Australia's corporate tax system is unsustainable, has a negative impact on investment and a bias towards debt, according to a new report from The Australian National University (ANU).
The report highlights five other "serious" systemic issues, including the high corporate tax rate, and the gap between the corporate rate and the top tax rate in the personal income tax system.
Many of these major problems would be solved by the introduction of an allowance for corporate equity, or ACE, according to the report authors Kristen Sobeck, Professor Robert Breunig and Dr Alex Evans.
They argue that Australia should urgently modify its corporate taxation system with the addition of an ACE.
"ACE is an additional tax deduction given to companies that expand their equity base with investment," Professor Breunig said. "Not only will an ACE raise investment levels in Australia, including new money from overseas, it will also lower Australian companies' exposure to debt.
"The ACE deduction will encourage companies to invest, will allow companies to earn more profit before they begin paying tax, and will make them more financially secure by removing the current system's bias towards debt.
"The deduction can be thought of as providing a tax-free area for corporate profits."
According to the report's authors, an ACE could be linked to the current government bond rate, meaning companies would receive $21,000 to offset their tax bill for every $1 million of equity investment.
"The first $21,000 of taxable income will be tax-free, after which they will pay corporate tax on any income as per normal," Professor Breunig said.
"Under the current system, an investment that generates $21,000 of income before tax will attract $6,300 of taxes, leaving the owner with $15,700. As this is a lower rate of return than a risk-free government bond, investment is less likely to occur.
"Currently, companies are better off borrowing $1 million than investing $1 million of equity. They get a deduction for the interest on their borrowing to offset against profits before paying tax."
Report co-author Kristen Sobeck said: "While some researchers have previously recommended a cash-flow tax (CFT) for Australia, an ACE could be more easily integrated with the current corporate income tax system and has fewer transitional challenges than a CFT, such as managing debt interest.
"Unlike a cash-flow tax, an ACE has also been implemented nationally in other countries. In these countries that have adopted an ACE, we observe that companies became less leveraged and investment increased."
According to the authors, an ACE in Australia is likely to induce similar effects and generate more jobs in the process.
"By making investment attractive in industries that earn lower profits than mining and banking, Australia's economy will become more diverse and more complex. Increased economic diversity, less complexity, and reducing the systemic risks posed by highly-leveraged companies will insulate us from global shocks," Professor Breunig said.
"An ACE is also a better solution than cutting the corporate tax rate. While this could stimulate investment, a cut would also generate undesirable outcomes, including handouts to foreign investors and undermining the personal income tax system."
Corporate income taxation in Australia is published by the Tax and Transfer Policy Institute at the ANU Crawford School of Public Policy. Read the full report online.