There is a growth alternative to cutting company taxes

Both major political parties agree on the need for the next Australian government to facilitate the smoothest possible transition from the mining boom's end to a more diversified economy offering well-paid jobs. They differ, however, on how best to achieve it. The centrepiece of the Coalition's plan for jobs and growth is a corporate tax cut designed to attract more foreign investment. Labor's plan involves investing in the skills and creativity of young people through a new, needs-based school funding system.

The reason for the choice between the two is the pressure on Australia's AAA credit rating from the federal budget's structural deficit. It is generally accepted that we can't afford both plans. But can we? There is a better way.

A re-elected Turnbull government would be relying on a corporate tax cut, phased in gradually from 2022 – as the prime minister has said, three elections away – to attract greater foreign investment. While the corporate tax cut would start earlier for smaller firms, it offers little benefit under the dividend imputation system. For Australian shareholders, corporate tax payments are a pre-payment of personal tax. If the corporate tax pre-payment goes down, the personal tax payment goes up commensurately. The Council of Small Business Australia estimates only 5 per cent of small businesses retain earnings. For the other 95 per cent, what the government giveth with one hand it taketh away with the other.

So it's up to the foreign multinationals from 2022. Most of the up-front $48 billion cost to revenue from the corporate tax cut is a gift to them and to the US Treasury under the double taxation agreement between the two countries. The reason for the gift to multinationals is that, over the 10-year costing period and beyond, foreign investors would enjoy a tax cut on the incomes they receive on the stock of pre-existing investments they have made at the 30-cent rate.

Add to the up-front gift to multinationals the ongoing $8 billion annual cost of the corporate tax rate cut. The government's preferred modelling estimates that of this $8 billion per annum, only $1 billion is recovered from the fabled growth dividend. Almost $4 billion is assumed to be from multinationals experiencing pangs of conscience and curbing their profit shifting to tax havens after the nice Australian government reduces their tax rate from 30 to 25 per cent. The remaining $3 billion is from increased personal taxes on Australians or unspecified spending cuts.

Based on these and other assumptions, the modelling estimates that, after several decades, a corporate tax rate cut could increase real wages, before tax, by up to 1.4 per cent. That's it – a $48 billion up-front cost and an $8 billion annual cost for a rounding-error wage rise more than 20 years down the track.

While the government's preferred modelling assumes David Gonski's needs-based school-funding system and all other government spending is useless, the international evidence is to the contrary. How can we be Turnbull's agile, innovative society if we are unwilling to increase investment in schoolchildren, especially in struggling students?

We can have both more job-creating foreign investment and a high-skilled, creative workforce while maintaining our enviable AAA credit rating. This better plan for jobs and growth involves going ahead with the Gonski reforms while targeting foreign investment with a sharper instrument than a general corporate tax rate cut. When governments seek to increase R&D they implement an R&D tax concession not a general corporate tax rate cut. When they seek to increase investment they should introduce an investment allowance for new investments not offer a windfall gain on the income streams from existing investments. The government could allow investors to claim an extra, up-front deduction of, say, 20 per cent on new capital expenditure. Or it could accelerate existing depreciation allowances. Or it could do both.

The investment allowance could start in six months' time, much quicker than the six years when the phase-in of the corporate tax rate for foreign investors is scheduled to start. The investment allowance would also benefit incorporated and unincorporated Australian small businesses. It could remain in place for as long as investment remains weak. And it could be replaced by a general corporate tax rate cut if and when the budget could afford it. Sometimes it is possible to have the best of both worlds.