Tax office data told a different story but the government ploughed ahead. As we learned, populism made for poor policy.

Last month, the British government announced a “Google tax” to tax 25 per cent of the profits earned by multinational firms in Britain that are “profit-shifted” to other jurisdictions.

As the London-based Institute of Economic Affairs pointed out, the British proposal is a “retrospective and arbitrary tax change designed to attack a particular small set of well-identified businesses that are not popular with the public”.

This financial year, the Australian government is budgeting to collect $71.6 billion in company tax revenue. Hockey says just 10 targeted multinationals could contribute up to another $3bn in revenue. This doesn’t seem plausible. Indeed, the entire corporate tax debate is a cloud of confusions and misconceptions.

There is a big difference between tax minimisation, which is legal and tax evasion, which is not and properly so. Hockey has made no allegation of illegality. Perhaps they are not paying as much tax as the government would like but there is no evidence that multinationals are not paying their correct tax liabilities.

Australia has some of the strongest tax avoidance laws in the world. Every government ­announces a “tax crackdown”. The idea that the powers which successive governments have granted the tax office are insufficient to deal with any problem in the tax system is ludicrous.

Governments have defined their own domestic tax base and established rules to define the international tax base.

The British Google tax is a big change to the principles of taxation. Countries can either operate a residency-based tax system or a source-based tax system. Many high-income countries ­operate residency-based systems and then enter into double taxation agreements to avoid (or minimise) double taxation.

The Google tax looks like a shift to a source-based tax system – or worse, an arbitrary hybrid of the two, designed on the run to meet temporary political goals. The British general election will be held within six months.

Politics aside, the question is how big is the problem of profit-shifting? The evidence isn’t as clear as governments and tax ­bureaucracies would like it to be.

In the past, academic studies suggested the amount of forgone tax revenue from profit-shifting was substantial. Shocked by those estimates, the OECD launched a broad campaign against profitshifting and tax competition.

Yet in recent years, economists have gained access to far more ­detailed data sets that offer a better picture of what happens within multinational firms. Now the story looks very different.

In a recent survey paper, Dhammika Dharmapala of the University of Chicago concludes “the estimated magnitude of (profit-shifting) is typically much smaller than that found in earlier studies”. Estimates of the amount of shifted profits are now between 2 per cent and 4 per cent.

This is not enough to justify undermining Australia’s relatively effective and coherent corporate tax system. Or risk damage to our investment reputation.

There’s another reason for Hockey to be careful. When all the dust had settled from Swan’s tax crusade, the mining tax raised almost no money anyway.

The Unspoken Benefits Of Tax Avoidance

Few things excite a treasurer more than tax avoidance.

The idea conjures up fantasies of great pots of untaxed money – money the government is morally entitled to but for one reason or another (the weakness of previous administrations, probably) is being denied.

No surprise then, as his budget savings fade away into nothingness, Joe Hockey has turned his mind to the old corporate tax avoidance chestnut.

On the weekend in Cairns the G20 finance ministers agreed to tackle “base erosion and profit shifting … to make sure companies pay their fair share in tax”. Our very own Hockey, as G20 host, is leading the charge.

Profit shifting refers to the fear that multinational firms are structuring themselves to route profits through lower-taxing countries.

Base erosion is the fear that this profit shifting is eroding the tax base, starving governments of funds.

The Organisation for Economic Co-operation and Development (OECD) started focusing on base erosion and profit shifting last year, pushing it to the front of the G20’s agenda.

They’ve been amply backed up by breathless newspaper stories about the complex tax structures of firms like Apple that have divisions in Ireland and the Netherlands.

All very interesting except for one thing. The profit shifting problem isn’t that much of a problem.

It’s true that in the 1990s, when economists and policymakers first turned their mind to how multinational firms plan their tax liabilities, they looked at aggregate country-level data and concluded (as one of the first major studies said) “companies locate a sizable fraction of their foreign activity in tax havens”.

This early work implied profit shifting was both real and substantial.

But now economists are working with more fine-grained data specifying how firms structure their internal debt around global affiliates. And as they look closer at those affiliates, the evidence is telling a very different story.

A 2014 overview of the empirical literature by one of the major scholars of global tax avoidance, Dhammika Dharmapala, concludes “in the more recent empirical literature, which uses new and richer sources of data, the estimated magnitude of (base erosion and profit shifting) is typically much smaller than that found in earlier studies”.

There is even, as Dharmapala points out, some evidence to suggest profit shifting has been declining in the last decade, not increasing.

We’re now talking about multinational corporations shifting somewhere between 2 per cent and 4 per cent of their profits to tax havens.

Two to 4 per cent is not nothing, of course.

But these lower numbers help resolve the big profit shifting puzzle. If the corporate tax base is being eroded, then why is revenue from corporate tax going up?

Between 1965 and 2007 corporate income tax revenue increased from 2.2 per cent of GDP to 3.8 per cent of GDP in OECD countries. (Revenue fell somewhat during the Global Financial Crisis but is on the rebound.) This despite the fact that corporate tax rates have been lowered over the last 40 years.

Even the OECD, in its 2013 paper Addressing Base Erosion and Profit Shifting, thinks the stability of corporate tax revenue is a bit odd (see here, page 16).

Perhaps the answer is simple: profit shifting isn’t as big a deal as newspapers and treasurers think.

At least, if nothing else, those facts ought to engender some scepticism about whether there really is a profit shifting crisis. Let alone one that requires urgent, internationally coordinated action.

So where is that scepticism?

We’ve seen how quickly commentators look for self-interested political motivations behind government pronouncements on national security and foreign policy. This is healthy. But all that valuable distrust seems to disappear when we talk about crackdowns on corporate tax – a field where political self-interest is blindingly obvious.

Hockey admitted earlier this month Australia has “amongst the strongest anti-avoidance laws in the world”.

Like many other countries, Australia has a general anti-avoidance rule, a catch-all law that allows a court to override any scheme it believes is designed primarily to produce a tax advantage.

Our anti-avoidance rule is incredibly broad and creates enormous uncertainty. But it is also extremely powerful. If there was really a tax avoidance problem in Australia the authorities would be well equipped to handle it.

Multinational corporations have to make choices when deciding where they should base themselves. Different countries have different labour costs, workforce skills, levels of infrastructure, protection of the rule of law, and, of course, different tax rates.

The G20’s real gripe is that they are being forced to compete for the tax affections of the world’s biggest companies.

You can understand why the treasurers of the world think tax competition is harmful. They want to maximise their government’s revenue.

It’s not obvious why we should share their concern.

At the end of the day, consumers and workers benefit when corporate tax rates are low and attractive. Anything that pressures our governments to keep those rates low is a good thing.

Tides To Turn For Shorten On Debt, Boats And Tax

Bill Shorten is romping ahead in the polls right now, but being in opposition is a long-term goal and the tables will turn on three big policy areas before the next election, writes Chris Berg.

Bill Shorten has one of the worst jobs in Australian politics – first opposition leader after a loss of government.

Just ask Brendan Nelson, Kim Beazley, Andrew Peacock, and Billy Snedden.

Yet, thanks to the Government’s disastrously bad selling of the budget, Shorten has an impressively winning poll position. If the election were held tomorrow, Labor would romp it back in.

Unfortunately for Shorten there are no federal elections scheduled for tomorrow.

Opposition is a long-term game – almost certain to be longer term for Shorten than most, as Labor’s new party rules make it virtually impossible to spill him before the next election.

In the Sydney Morning Herald on Sunday Mark Latham claimed the “right-wing hunting pack” is targeting Shorten because he is too successful. (This is the sort of canny judgment that made Latham such a success himself.)

But polls go up, polls go down. If we look out two years from now to the next election, Labor’s political profile is very different. Where Shorten looks strong now, he is vulnerable in 2016. Where he looks vulnerable, he is actually quite strong.

Let’s take the big issues of last year’s election: debt, boats, and the carbon tax.

The debt is Shorten’s biggest weakness.

This seems paradoxical, perhaps, because the Coalition’s budget – that is, its solution to the debt problem – is deeply unpopular. According to an Essential Poll earlier this month, just 23 per cent of voters think that Labor should support university deregulation. Just 27 per cent think Labor should support the pension changes. Just 32 per cent think Labor should back the Medicare co-payment.

These are gimmes for Shorten. Yet opposing the specific proposals will do little to rebuild Labor’s economic reputation.

Wayne Swan destroyed Labor’s standing on the economy when he was unable to wrestle the budget back into the black. Year after year Swan claimed that the budget was returning to surplus. Year after year we got deficits.

It’s easy to free ride on public dissatisfaction with government policy. Voters might be hostile to the Coalition’s individual budget measures but voters are not stupid. Shorten has to suggest – perhaps just hint, allude, imply, give us a knowing wink – that there could be a better way to fix the deficit.

That’s the difference between being a time-serving opposition leader and a viable potential prime minister.

If Shorten is strangely weak on the budget, he is strangely strong on boats.

Labor has careened from one side to another on the asylum seeker issue. Last week a few in caucus tried to engineer a shift back to the left again. Quite apart from the morality and practicality of the policy, Labor looks hopelessly divided and confused.

But will it in two years?

Right now, Labor will be secretly crossing its thumbs that the boats have, in fact, stopped, and stay stopped. It is in Labor’s interest to get boats off the front page; to remove asylum seekers from the centre of Australian politics. A weakness isn’t a weakness if nobody is talking about it.

For Labor, the carbon tax is neither vulnerability nor strength.

This is strange, perhaps, because the carbon tax has been one of the defining policies of the last decade. Elections have been won and lost on it. Prime ministers and opposition leaders have fallen at its altar.

Yet much of the heat dissipated from the carbon tax debate after it was introduced. Kevin Rudd smothered what remained when he announced he would transition from the tax to an emissions scheme. This is a rare example of trying to confuse voters as a deliberate political strategy. (I outlined the farcical nature of this announcement on The Drum when it was made last July.)

Climate activists have tried to respark climate change as a political issue – every once in a while the Climate Institute puts out a poll to try to get momentum going again, as they did yesterday – but realistically the issue is on hiatus. All sides have dug in. It isn’t a positive. It isn’t a negative. It just is.

It is often said that the Coalition didn’t win the 2013 election, Labor lost it.

In other words, it was the Rudd and Gillard government’s faults that were highest on the minds of voters as they faced the September ballot, rather than Tony Abbott’s virtues.

This is true as far as it goes, but those faults were made powerful because of the Coalition’s dogged prosecution of them.

Abbott made the carbon tax into a political liability. It wasn’t before. Same with the boats. And Abbott and his predecessor Malcolm Turnbull made Labor wear its deficit spending.

By contrast, Shorten is just along for the ride. He’s been gifted the budget backlash. He’ll likely be spared the need to take a stand on asylum seekers. And he’s been excused from boldness on the carbon tax debate.

Shorten might be polling well now, but if he wants to be competitive in 2016 he’ll have to be more proactive than that.

You Can’t Just Tax Your Way To A Surplus

In 1979, the free market economist Milton Friedman reviewed Margaret Thatcher’s first budget in his Newsweek column. Like Australia today, Britain faced a serious long-term budget problem. Like Tony Abbott, Thatcher had been voted in to fix it.

Friedman thought her budget was excellent – a rare example of financial prudence in a highly imprudent decade. It was chock-full of privatisations and tax reforms. The sort of stuff Thatcher became legendary for.

But, alongside the tax reductions and spending cuts, the Thatcher budget also increased Britain’s sales tax to compensate for some lost revenue.

This was a problem. As Friedman wrote, “From the long-run point of view, it seems to me preferable to resort to a temporarily higher level of borrowing rather than a possibly permanently higher level of indirect taxes.”

In other words, if the unpalatable choice is between a deficit and a tax hike, then a slightly prolonged deficit is the lesser of two evils.

Thirty-five years later, the Abbott Government’s proposed deficit levy is supposed to be a temporary measure – perhaps limited to four years.

Abbott should listen to Friedman. “Temporary” taxes are rarely temporary. Once introduced, they have a habit of staying high and sticking around.

After all, Australia’s income tax itself was only meant to be short-term thing. The Commonwealth Government introduced the income tax during the First World War in order to pay for the high cost of military participation.

Of course, as the Commission of Audit demonstrated dramatically last week, the choice the government faces is not between a prolonged deficit and higher taxes. The Government could cut spending and abandon its Direct Action and paid parental leave schemes.

There is something faintly ludicrous about a Government fighting its budget battle on two fronts.

For the free market right, the deficit levy is not just a broken promise – we’ve come to expect broken promises in Australian politics – but a betrayal by a leadership team that, for the last six years, has been claiming to favour low taxes above everything else.

For the left, the Commission of Audit represents a fundamental attack on the Australian social democratic settlement.

The audit commission report is remarkable. It is incredibly rare to see major government reports so explicitly driven by philosophical beliefs about the proper scope of government.

This is something Australian politics could do with more of, not less. Bold premises, radical conclusions. It’s similar in a way to what came out of Kevin Rudd’s 2020 Summit, but the audit commission is more coherent and doesn’t bother pretending to be the result of Ruddian consensus politics.

Yet to what end? The Abbott Government won’t do much with the report. What is radical in the audit commission is unlikely to be adopted. The policies which will be adopted have been floating around forever.

There is no way that this Government will be returning income taxes to the states. Sure, Tony Abbott has gone through an evolution of his views on federalism since he wrote his 2009 book Battlelines. He is apparently no longer a myopic centraliser. But there is no one in Government with appetite for such epoch-making reforms.

The things that will be adopted – like selling Medibank Private – have been obvious low-hanging fruit for many years.

So in many ways the audit commission reveals the Abbott Government’s lack of reforming ambition rather than its radicalism.

The deficit levy underscores that timidity. Don’t be fooled by the recent polls. Compared to cutting spending, raising taxes is the easy option.

The basic political economy problems with deficits and taxes are similar.

The reason it’s important to return the budget to surplus is to ensure that there is constant pressure on politicians to spend only what the tax system brings them. This is because every political incentive goes the other way. The best way to ensure a voting bloc supports you is to offer them financial support. Unchecked, governments want to spend more than they tax.

The only real constraint on this runaway spending dynamic is the fiscal norm that says budgets need to be returned to surplus. Short-term governments rarely worry about long-term consequences.

So it is important that we reduce the deficit as soon as possible. But not by any means possible.

Because, as Milton Friedman cautioned Margaret Thatcher, while the long-term dynamic of forgiving budget deficits would be bad, the medium-term dynamic of introducing higher taxes would be far worse.

Yesterday morning Tony Abbott said “in the long run the voters will thank us for doing what is absolutely necessary”.

Maybe. But in the long run voters should have no confidence that this Government – or a future Labor government – will happily forego the new stream of revenue the deficit tax will provide.