Do Tax Cuts Lead To Higher Wages?

What’s the impact of company tax cuts on Australian businesses? Do companies hire more workers, increase wages and boost investment?

Despite the importance of these questions, economists and policy-makers often struggle to answer them precisely, in part because of a lack of quality, firm-level data.

Until now, the tax debate in Australia has been heavy on opinion but light on facts. But a new report we released in early May answers these questions by directly observing how Australian businesses responded to the 2015 company tax cuts, using the latest small business insights from Xero, Australia’s leading cloud-based accounting software platform.

This is the first time such data has been used and is the first evidence-based conclusion on the impact of tax cuts.

In 2015 corporate taxes were cut from 30 percent to 28.5 percent for Australian companies with turnover below $2 million (90 percent of all incorporated companies). The data allows us to observe what tens of thousands of firms did with their tax cut.

Image: Supplied.

The most important finding is that firms that received the 2015 tax cuts hired slightly more workers than similar firms that did not, but had virtually no impact on wages.

The average benefit of the tax cut was $2,940 for firms near the turnover threshold, of which:

  • 19 percent was used to hire more workers
  • 3 percent was used to raise workers’ wages
  • 27 percent was used to lift investment
  • 51 percent was retained for boosting cash reserves, paying down debt, lifting dividends or other purposes.

These results come from analysing the actual anonymized accounts of tens of thousands of small businesses, some of which received the tax cut because their turnover was under $2 million and some of which did not receive the tax cuts because their turnover was above $2 million.

To date, the benefits of tax cuts have been surmised largely through modeling and speculation, with a lack of confirmed data to support it. In this report we directly observe how Australian businesses reacted to recent corporate tax cuts.

We found that the cuts increased job creation in the short term, and found some weaker evidence that they contributed to investment and little evidence that they contributed to higher wages.

"We found that the cuts increased job creation in the short term."

It’s important to note that this study only covered the first two years after the tax cut was introduced. It could be that wage effects take time to come through and they require labour market adjustment, but it could also be that the impact on wages of company tax cuts isn't very high.

This study was purely focused on small businesses so will have limited use in predicting how much larger companies would respond to a tax cut.

And here's the good news. New data is becoming available every day that will improve our understanding of the economy and policy. It is critical for policy debates to have evidence and data-driven findings.

With better data, more policy can be subjected to rigorous analysis, evaluation and informed debate.