Reserve Bank governor Philip Lowe described the apparent global race to bottom on company taxes as "regrettable". Credit:David Moir/AAP A root-and-branch review of Australia's tax system. The review was quickly established, helmed by then Treasury Secretary Ken Henry, and the final report, released in May 2010 is regarded by economists as something of a "holy bible" for Australian tax reform. But after a divisive debate about the Henry review's proposal for a mining super profits tax, the remainder of the Henry review has largely laid gathering dust on the shelf. Until now. The Coalition government's proposal to slash Australia's corporate tax rate from 30 per cent to 25 per cent is lifted straight out of the Henry review – albeit, from a somewhat selective reading.

Economist Saul Eslake has emerged as a prominent skeptic of the benefits of reducing the company tax rate. Credit:Christopher Pearce To quote from the book of Henry, Part 2, Volume 1, Chapter B: "Economic theory and growing empirical evidence support a shift away from company income tax towards taxes on less mobile factors as a means of increasing investment, GDP and growth. "The company income tax rate should be reduced to encourage investment in Australia, particularly highly mobile foreign direct investment. In the long-run this would increase income for Australians, by building a larger and more productive capital stock and by generating technology and knowledge spillovers that would boost the productivity of Australian businesses. In the long-term, a larger and more productive capital stock would not only result in higher growth but is also likely to result in higher wages." A crucial table in the Henry review compared the "welfare loss" to the Australian community from particular taxes. Of federal taxes, company tax topped the chart for creating the biggest losses – each additional dollar raised this calculated to destroy about 40¢ of welfare. By contrast, personal income taxes were found to destroy about 25¢, and the GST about 10¢. The overriding commandment of the Henry review was that government should seek to shift the burden of taxation away from the most distorting taxes, towards the lesser distorting ones.

On company tax, it was crystal clear: "The company income tax rate should be reduced to 25 per cent over the short to medium term, with the timing subject to economic and fiscal circumstances. Improved arrangements for charging for the use of non-renewable resources should be introduced at the same time." A decade on, this proposal has been warmly embraced by the Coalition government – albeit divorced from the proposal that revenue losses be recouped through a mining tax. Debate has raged in recent weeks about the merits of the proposed company tax cut. With Labor opposed to the reduction and the government digging in its heals, the issue looks set to dominate the political landscape leading into the next election. Most economists accept the Henry gospel that a lower company tax rate would, in theory, help to stimulate investment and wages. But substantial disagreement abounds about the true size of the potential gains and the appropriateness of the measure given the economic and budgetary environment.

On Treasury's reckoning, the proposed phased reduction in the company tax rate would boost economic growth by about 1 per cent in the long run. This would come at a cost to the budget bottom line of $65 billion over the first 10 years. Once the cut is delivered in full, the annual cost is estimated at around $15 billion. On many accounts, that's a fairly modest economic bang for a lot of budget bucks. Part of the reason for the modest economic effect is that a large chunk of the reduction in the company tax burden would be immediately met by an increase in the burden via personal income taxes. That's because domestic shareholders in Australian firms would immediately receive lower "franking credits" to offset their personal income tax liabilities.

Because of Australia's unique system of "dividend imputation", this means that the benefits of any reduction in the corporate tax rate would largely go to foreign investors and owners of capital. And yet, as politically unpalatable as that is, it is also entirely the point. Corporate tax rates around the world are falling, most recently last December with US President Donald Trump's legislation to reduce their statutory rate to a flat 21 per cent. As an investment-hungry nation, Australia's continuing ability to attract foreign investment is now the focus. Reserve Bank governor Philip Lowe last week described the apparent global race to bottom on company taxes as "regrettable", without offering a view on whether Australia needed to join it yet.

Former Reserve Bank board member now Lowy Institute non-resident fellow, John Edwards, believes Australia can wait. "There doesn't seem to be any urgent problem with the attractiveness of Australia as an investment destination," Edwards says. "If this did become the case, then we might want to change." Edwards makes the point that while Australia's 30 per cent statutory rate increasingly looks high, the rate that companies here actually pay is reduced by a wide range of deductions, including depreciation and research and development offsets, and the ability to carry forward losses. Meanwhile, companies investing in other countries like the US face hidden taxes like state taxes and the costs of providing private health insurance for employees. Overall, according to Edwards: "I would say we're on a good path to postpone it for several years, until you get a better sense of what the global situation is." Economist Saul Eslake has emerged as a prominent sceptic of the benefits of reducing the company tax rate.

"I personally have never taken Henry as gospel," he says, adding that the review was "incredibly wussy" in not advocating for a stronger reform of negative gearing and capital gains tax concessions on housing. On company tax cuts: "I would say that most economists agree with the theory, but economists have struggled to prove that it works with any statistical significance in practice." Eslake points to the Canadian and UK experiences where taxes have been cut but wages growth and investments have disappointed. However, Eslake notes that there is nothing magic about Australia's current corporate tax rate. "I'm not opposed to cutting the company tax rate ever. There's nothing to suggest it's optimal at 30 per cent."

It's about how you pay for it that really matters, he says. "Taxes are money that gets spent. Taxes that aren't raised from one place have to be raise from somewhere else." While the International Monetary Fund recently revised up its forecasts for US economic growth in the coming two years based on the Trump tax cuts, Eslake points out that it actually shaved forecasted growth beyond that because of an explicit assumption the lower corporate tax take would have to be offset by higher taxes elsewhere. Eslake says he would prefer cuts to personal income tax rates to more directly address the main problem besetting the Australian economy – weak consumer spending. While championing the benefits of company tax cuts, Ken Henry, too, was alert to the risk of a global race to the bottom on tax.

In a speech in 2010 he warned: "From a global perspective, however, the consequence of individual countries' decisions to reduce capital income taxes may be an inefficiently low level of capital taxation that limits their ability to finance public services and undertake redistribution." Adjunct professor at Monash University, Stephen King, has literally written a textbook on economic principles. Like every other economic textbook, students are introduced to the idea that taxes impose a "deadweight loss" on economies. "Taxes cause distortions by essentially messing up prices. If you change the price, you change the quantities." And yet taxes remain a necessary evil to fund the social payments and productivity enhancing infrastructure that societies demand. As for the benefits of reducing the company tax rate: "My response would be that it depends. It depends on a whole range of things. Yes, in theory it can boost the economy, but in practice it becomes an empirical question. I suspect every economist would say in theory it would help, but in practice they really can't say."

Ultimately, King is also cautious about Australia joining the global race to cut corporate taxes, likening it to a global trade war, where countries impose tariffs on imported goods to protect domestic workers. "Would a unilateral tax cut improve the Australian economy? I think that's ambiguous. Would a global tax race of beggar thy neighbour by cutting company tax be good for Australia? The answer clearly is no. The best thing that a country like Australia could do is to try to use our influence on the international stage to make sure that doesn't happen. It's best to stop it." But in such a world, would Australia be advised to join the corporate tax cut war? According to King: "That's a bit like asking the next lemming should you jump off the cliff as well."