The government’s plan to cut company tax rates has been found by a new report from the Grattan Institute to be a major ongoing cost to the budget and will not improve national income for up to 20 years. In light of figures that show investment has now been falling for over four years, the government’s solution appears to be one that could be worse than the problem.

The latest investment figures released last week by the Australian Bureau of Statistics were again disappointing. Private new capital expenditure fell 3.1% in the December quarter – the 17th quarter in a row:

As has been the case throughout the past four years, the main culprit was mining investment – down 64% on the past four years:

The drop matters, especially this week with the GDP figures released on Wednesday.

The economy is essentially made up of four things: household spending, government spending, the amount of exports minus the amount imports, and investment. And historically, when investment is falling, the economy is either in a recession or near one.

One reason we’re not in a recession now is because the ramp up in investment from 2004 to 2012 involved building mines that are now operational and are exporting absolute masses of iron ore:

But investment is a key driver for the economy and for jobs, and is why the government has focused much of its economic policy around lifting investment. Its primary policy to achieve this is the plan to cut the company tax to 25% over 10 years.

A report out this week by the Grattan Institute, “Stagnation nation? Australian investment in a low-growth world,” however, suggests that while lowering the tax would “probably attract more foreign investment” it would also “reduce national income for years”.

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And crucially – in light of the government’s desire to return the budget to surplus – the report estimates the tax cut will cost the budget $4.8bn a year over the long-term, because the increase in investment will never lead to enough of an increase in tax revenue to compensate for the cut in the tax rate.

Pretty much the only impact from cutting the company tax rate is to attract foreign investment. As the governor of the Reserve Bank, Dr Philip Lowe, told the House Economics committee last week, “if you just think about domestic firms ... because we have dividend imputation, I do not think the tax rate really makes that much difference to their investment decisions.”

But because other nations around the world have been cutting their company tax rates, all other things being equal, Australia has become less attractive to international investors.

Of course all other things are never equal, and while the Grattan Institute suspects lowering the rate will likely attract more investment from overseas, they do note that the recent evidence on whether it will is “mixed”.

The report’s author, Jim Minifie notes that foreign direct investment in Australia since 2010 has remained “relatively stable” even while our tax rate has risen relative to other nations.

But as the report notes, attracting investment is not an end in itself – the key issue is whether a company tax cut will improve the living standards of Australians. And here the report suggests that the benefits are rather less tangible. It notes that Australia’s national income would drop by “about 0.25% ($4bn) immediately after the tax is cut” – because the benefits in the short term go to foreign investors.

And while the report suggests increased international investment would mean in the long run the tax cut “will probably benefit Australians”, it notes “the long run” is a ways off.

The report cites analysis used by Treasury which suggests that national income will “eventually rise above where it would have been without a tax cut”. But we’re talking in “about 20 years” – and that is only after the full cut to 25% has occurred in 2026-27.

Due to the long wait for benefits, the uncertainty over the impact on investment, and the hit to the budget, the report concludes that “committing to a tax cut before the budget is on a clear path to recovery risks reducing future living standards”.

The report is also pretty damming of cuts to the tax rate for small businesses. Of the policy that is favoured by the ALP, the Greens and the Liberal party, the report notes that it “is unlikely to lead to a substantial increase in investment”.

The report suggests other measures, such as accelerated depreciation and immediate asset deductibility schemes, which “allows firms to write off new capital investments faster”. Yet it also notes this would be a substantial cost to the budget if, unlike the $20,000 accelerated depreciation for small businesses in the 2015-16 budget, it was applied to all businesses.

One problem for encouraging investment is that the lending costs for businesses are already extremely low:

As a result there is unlikely to be further cuts that might stimulate further investment.

The report suggests that government could seek to invest in infrastructure in order to stimulate economic growth. However, it notes that the main problem with infrastructure spending is “finding quality projects that can be built quickly”. Infrastructure Australia currently has only seven projects currently designated as “high priority”.

Given there is no real silver bullet for improving investment, the story might seem rather gloomy. But the report provides some nice context, pointing out that Australia has had a high level of investment compared to the USA and UK – even if we exclude mining:

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And while the latest capital expenditure figures were not good, they contained some pleasing signs for the year ahead. The latest figures contained the first estimate for investment in 2017-18. While the drop in mining investment is set to continue, there was a 7% increase in the estimate for investment in the non-mining sector:

That is the best pick-up since 2008-09, and while that doesn’t always translate into actual investment, after four years of falling expectations from 2012-13 to 2015-16, it does appear things are improving.

When parts of the economy turn bad, the tendency is for governments to seek a solution. But it is important to ensure the solution to that specific issue actually leads to a better outcome for the economy as whole.

The Grattan Institute’s report suggests the government’s policy to cut company tax rate will probably lead to increased investment in the long-term, but less confident that it will lead to benefits for the economy. But the cost to both the economy and the budget in the short-term are very much certain.