Australian corporate tax cuts and GDP growth

Not all company after tax profit is retained. In fact, about 70% is paid out in dividends with 30% added to retained earnings. We have already talked about the process that can be expected to apply to the 30% of retained earnings.

Of the other 70% paid in dividends, this will also have a multiplier effect on GDP - to the extent the recipients are Australian residents - as they spend their higher dividends on consumption of goods and services, again stimulating other sectors of the economy.

The final total impact on GDP will depend upon the size of the initial stimulus and the size of the multiplier. The OECD has estimated that Australian corporate tax is around 6% of GDP. A cut in the corporate tax rate of 5% - being a cut of one sixth - would therefore reduce corporate tax as a percentage of GDP by 1.0%.

The tax cut is equivalent to an extra 1% GDP circulating as income to somebody in the private sector – instead of being taken by the government as tax. This stimulates additional consumption and investment spending throughout the private sector as we have previously described. This increases the production of goods and services over that which would have occurred without the tax cut. This also creates more jobs in the process.

As noted earlier, an extrapolation of recent Treasury modelling would put this aggregate impact on GDP as amounting to a net increase in GDP of 1% above what GDP would otherwise have been without the tax cut stimulus.

The Australian GDP for the year to March 2016 was $1.657 trillion. As at May 2016 there were 11.9 million jobs in the Australian economy. One percent of a $1.6 trillion economy is $16 billion of extra GDP. Furthermore, this would be a $16 billion increase in the annual level of GDP over what it would have been without the tax cut.

This is a permanent $16 billion increase in the level of GDP. This would lead to extra jobs to maintain an economy at a production level which is annually $16 billion bigger than it would have been in the "no tax cut" case.

A permanent 1% increase in Australian GDP means more jobs. How many additional jobs might we expect? When the economy grows in output, it tends to also grow in productivity. The long term growth rate in productivity would appear to be around 1.5% per annum. This means that we need 1.5% fewer workers each year to produce the same amount of GDP.

Over 10 years, this means we need around 16% fewer workers to produce the same level of output. Over 10 years then, a 1% increase in GDP would therefore produce around a 0.84% increase in the number of jobs. Right now there are 11.9 million jobs in the Australian economy so an extra 0.84% would mean an extra 99,960 jobs. Let us just round it up and say around 100,000 extra jobs.

Statistical Testing

Evidence of the relationship between after tax earnings of Australian corporations and GDP is hiding in plain sight. It is commonly said that the stock market is the leading indicator of the economy. When the stock market is strong the economy tends to be strong in the following period. When the stock market is weak, the economy tends to be weak in the following period.