Instant expensing: an instant alternative to company tax cuts?

by Jim Minifie

Published in the Australian Financial Review, Sunday 15 April

The government’s proposed company tax has languished between the House of Representatives and the Senate, unloved by those who see it as a gift to international capital at a time when budget repair should be a priority. Labor announced an alternative to the company tax cut in March, but you can be forgiven if you didn’t notice amid the furore about its proposed dividend imputation changes.

Bowen proposes that all firms be entitled to instantly claim 20 per cent of qualifying capital expenditures, before putting the rest on a standard depreciation schedule. The scheme delays the tax a company has to pay, without changing the amount. Such schemes have often been used temporarily to stimulate investment, but Labor envisages that this one would be permanent.

So how does the Bowen scheme compare to a company tax cut in its effect on investment overall, on investment in different asset types, on the budget, and on wages and wealth, and on corporate debt?

First, the Bowen scheme will probably boost investment by less than the government’s proposed company tax cut. It boosts the average after-tax return on investment by about the same amount as the company tax cut. But much investment does not qualify for the scheme: investments under $20,000, structures, and passenger vehicles are excluded.

Second, the scheme introduces new distortions. Its exemptions are arbitrary: there is little reason to think that the assets that do qualify for the scheme offer more value than the buildings, passenger vehicles, and smaller assets offer less value than the other, that don’t. A better scheme would have broader coverage. But even then, firms that can already write down their investments immediately (for example, because their investments are mostly in firm culture and marketing) won’t respond to an investment allowance.

Third, the Bowen scheme is a better budget deal than a company tax cut after the first few years. At about $2 billion a year initially, it is much cheaper than the company tax cut, which would cost over $7 billion (both before imputation credits). Most of that gap is because many assets do not qualify for the Bowen scheme. On a “bang for buck” basis, instant expensing is ultimately cheaper than a company tax cut as it functions like an interest-free loan that firms pay back with higher tax payments after a few years.

Fourth, who benefits? Instant expensing gives no tax break to the “back book” of investments made in the past, including those financed by foreign shareholders. That means that it does not hit national income in the way that a company tax cut does for first five or more years.

For the same reason, the scheme will not boost share prices as much as a company tax cut would. A company tax cut boosts the post-tax return on equity for international shareholders, and so boosts share prices and the wealth of Australian shareholders. Instant expensing, by contrast, doesn’t boost the return on the back book of capital, so the wealth effect is smaller. Over the longer run, both the company tax cut and instant expensing are likely to boost wages a little bit, as they push up the capital:labour ratio.

Finally, where a company tax cut softens the incentives for companies to gear up, the Bowen plan does nothing. When the company tax rate is high, as it is today, and interest expenses are deductible, firms can benefit by loading up with debt. A company tax cut softens this incentive, while instant expensing does not. But corporate debt isn’t high in Australia (probably in part due to dividend imputation), and hasn’t changed much in recent years.

Overall, the instant expensing scheme is a welcome recognition from Labor that company taxation, at the margin, is probably deterring investment in Australia. The scheme is not perfect: it favours some asset types over others. But it would cost the budget less, after the first few years, than a company tax cut with equivalent investment benefit would, and it gives away less to foreign investors. It warrants serious consideration.