Peter Martin can spot a good idea when he sees one

But I would say that wouldn’t I?  From today’s Age.

IT’S crunch time at the Henry tax review.  . . . The good news is that many of the ideas that will work are quite simple. . . . These good ideas may be simple, but they are also disturbingly big.

None is bigger than destroying one of Labor’s most important tax measures to slash the company tax rate.

Dividend imputation was pushed through the Labor caucus only by the force of treasurer Paul Keating more than 20 years ago. . . .

[F]rom 1987 almost alone in the world, Australia taxed the corporate profits received by Australians only once. . . .

Much of the rest of the world followed Australia. Britain already had such a system, but has since abolished it, as has Ireland. They found it complicated and not particularly appreciated.

Appreciation matters. Nick Gruen of Lateral Economics points to a study that finds Keating’s gift to be so little appreciated by Australian shareholders that it is “unable to reject the hypothesis that companies with dividend imputation do not attract any share price premium”. . . .

The shareholders they need to impress are the ones from overseas the so-called “swing” shareholders with investments in every country. Yet they are excluded from dividend imputation.

What they get instead is a 30 per cent headline corporate tax rate. About standard or not, it looks unattractive compared with other countries’ headline tax rates.

Our system of imputation prevents them from getting a tax cut a big cut that would bring the corporate tax rate down to 19 per cent.

That’s what Dr Gruen believes would be possible if dividend imputation was axed. It costs more than $20 billion a year.

And he says the cut in the company tax rate could be even bigger. If cutting the rate brings in more foreign investors, as it is likely to, it will make it cheaper for Australian companies to raise money, boosting their profits and possibly funding further cuts in the headline rate.

All this without costing the Treasury a thing.

Who’s going to mind? Well the Australian shareholders enjoying imputation credits are likely to be upset but less so if Gruen explains his thinking to them.

He believes the tax cut would lift foreign direct investment in Australian companies by almost one-quarter. It’s the sort of thing that happened when Ireland and Britain abolished their imputation schemes to fund corporate tax cuts. Ireland in particular was flooded with foreign capital.

What would this do to Australian share prices?

Gruen believes it would push them high enough to compensate the Australian investors who would miss out on their imputation credits. They would get higher share prices instead.

And a decade ago, Australia halved its rate of capital gains tax, didn’t it?

Well, actually, it didn’t. Australia halved only the headline rate of capital gains tax and recouped much of the loss by removing the inflation discount.

But it was the headline rate that mattered. All manner of Australians began gearing up to invest. This is partly Gruen’s point: headline rates matter. Australia is denying itself a 19 per cent corporate tax rate and the flood of money it might bring for no particularly good reason.

It is also denying itself a much simpler tax system.

Gruen has persuaded the Committee for the Economic Development of Australia of the merits of the change and also the Government’s Innovation Review, of which he was a member.

It found that switching from dividend imputation to a lower tax rate looked “extremely promising from the perspective of promoting entrepreneurialism, productivity, investment and economic growth”.

It reported that the equity issues were “surprisingly mild for such a large change”.

Who’s left to object such an apparently good and simple idea? Two members of the Henry review Ken Henry and Greg Smith helped introduce dividend imputation while working on tax at the Treasury in the mid-1980s. But that’s unlikely to matter much. They were bright enough to recognise a good idea two decades ago. They will be bright enough now to assess whether there’s a better one.

The Tax Office likes dividend imputation as an “integrity measure”. It keeps (some) companies honest in reporting profits. But many more don’t bother with imputation.

And managed trusts. Many owe their livelihoods to offering small investors dividend imputation and its benefits. They began fighting such a change the day Ken Henry was asked to chair the review.

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SJ
SJ
13 years ago

So what’s his source, Nick?

Does this come from some formal refutation of Miller-Modigliani that you’ve done, or is this just something off the top of your head?

Damian Jeffree
Damian Jeffree(@damian-jeffree)
13 years ago

I reckon this one has legs. Simplifies, removes weird biases for business, works the headline number etc.

There is the possibility it could take a haircut on the way through, would that concern you?

SJ
SJ
13 years ago

Thanks for the link, Nick, I’ll read it in the morning. :)

TerjeP
TerjeP
13 years ago

It would be better to simply abolish company tax entirely and to instead tax dividends as normal income if earned by individuals (ie not companies). Estonia does something similar to this. If compliance is a concern you could do the same as we do with bank interest and impose a withholding tax on dividends for shareholders that don’t register their tax file number.

If we did this we would then have a headline corporate tax rate of 0% and Aussie investors would still pay about the same in tax. And we would not only boost the capital available to business via foreign investment we would also boost it via retained earnings.

Of course if you wanted to soak the foreigners a little you could apply a 19% tax on dividends paid to foreign companies/individuals.