RDP 9011: Inflation and Corporate Taxation in Australia 5. Conclusions

Australia's corporate structure entering the 1990s reflects in large part the corporate decisions made over the past decade. These were strongly influenced by a tax system that favoured debt, in combination with expectations of rising asset values which ultimately proved to be unrealistic. Biases in the corporate tax system have been much reduced by recent reforms, especially the introduction of dividend imputation and capital gains taxation. However, the paper has argued that a number of distortions remain. These include biases affecting the allocation of investment spending among assets of different lifetimes, biases favouring assets which yield their income as capital gains, and some (minor) biases affecting the funding decision. The distortions to investment are exacerbated when inflation rises. The paper has not discussed the administrative complexities involved in any attempt to achieve comprehensive inflation-adjustment of the corporate tax system, and it does not advocate that such an attempt be made. Rather, it is intended to highlight the costs of inflation, even under a tax system that has already undergone substantial reform.

In assessing the economic significance of these results, it is worth emphasising the partial-equilibrium nature of the model which has been used. To isolate the corporate sector, it has been necessary to take the interest rate as given, rather than modelling its determination in an economy-wide equilibrium. Because of this, the paper probably understates the importance of inflation-induced distortions as implications for the real exchange rate have been ignored.