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LVRG ScrapbookMonday, September 12, 2005:

Tax relief for listed companies


For every listed company, the Federal income tax (including capital gains tax) should be replaced by a periodic tax on the total value of the company's shares.

1.  The problem and the opportunity

Export income is not exempt — and, under international trade rules, cannot be exempt — from corporate income tax. Hence, in terms of international competitiveness, Australia's 30% corporate income tax is equivalent to a 30% tariff in every country of destination of Australian exports. Abolition of that tax would be equivalent to the imposition of a 30% tariff on all imports, but would not violate any trade rules.

Although corporate income tax is usually regarded as a direct tax, it is in fact a variable cost — that is, a cost that increases with turnover, and which must therefore be recovered through prices if the company is to grow. If this variable cost were replaced by a fixed cost — that is, a cost that does not increase with turnover — the cost per unit turnover would decrease as turnover increased, allowing the company to expand its business while simultaneously cutting prices or increasing margins. The macroeconomic effect would be to increase domestic production and reduce unit costs. This would allow lower interest rates, not only by reducing inflationary tendencies, but also by making domestic products more competitive with imports, thus reducing the temptation to use interest rates as a brake on imports. Lower interest rates mean faster growth, lower unemployment, less poverty, and less expenditure on welfare, hence more scope for future tax cuts.

Realization of these benefits requires an alternative corporate tax base such that the tax thereon approximates a fixed cost.

2.  Market capitalization as a tax base

In the case of a listed company, the market capitalization, i.e. the total value of the company's shares, exhibits only a delayed response to increased turnover, so that a tax of so many percent per year on market capitalization would be a fixed cost in the short term. Moreover, as the share price reflects not only the company's efforts, but also government policies (through subsidies, concessions, infrastructure, education, and health services), exclusive rights, natural monopolies, business conditions, market sentiment, and a considerable element of luck, a large part of any tax on market capitalization would behave like a “fixed” cost even in the long term.

Having established that a tax on market capitalization satisfies that basic requirement, let us try it against Adam Smith's canons of taxation (Wealth of Nations, Bk.V, Ch.II, Pt.2).

I. As a company's share price reflects its success, a tax on its market capitalization reflects its capacity to pay. Inasmuch as the share price also reflects the benefits of government policy, and of the community's progress as measured by the values of monopolies, a tax on market capitalization also reflects benefits received.

II. As a company's share price (in each tranche) is known from moment to moment, a tax on market capitalization can be made absolutely certain as regards both the amounts payable and the timing of payments. For example, the closing price at the end of each day's trading could provide the tax base for the period since the end of the last day's trading, and the tax for that period could become payable at the close of trading.

III. If indeed the tax were payable at the end of each day's trading, the timing of payment would be no less convenient than that of any other tax remitted by companies, while the manner of payment would be far more convenient, as the entire process could be automated.

IV. The tax would be uncommonly efficient, as it would involve negligible collection costs and compliance costs, and, by comparison with corporate income tax, would have little deterrent effect on productive activities and little effect on prices.

3.  A few details

To value the Australian subsidiary of a multinational company, one needs a method of specifying the number of shares by which to multiply the share price. If all else fails, one can simply require each multinational company to float a minority stake in its Australian operation, and let the market decide what that operation is worth.

As the total tax paid on each tranche of shares in any accounting period is known, one can divide this tax by the number of shares to obtain the franking credit per share. This can be used in the existing system of dividend imputation for shareholders who pay income tax. Franking credits would not be relevant to shareholders that are themselves listed companies; the dividends received by such shareholders would be pooled with their other revenue and reflected in their (taxable) share prices.

4.  Q&A

Q. Won't the abolition of corporate income tax lead to massive tax avoidance as people contrive to turn personal income into corporate income?

A. No. The main use of companies in personal tax avoidance involves passing income through unlisted companies and then splitting it between persons. This stratagem relies on multiple thresholds and progressive rates in the personal income tax system — not on the rate of taxation of retained profits in unlisted companies, let alone listed companies.

Q. If the total share value of a company becomes a taxable asset, won't the company be at risk of ruinous tax bills when its share price rises?

A. No, because current and prospective shareholders will know the tax implications of a high share price and will respond by bidding down the price. Likewise, they will know the tax implications of a low share price and will respond by bidding up the price. Thus a recurrent tax on market capitalization stabilizes share prices, avoiding bubbles and bursts in the share market. This is supremely desirable in view of the correlation between stock-market crashes and recessions.

Q. But couldn't a rogue company bid up the share price of a smaller rival in order to tax it into oblivion?

A. To do this, the “rogue” would need to offer an unrealistically high price for a large fraction of the smaller rival's shares. Thus it would acquire a large stake in the smaller rival and would become liable for a large share of the tax problem — and presumably attract the attention of the ACCC into the bargain. ASIC might also take an interest in such manipulation. On balance, the price stabilization due to a recurrent tax on market capitalization would reduce the scope for market manipulation; in particular, the proportionality between the share price and the tax liability would make it more difficult, and less attractive, for directors to talk up the share prices of their own companies.

Q. A tax of so many percent per annum on market capitalization would require a newly floated company to pay tax before it became profitable. Wouldn't that deter floats?

A. Profitless companies pay many other taxes, including payroll tax and sales taxes. While they do not pay corporate income tax, which is the specific tax targeted for replacement in this proposal, they still incur a wide range of tax-related compliance costs in order to establish that no income tax is payable. This proposal would eliminate those compliance costs. If a simple periodic tax on market capitalization were implemented at the rate required to replace the revenue from corporate income tax, a profitless company could survive for decades before the tax consumed the entire start-up capital, even if the share price did not fall below the issue price (which it would). That said, the situation of newly floated companies could be eased by allowing the total issue price of each company's shares (perhaps adjusted for inflation) as a deduction against the taxable market capitalization. In other words, the tax base could be restricted to the above-par component of market capitalization. This of course would require a higher tax rate for the same total revenue. But it is not clear that any such restriction of the tax base is necessary.

5.  Conclusion

Corporate income tax (including capital gains tax) should be replaced by a periodic tax on market capitalization. By cutting marginal costs and compliance costs — not by sacrificing revenue — this reform would make Australian listed companies more internationally competitive and reduce inflationary tendencies, making it possible to sustain lower interest rates, hence faster economic growth, lower unemployment, and lower expenditure on welfare.


If these statements are not true of corporate income tax alone, they are true of income tax as a whole. See “Abbott's reverse tariff” and “Draft: Federal Budget Speech, 2013-14”.

Since I wrote this article, I have come to the view that the above-par component is to be preferred because it is a rough proxy for super-normal profit. For listed companies, a tax on the above-par component of market capitalization might therefore replace “resource-rent” or “super-profit” taxes. — GRP.

[First published at grputland.com. Reposted August 18, 2012.]

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