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Company Tax

Company Tax

By Gordon F Copeland

Note: United Future has been calling on the Government to immediately reduce the corporate tax rate from 33% to 30% . Business NZ have made their top "key priority" a reduction of the corporate tax rate in stages to 20% by 2010.

To date this has fallen on deaf ears and Dr Cullen has had a tendency to dismiss those call with the simple comment that it is "not high on the list of Government priorities". In my view that response fails to understand the lift in economic growth that would result from a reduction in the corporate tax rate. I have written the attached opinion piece to explain why this would be good for the NZ economy and NZ society.

I express the hope that both the general and the business press might pick this issue up and ensure it is understood and debated by as many people as possible. At the end of the day I continue to hope that common sense and good information might lead to a rethink by Government.

During my BP London days I was part of the team which crafted that giant corporation's international investment criteria. In common with other corporations it was expressed thus:

"To achieve a net present value (NPV) of 10% in inflation adjusted terms after tax."

I will return to the 10% figure but will first concentrate on the "after tax" feature of that criteria.

Let's suppose that a NPV of $1,000 after tax satisfies the criteria. If the corporate tax rate is 50% then the pre-tax NPV needs to be $2,000. If 33% it needs to be $1,500. If 30% it needs to $1,428.57. If the rate is 20% it needs to be just $1,250.

Accordingly it is clear that a lowering of the corporate tax rate will, in and of itself, encourage new investment by companies, and it is new investment which leads to growth and creates jobs.

Also I don't believe, when the bigger picture is looked at, that a reduction in the corporate tax rate will have a negative effect on the Government's revenue base for two reasons.

Firstly under the company tax imputation system that portion of a company's profit which is distributed as dividends (typically around 60%) ends up being taxed at the marginal rate of the shareholders. This means that the Government will continue to collect tax on dividends at the 33% and 39% rate paid by the majority of shareholders.

I have worked out that a 9.1% reduction in the company tax rate for example, would likely reduce Government revenue by only about 3.5%.

Secondly, and perhaps more importantly however, this is also a classic case where what the Americans call "dynamic scoring" needs to be taken into account. A drop in the corporate tax rate will induce additional investment by companies since projects which previously failed to meet the after tax investment target will now do so.

The importance of this factor cannot be underestimated. International studies and the history of corporate investment clearly indicate that investment opportunities increase dramatically as the rate of return hurdle is lowered following a reduction in corporate tax rates. This in turn multiplies the opportunities for profitable investment and, from the Revenue's point of view, additional taxation. This factor plus the reduction in the level of unemployment benefits, and the increase in the level of personal tax revenue as people enter the work force, may mean that the tax collected by the Government increases rapidly.

I want to revert now to the way a corporation arrives at its target rate of return of say 10%. Detailed calculations are undertaken to arrive at a corporation's "average weighted cost of capital". The cost of capital consists of interest paid on borrowings (within a carefully defined debt:equity target) and the costs of raising equity capital. Both interest and equity costs can vary from country to country and market to market for a myriad of reasons.

However the Reserve Bank candidly admits that real interest rates in New Zealand are higher than they are in Australia, the UK, and most other OECD nations. The reasons are many, varied and complex, but at the end of the day NZ businesses are left with that stark reality. Since it is part of the cost of capital this places NZ business at an internationally competitive disadvantage. One way of alleviating that reality would be to cut the corporate tax rate.

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