Research shows that tax cuts lead to increases in corporate investment. But analysis of Australian companies’ financial statements, and what American companies have done since the Trump tax reform, show this increased investment could be rather small.
The idea behind tax cuts driving investment is that they create more “free cash flow”. This is the amount of cash a business generates from its day to day operations minus what it spends on capital expenditure (property, equipment and maintenance for example).
Studies show more free cash flow does, on average, lead to increased investment. But the extra cash is also used to pay down debt, pay dividends and increase working capital (cash used for day to day expenses).
This is plausible, but a 5% tax cut is not likely to lead to huge increases in profitability or cash flows for Qantas. At least in the short term.
Qantas will not pay tax until its profits in the years after 2014 exceed the tax losses recorded before 2014. Only once these tax losses have been used up will a lower tax rate lead to an increase in cash flow.
Given 1.2% profit growth, a 5% reduction in Qantas’ effective tax rate would mean an additional A$60 million in after tax profit in 2018.
This investment was planned, and it’s irrespective of any tax cuts. Qantas generated over A$2.7 billion in cash in 2017, so the A$3 billion capital investment was already plausible without a tax cut.
A similar analysis on Wesfarmers’ 2017 results shows a 2017 pre-tax profit of A$4.1 billion. A 5% reduction in the tax rate would correspond with an approximate saving of just A$206 million in 2017, compared to A$ 1.6 billion in capital investment.
For a smaller company like MYOB, with a pre-tax profit of A$73.7 million in 2016, the impact is even smaller. A 5% tax saving would result in an increase in after-tax profits of just under A$4 million.
So, it is plausible that tax cuts could lead to increased investment, more jobs or higher wages. Changes in tax rates can affect both investment decisions and shorter-term operational decisions.
But beyond the circumstances of individual companies, there are other factors that in how tax cuts factor in to company investment. This includes how competitive an industry is, and whether it is capital or labour intensive.
One way to do this is to pay bonuses. In the United States, we have seen over 150 public companies announce bonuses following the recent tax reform. These bonuses are not a permanent salary increase. They are being paid this year, reducing the firm’s current taxable income, before tax rates change.
While the claims of increased corporate investment and jobs are supported by the research, and even the recent US experience, we should be wary about how large the benefits are.
- ^ Research (faculty.tuck.dartmouth.edu)
- ^ Trump tax reform (theconversation.com)
- ^ campaigning (www.businessinsider.com.au)
- ^ already announced (www.qantasnewsroom.com.au)
- ^ Why Australia doesn't need to match the Trump tax cuts (theconversation.com)
- ^ free cash flow (onlinelibrary.wiley.com)
- ^ Studies (faculty.tuck.dartmouth.edu)
- ^ one of the most vocal (www.businessinsider.com.au)
- ^ currently has (investor.qantas.com)
- ^ before 2014 (investor.qantas.com)
- ^ forecasting (www2.commsec.com.au)
- ^ A$3 billion (www.qantasnewsroom.com.au)
- ^ 2017 results (www.wesfarmers.com.au)
- ^ in capital investment (www.wesfarmers.com.au)
- ^ MYOB (investors.myob.com.au)
- ^ Business investment is weak, but an unfunded company tax cut won't fix it (theconversation.com)
- ^ how competitive (www.businessinsider.com)
- ^ will also (www.jstor.org)
- ^ over 150 (www.atr.org)
Authors: Jeff Coulton, Senior Lecturer, UNSW