The government’s effort to spark a new tax debate — apart from its advocacy of company tax cuts — has some ideas well worth pursuing, although they’re kept hidden behind broad-brush questions rather than specific proposals.
The white paper explicitly raises the fairness of superannuation tax concessions, after noting that the benefits disproportionately accrue to high-income earners — although it doesn’t specifically note the extraordinary cost of super tax concessions to the budget (something Joe Hockey exacerbated with his removal of Labor’s super tax changes in 2013). It identifies the significant distortionary effects of negative gearing, although it gets off a bit lightly in terms of the role it plays in creating one of Australia’s significant economic problems, over-investment in existing housing stock compared to new housing. Above all, the paper does something Labor was too scared to do in the Henry Tax Review — raise the possibility of increasing and/or expanding the GST. The Henry review was by far the superior document — it offered a much more coherent and comprehensive analysis of Australia’s tax and transfer payment system — but the omission of the GST from it was a major weakness.
Of all the suggestions, the one that will be opposed the most is any change to dividend imputation, which prevents double taxation of domestic company profits and ensures they are taxed at shareholders’ appropriate tax rate. Yet it is increasingly clear that it has outlived its usefulness, especially if you are talking about dropping the company tax rate.
For all the parts of the current retirement savings system, dividend imputation is the biggest and richest pool. It is right that foreign companies can’t access it, but that has slowly morphed into a distortion of the system. One of the attractions to Australian institutions buying Chevron out of its 50% stake in Caltex Australia over the weekend was the $1 billion in franking credits that Chevron couldn’t use. That money will eventually be distributed back to all shareholders, boosting the share price and reducing the apparently high per-share purchase price for those institutions. Although there is a respectable reason why Chevron couldn’t use those credits, being a foreign corporation, it is a distortion of the imputation system that existing holders of the non-Chevron 50% stake in Caltex get the chance to double dip after already getting one round of imputed dividend relief. And if that happens, taxable income and tax revenues will be lowered when they shouldn’t be.
Non-useable franking credits have become a tradeable asset — last year Woodside tried to use the Shell credits to buy back $3 billion of Woodside shares held by Shell in a very complicated deal. A minority of shareholders opposed that plan and stopped it. That is not what the dividend imputation system was supposed to be when it was introduced. It is being used to sweeten sharemarket deals and takeovers where the franking credits are used to lower the bid price and cost for the acquiring company. At the same time, the tax credits can be used to lower any assessable capital gains tax.
While dividend imputation has cut the cost of equity for Australian companies and gearing and helped boost involvement in the sharemarket, it has also lifted pressure year after year on companies to increase their dividend payout ratios (regardless of the current circumstances) at the expense of retaining earnings and boosting investment. It is something we are now seeing after the December 31 reporting season with companies from Orica, to Telstra, Seven Group Holdings and Nine Entertainment, as well as Amcor, announcing share buybacks. They make big shareholders happy, boost earnings per share (helping the executives and boards look better, thereby boosting share prices and making shareholders, boards and executives richer again), but at the cost of removing incentives to invest and take risks.
The Murray report into the financial system spotted the current flaws with dividend imputation and the way it allowed investors to concentrate their investments in domestic shares, at the cost of a wider, more diversified portfolios. This is why the share prices of the big four banks (ANZ, CBA, Westpac and the NAB) are so high — they pay out between 50% and 70% or more of their profits each year in fully franked dividends. For years this cash stream was rorted by clever big investors who used the tax and sharemarket rules to get two bites at the tax benefits of imputation in bank stocks. If ever we get another bank or sharemarket crisis and share prices slump sharply, then it will be the addiction to dividends, promoted by the imputation system, that will bear a lot of the blame.
If Treasury is serious in wanting to slash company tax, the tens of billions of dollars in tax credits generated by imputation could easily finance a sharp fall in corporate tax across the board — and eliminate tax for a whole group of small taxpayers and small companies.
Still, there’s a real question about whether this will go anywhere. The government wants a debate to commence about where to go on tax reform. It’s the correct way to initiate significant reform. But ultimately this is a government that has signally failed to maintain a coherent line on anything economic for more than five minutes lately. Remember the intergenerational report?