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Submission No. 242 Back to full list of submissions
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PACIA SUBMISSION

on

REFORM OF BUSINESS TAXATION

April 1999

 

Executive Summary

PACIA welcomes the opportunity to provide this submission to the Review of Business Taxation. PACIA supports the proposal to lower the corporate rate of taxation to 30 per cent and recognises that a lower corporate tax rate would make Australia a more competitive location for business.

That said, PACIA notes that the proposal to lower the rate of corporate taxation is linked to the withdrawal of the accelerated depreciation concession to achieve revenue neutrality. PACIA is of the view that Australia must provide an internationally competitive environment if it is to attract investment. The accelerated depreciation concession provides a useful mechanism for bringing forward the benefits of capital investment. Many countries in the region provide similar, or even superior, concessions as well as attractive rates of corporate taxation. If Australia is to become an attractive location for global investment, then Government must consider replacing this concession with other mechanisms that achieve similar ends in addition to the reduction in the corporate tax rate.

PACIA has previously outlined the investment opportunities facing the Australian chemical industry in a detailed report released in 1998. The report provided an independent assessment of the comparative costs and returns to investment projects in Australia and competing locations. The assessment identified the contributions of both specific impediments and government incentives to differences in costs and after-tax returns. An element of the financial viability identified by that report was the accelerated depreciation provisions. Withdrawal of these provisions puts at risk potential investments of up to $6 billion.

The recent Report by the Review of Business Taxation argues that there is a limit to the extent that Australia can match the taxation incentives provided by other countries. To do so would result in a taxation system that did not generate sufficient revenue to fund government programs. While PACIA accepts this argument in respect of the overall taxation system, it does not necessarily follow that it applies equally to all forms of taxation. There is a need for business taxation to be internationally competitive with respect to investments of a global nature.

Introduction

PACIA supports the proposal to reduce the corporate rate of taxation to 30 per cent. The proposed reduction would result in a more competitive business taxation environment. PACIA recognises that this proposal is linked to the withdrawal of the accelerated depreciation provisions and the related need to retain revenue neutrality. Accordingly, this submission concentrates its comments on:

  • the need for a taxation system to raise sufficient revenue to fund government programs and
  • the provision of the accelerated depreciation concessions and the implications for the chemical industry
  • the need to attract investment.

The Need to Raise Revenue

National taxation systems need to meet the revenue raising objectives of governments. It is not surprising, therefore, that taxation reform proposals should also be scrutinised in respect of their impact on revenue.

The recent report by the Review of Business Taxation notes that: "There is a limit to the extent that Australia can match taxation incentives provided by other countries. As noted in An International Perspective, if Australia attempted to match the incentives provided by other countries, it may finish up with a taxation system that would not generate sufficient revenue to fund the current level of government provided services." Whilst PACIA, naturally, accepts the validity of this statement with respect to overall taxation, this does not necessarily apply to each individual part of the taxation system.

Some business sectors are purely domestic by nature, but the goods and services of other sectors are traded internationally and investments in these industries in most cases can be located almost anywhere. This reality can have adverse consequences arising from uncompetitive taxation environments regarding running a business and new capital projects. The bottom line should be that if the community chooses to have a higher level of government provided services, the community should fund it – business, on the other hand, must compete. Unlike the community, business has no choice. Nevertheless, PACIA notes that the terms of reference of the Review of Business Taxation imposed a revenue neutrality constraint on business taxation.

The revenue neutrality constraint on business taxation raises two issues: the time horizon over which this neutrality should be achieved and the long-term implications of the reforms.

PACIA notes that the Business Coalition for Tax Reform in its submission to the Review’s first discussion paper: "encouraged the Review to consider this constraint as a long term objective and one which does not prohibit short term investment (revenue reduction) for long term economic growth and, therefore, increased revenue and prosperity for the nation."

The Treasury’s cost estimates of possible reform options are based on a four-year analysis – the normal budgetary forecast period. This time horizon falls short of an appropriate consideration of revenue neutrality. Given the long-term nature of the kind of projects currently being considered by the chemical industry, a twenty-year horizon would seem more appropriate. It would seem reasonable to expect that the impact on revenue of removing accelerated depreciation would decline over the longer period. Accordingly, it would seem appropriate to analyse the implications of this reduction on overall revenue over a longer time period.

In addition, PACIA understands that the Treasury estimates of the costs to revenue of the different taxation arrangements appear to be based on similar investment growth assumptions. While accepting that a lower corporate tax rate would offset to some extent the withdrawal of accelerated depreciation, it is not unreasonable to expect lower investment growth given that Australia does not have a competitive taxation regime. Accordingly, one should consider the impact of this proposal in terms of the cost to revenue taking into account lower investment growth and its impact on economic growth.

Accelerated Depreciation Provisions and Implications for the Chemical Industry

As the Review of Business Taxation’s A Platform for Consultation notes: "Accelerated depreciation is the allowance of deductions for declines in the value of an asset at higher rates than are expected to occur in practice". The advantage of accelerated depreciation is to recognise that a substantial up-front capital expenditure has been made and to allow for an earlier deductibility of this expenditure relative to the actual economic life of the asset. These early deductions are important to the overall rate of return of a long-term investment.

There are several reasons for the provision of accelerated depreciation provisions. These reasons include the fact that the future is uncertain and the more distant the future (or the longer the economic life of the asset), the greater the uncertainty. To ensure that long-term projects are not handicapped by artificial measures such as economic life depreciation, faster depreciation rates are often provided by governments around the world. The international availability of such depreciation provisions is also an important reason for an individual country having accelerated depreciation provisions.

Unless local industry can access similar provisions, it will be placed at a competitive disadvantage by, over the longer term, operating obsolete plants (both in the economic and environmental sense). This point is particularly important to the Australian chemical industry with many older and sub-optimal plants now nearing the end of their economic life. The withdrawal of accelerated depreciation provisions will be the final disincentive to restructuring and further investment in world scale plants. This will eventually adversely affect the industry’s international competitiveness as well as undermine the community’s environmental expectations of the industry.

It must be clearly understood that this will not be a problem only for the chemical industry. The presence of local chemical manufacturing assists and provides benefits to downstream industries. The local chemical manufacturing industry provides a source of technical advice for downstream users as well as the community. This technical advice would not be available if Australia relied on imports.

The presence of a local chemical manufacturing industry is also important to downstream users who predominantly rely on imports as the source of their chemical inputs. A domestic chemical manufacturing industry provides logistic assistance to the importer so that greater control of one’s supply chain is possible than if one had to rely only on imports.

Another issue of relevance to accelerated depreciation provisions is the location of a greenfield investment. Sometimes the location of such investment is in areas where logistical infrastructure is either non-existent or not well developed. Provision of accelerated depreciation provisions is sometimes viewed as partial compensation for such lack of infrastructure.

All of the above reasons apply to the chemical manufacturing industry. Plants have a long life, neighbouring countries have similar or, for that matter, even more attractive depreciation provisions amongst a suite of other investment provisions. Greenfield sites often lack suitable infrastructure. Withdrawal of such depreciation provisions, without the introduction of an alternative instrument, will undermine investment plans, condemning the local industry to obsolete and uncompetitive technologies over the longer term.

Accordingly, there are good theoretical and practical reasons for maintaining (indeed, improving) existing accelerated depreciation provisions or introducing an alternative. In 1998 PACIA released a study of investment opportunities in the chemical industry. The purpose of the study, undertaken by Access Economics, was to:

  • provide an authoritative independent assessment of the comparative costs and returns to greenfield investments in Australia and in competing locations, and to identify the main reasons for any differences;
  • identify the contributions of specific impediments, government incentives etc. to the differences in costs and after-tax returns; and
  • motivate a discussion of initiatives that could be taken to increase the likelihood of large-scale chemical investment proceeding in Australia.

An element contributing to the financial viability of these projects was the accelerated depreciation arrangements of the different locations.

To put the scope of the investment opportunities into perspective, these investments amounted to around $6 billion – with the Pilbara Petrochemical Project being the principal source of investment. This project alone would create employment of 27,569 person years directly and, in total, 39,534 person years.

PACIA accepts that a lower corporate rate of tax will move Australia’s overall tax rate more in line with our competitors. However, without an alternative, a less attractive depreciation environment for new investment projects will offset this improvement.

The Need to Attract Investment

This submission has already argued that the proposed lower corporate rate of taxation will put Australia’s business tax rate more in line with our international competitors. However, to the extent that this lower rate of taxation is to be achieved at the expense of accelerated depreciation, this will reduce the attraction of locating global investments in Australia. PACIA has already identified the benefits that such investments provide to the Australian economy in an earlier section of this submission.

This effectively means that if such investment projects are to be secured for Australia, then some other measures need to be developed to achieve this end. While the Invest Australia program no doubt assists in the area of assessing investment proposals targeting Australia as one possible choice amongst competing locations, this program is considered too ad hoc for global investments where Australia is already ruled out as clearly uncompetitive despite considerable comparative advantages regarding input pricing and availability. PACIA believes that the chemical industry is one such industry. Failure to attract such investments will result in a continually increasing trade deficit in respect of chemicals. During 1997/98 the basic chemical trade deficit reached $3.5 billion (in 1990/91 the basic chemical trade deficit was only $2 billion). Failure to replace existing assets with competitive world scale plants will result in this deficit continuing to increase – with adverse consequences for investment, economic growth, employment and the balance of payments. PACIA notes that exports from primary and capital intensive industries are critically important to Australia’s balance of payments.

If accelerated depreciation provisions are withdrawn to allow for a lower corporate tax rate, the challenge to government seem to be to develop alternative measures that attract investment while meeting the Government’s revenue needs.