CoPS/IMPACT Working Paper Number G-282

Title: The Effectiveness of Investment Stimulus Policies in Australia

Authors: J.M. Dixon and J. Nassios


We present the results of three economic modelling simulations of changes to tax policy intended to stimulate investment in Australia. We begin with a comparison of a company tax cut and an investment subsidy, both unfunded and calibrated to yield equivalent Federal Government budget impacts. Our key findings (summarised below) illustrate that an investment subsidy is a more effective policy instrument for stimulating investment and improving domestic welfare:

1. With both policies calibrated to the same budgetary cost, the investment subsidy is more effective in raising the volume of investment;

2. The investment response to a company tax cut is skewed towards foreign investors, while the investment response to an investment subsidy is equitably proportioned across foreign and local investors;

3. The company tax cut induces an increase in net foreign liabilities and associated servicing costs while the investment subsidy has little long-term effect on net foreign liabilities;

4. Both policies lead to increases in gross domestic product (GDP), employment and real pre-tax wages; and

5. The impact on gross national income (GNI), an indicator of domestic material welfare, is positive for the investment subsidy but not for the company tax rate cut.

In a final simulation, we revisit the investment subsidy to assess the net impact when the policy is fully funded. While many potential funding models exist, herein we assume partial funding via the denial of cash refunds of franking credits, with the remainder of the funding sourced via a small increase in economy-wide average personal income tax. We find that the investment subsidy still leads to a long-term gain in domestic welfare. When fully funded in this manner:

6. The investment response remains positive but skewed toward foreign investors;

7. Net foreign liabilities fall as a proportion of GNI;

8. The investment subsidy still returns positive results for employment, GDP and the real pre-tax wage;

9. The long-term gain in real post-tax wages is lower than in the unfunded case, but it remains positive; and

10. Fully funded, the investment subsidy still leads to a long-term gain in GNI.

Based on these results, we strongly recommend that policy-makers consider an investment subsidy instead of a cut to company tax as a better value-for-money policy initiative to increase both investment and domestic material welfare.

JEL classification: H2, O16, E22, C68

Keywords: Company tax, investment subsidy, CGE modelling

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