It’s a shock coming home from a trip to the Southern Hemisphere.  Besides returning to the tail-end of winter after a brief summer respite, I’m finding as a tax policy wonk that the political climate in Washington, DC also takes some adjusting to.  Here, the Congress is rushing to pass a tax bill to confiscate bonuses that have aroused public ire (See March 19 blog).  Down under, they actually discuss serious tax reform.

The most pressing issue is the taxation of income from corporate equity.  The top Australian corporate tax rate is 30 percent (It’s 35 percent here, plus an average of a bit over 4 percent for state taxes.)  And Australia has eliminated the double taxation of corporate dividends; when Australian shareholders receive a dividend from an Australian company, they receive a credit for the company tax paid.  The result is that shareholders are taxed once at their individual rates of up to 46 percent.

In a remarkable speech at a tax reform conference I attended, Australian Treasury Secretary Ken Henry (a career civil servant) provided a cogent argument for reducing the corporate tax rate and restoring a second tax on dividends.  His argument, though over-simplified, has a strong logical base.  Company tax rates are imposed on all company income originating in Australia, so a higher tax moves investment to other countries.  According to Henry, “when capital is perfectly mobile, the supply of capital from abroad is totally elastic.  In these circumstances, the burden of taxes on capital is shifted onto immobile factors such as labor via an outflow of capital that lifts its marginal product to offshore investors.”  But taxes on Australian shareholders work differently.  “In contrast… the taxation of domestic savings does not affect the level of capital investment in Australia … any reduction in Australian-owned capital is offset by an increase in imported capital from abroad.”  The implication: reduce the company-level tax and increase the tax on dividends to Australian shareholders.

Henry’s argument is oversimplified and does not fully apply here.   For starters, creating a larger gap between the top corporate and individual rates by reducing the corporate tax rate will require special rules to prevent individuals from sheltering their income within corporate entities.  And the United States is not a small open economy, so capital bears more of the corporate tax here than in a small country like Australia. But the U.S. is ever more exposed to international capital movements and has a lot to learn from policy ideas in countries that have depended on trade and capital flows for a long time (including the Nordic countries, which are taking a different approach.)  

In that light, we should rethink our recent policy of providing double tax relief at the individual level through lower taxes on capital gains and dividends, while maintaining a relatively high corporate tax rate.  With internationally mobile capital, it makes much more sense to tax capital income of U.S. residents (who are unlikely to emigrate) than to tax capital invested in the U.S. (which is much more mobile internationally.)   The implication: lower the U.S. corporate tax rate and raise the tax on dividends and capital gains.  My colleague Rosanne Altshuler has shown how this can be done and why it makes sense in a recent article co-authored with the U.S. Treasury’s Harry Grubert.

By the way, someone was paying attention to Secretary Henry.  You won’t be surprised to learn that his speech was read carefully in New Zealand.  New Zealand’s corporate tax rate is 33 percent and they too have eliminated double taxation of corporate dividends.  New Zealand, like Australia, just changed ruling parties (to conservative in New Zealand and to labor in Australia), but the Kiwis too are rethinking their tax policy, while keeping a close eye on their neighbor across the Tasman Sea.