Tax reform redux

tax day.gifYes folks, it’s on again!  Well it’s probably not on, but someone wants me to pontificate on tax reform as one of a range of issues in some ‘vision’ pieces. I get to paint my own picture.  But I wanted to throw things out to the crowd.  What things did Henry get right, what wrong?

Just rereading the executive summary, I think it’s a very impressive document and it will be a useful blueprint for the future. (As an aside, the whole cockamamie idea of an 18 month review to be served up six months before an election beggars belief for political ineptitude. The motivating idea of some comprehensive (root and branch – yada yada) review is not much closer to reality either.

Tax policy is always and everywhere a matter of profoundly difficult political management. So while some basic architecture is important for people to know where they’re going and how things fit in, a great deal of the task is known in advance and broadly able to be quarantined into parcels – land tax is better than stamp duty, there either is or is not a strong case for abolishing dividend imputation and lowering company tax. GST input taxation on finance either should be replaced with some sector specific tax (as recommended in Henry) or it should not.  That’s not to mention a whole host of rats and mice that should always be bubbling up, and infact bubble up much too little. Henry had some of these – like removing duty free concessions on international travel for tobacco. None of this requires a comprehensive review.

Personally I’d favour the Treasury continually putting work into such a blueprint so that it can progressively feed it into budget considerations as they roll around and so that it’s ready for the next crisis.  Sadly it’s mainly crises which create the opportunity (indeed, the ‘window’)  in which governments are alive to the fact that they have to choose between one kind of political pain and another.  Most of the time they (wrongly) imagine that they can avoid political pain altogether. It is sad that such insightful periods are as rare as they are but when they occur we want wise advice being whispered into the ear of the prince.

Things that stand out for me are:

  • There was a strange, unsatisfactory and ultimately arbitrary way that the Henry Review chose to play its political cards.  It decided that it would hold its fire on some things. Things like death duties.  So it held off on a formal recommendation on them, but drew attention to its own liking for them and proposed, as prominently as in any recommendation, that there be community debate about such things. I think this is silly.  Neither Ken Henry, nor anyone else on the panel were politicians. So since they weren’t equipped or asked to provide any political advice, they should have made recommendations and let the politicians make the call.
  • The Henry Review did something similar on dividend imputation.  It seemed quite sympathetic to the views I’ve promoted that dividend imputation is a wasteful anachronistic monument to Paul Keating’s views about his dad’s family business.  Paul was brought up to think that double taxation was evil (it is evil, but only relatively speaking – genocide is far worse and it turns out that dividend imputation is a waste of money. This makes the evil of having it, a lesser evil than not having it). Careful thought suggests it would be very difficult to think of any way of foregoing over $20 billion each year in capital tax revenue without lowering the cost of capital, but dividend imputation manages to do it. It should have been scrapped, and with a resource rent tax and an undistributed profits tax we could have reduced our company tax rate to 15 percent or below. Further this would not be at the expense of equity as it involves a swing away from favouring domestic over foreign capital (which is regressive amongst Australian taxpayers), towards favouring foreign capital which will respond with a substantial increase in investment. This and the RRT would make the changes more progressive as would the introduction of undistributed profits which would eliminate a substantial and growing avenue of tax minimisation.  (As an aside a really big cut in the company rate might have crystallised the thinking of the two million odd businesses that stood to gain from the RRT at the expense of the 3,000 odd – now 200 odd – that would lose)
  • Henry seems to have thrown that old chestnut of aligning the company and top personal tax rates out the window.  Good riddance to bad rubbish. But if we’re to watch these rates deviate further – and Henry has it in mind that they end up around 20 percentage points out of whack (or should that be WACC?) shouldn’t some thought be given to the problem of avoidance that this widening of the gap exacerbates?  I can’t find it, or any discussion of the wisdom or otherwise of the obvious anti-avoidance measure – undistributed profits taxation. A mystery.
  • I agree with Henry that land tax is a good idea and should displace stamp duty.  But there’s not much chance of that politically.  It’s intriguing that the panel felt at liberty to formally recommend this, but not death duties. If I were a politician I’d much rather sell death duties – they’re very fair and one can combine them with a generous tax free threshold (say levy it on estates over $5 million) and complementary income tax cuts.  Of course despite its manifest fairness and efficiency, it might not be easy.  But you’d have a much better chance of getting there than replacing stamp duty on homes with a broad based land tax. (Those who’d recently paid a lot of stamp duty and didn’t plan on doing any more for a good while would be seriously displeased). [Postscript: someone from the bureaucracy has drawn my attention to page 269, Vol 1 of the Review where a range of transitional arrangements are discussed which I think address this difficulty to a substantial extent though the more palatable they were electorally, the more revenue they would give up.]
  • Henry also recommends that “[t]he personal tax structure should be the sole means of delivering progressivity in the tax system, supporting the even more direct distributional role of the transfer system”.  On that basis the panel recommends abolishing the luxury car tax. I’m in favour of broadening the base over which progressivity is delivered, and thus of what used to be called ‘sumptuary’ taxes. It’s called the politics of envy by some, but I wouldn’t call Adam Smith, Alfred Marshall, Cecil Pigou and Maynard Keynes the envious type. I’d call it the politics of modest consumption or the politics of taxing conspicuous consumption.  I’m happy if people want a fancy Merc or indeed a mansion costing, say more than a couple of million for there to be some sumptuary taxation in addition to progressive income taxation. That’s partly just the fact that along with the great men I’ve just mentioned I have a heart heavy with envy, but it’s also because it broadens the base of the effort to deliver equity. We’re living in a new gilded age and we need taxation to do more work delivering equity than we did when the incomes of the wealthy were less out of kilter with the rest of the community. In other words, given how much more effort would go into avoidance if we increased the top marginal tax rate, it makes more sense to share the burden and certainly not to abolish existing sumptuary taxes like the luxury car tax.
  • It was great that Henry focused on the taxation of rents, including resource rent, congestion costs and environmental Pigou taxation. Perhaps he could have added TV licences!

Two questions:

  1. Where am I wrong and why? (Trolls, take it easy)
  2. What have I left out. What else should be here?
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John Passant
11 years ago

Thanks Nick. I agree this was a long term plan for tax reform over the next decade and future governments will dip into it. That seems to be the way of much tax reform in Australia.

Do you think that the underlying approach of Henry was that we should tax non-mobile factors of production – land, fixed capital and labour – and reduce tax on mobile capital?

I wonder about dividend imputation. Maybe you could explain how it doesn’t reduce the cost of captial?

And my memory, very hazy, is that the undistributed profits taxes of the past created massive avoidance opportunities.

And a request. I am trying to read some material on economic rent and taxes (Henry draws an E Carey Brown) that helps me understand its economic roots and underpinnings, remembering I am a simple tax lawyer, not an economist.

As an aside interesting too that other countries (like China) are looking at resources rent taxes now. So the mining companies campaign against the RSPT on the basis it might inspire others may have failed. Good.

I am particularly interested in exploring this in the context of resource rich developing countries. Any thoughts?

spog
spog
11 years ago

What have you left out?

Well, the Henry Review was also about transfers, and their interaction with the tax system. Your notes are about tax…

Nicholas Gruen
11 years ago

Yes, fair point. It’s such a huge and complex area, I tend to leave it to the specialists.

Would you care to let us know some of your views on the subject?

John Passant
11 years ago

Thanks Nick.

Nic Walmsley
11 years ago

I haven’t read the review but I have seen what happened when our politicians tried to use it to shape tax policy. It’s typical industrial-grade public service mumbo jumbo, from what I can tell.

The number one issue has to be simplifying the tax system. If someone comes up with a solid plan to do that, they will attract voters from across the entire political spectrum. We need to find ways to lower the rates, broaden the bases, eliminate the exemptions, and most importantly reduce the myriad categories and classifications that govern the tax system. For example, could we just tax all transactions at a low rate?

The second issue has to be the moral quality of the tax system. We call it “progressivity” apparently. Why is it OK to have higher rates of income tax for “rich” people who earn $200,000 but if we try to increase taxes on the companies that earn more like $2,000,000,000 we are told the entire economy might collapse. I think there should be some progressivity when it comes to taxes on profits, so small business would pay a lower rate than big business. Even more radical, could we come up with a system that better synchronises the rates and thresholds affecting income and profit taxes?

Overall I’d say Henry was way off the mark and 90% of it will do nothing but give a few economists stuff to talk about. Sorry dude.

dorinny
11 years ago

undistributed profits taxation

This would never become tax legislation. Many companies leave retained earnings in the company to fund future growth. And imputation credits roll on forever so you can always pay dividends in the future. Retained earnings are essential for business prosperity – many companies who do earn taxable profit don’t actually have the funds available to distribute because they might have put a lot of cash into acquiring assets which are only deductible over the assets effective life.
This would not be an anti-avoidance measure; it would be an anti-business measure.

it turns out that dividend imputation is a waste of money

I don’t see what is costly about imputation credits? Is it just the fact that the government loses out on the double taxation, or something else? Could you please elaborate?

dorinny
11 years ago

I think there should be some progressivity when it comes to taxes on profits, so small business would pay a lower rate than big business

This would only create an incentive for big business to break down their company into smaller separate entities.

Nic Walmsley
11 years ago

@dorinny

While a transaction tax would disincentivise the break up.

Bruce Bradbury
Bruce Bradbury
11 years ago

The psychology and politics of taxing fixed factors vs transactions interests me. Economic theory says tax the former because this will not distort behaviour. However, I suspect this is what makes such taxes politically unsaleable – people hate taxes where they have no opportunities to avoid them by changing their behaviour. This description implies economically non-rational preferences – but I suspect it might nonetheless reflect a psychologically relevant fact that people get some enjoyment from changing their behaviour to avoid taxes.

Patrick
Patrick
11 years ago

I think you left out the elephant..GST, except for its tail (financial sector).

The last IMF report I read, mid-last year, proposed something different to a tax on equity. They proposed a notional deduction for equity. This was for share capital not undistributed profits, but they are basically the same thing in the next year, at least from the perspective of your tax they are.

I could imagine that your tax would similarly increase the bias towards debt, which people who know more than me say would be a bad thing.

IIRC, and I probably don’t because I am too young to, undistributed profits tax was what drove the bottom-of-the-harbour schemes.

I don’t mind death taxes. I think the most appropriate sumptuary tax and perhaps the only one I would support is land tax on residential property above a certain threshold, I think that is fair and efficient which is rare enough to be leapt at :)

Patrick
Patrick
11 years ago

Also I too would support scrapping imputation for a sharp cut in company tax. I wouldn’t support paying the parliamentary counsel to draft the legislation (all three lines) for a 2% cut.

observa
observa
11 years ago

First and foremost you need to understand that taxation is really the big picture in that it sets the Constitution of our marketplace and consequently impacts what pops out the end of it all. ie think of our science of muddling through with various taxes to date and the glaringly obvious problem of housing affordability. Contrast that outcome with the inevitable demise of a John Wlamesley’s Earth Sanctauries Ltd and the picture becomes even more starkly contrasted. Yes dear Henry, we need more wombats and less hairy nosed taxes if we’re not to continue down the path of bowling over our natural environment for more bitumen, concrete and McTuscan mansions, or simply exponentially turning our natural environment to our insatiable wants. That’s the burning issue of our times (well ever since we looked out that porthole with the Apollo astronauts in 69 and Spaceship earth entered the consciousness it has been)and was clearly apparent in the rush by so many to blithely accept the Great Moral Imperative of our time, on some increasingly flimsy and scant thermometer records and very fanciful computer modelling. Nevertheless even unconvinced skeptics can appreciate peak oil or simply our ability to use fossil fuels to turn Gaia to our wants at an ever increasing rate and we don’t need Asians to remind us of that. They want what we’re having but we know deep down now there’s a fallacy of composition there.

So, when you recognise that taxation sets the fundamental Constitution of your marketplace and what pops out the end of it all, coupled with recgnition of the Great Moral Imperative of your time, a logical hypothetical solution immediately presents itself. Why not raise ALL the agreed level of taxation via a CO2E mechanism? Is that the simple third way answer to stop all the bickering and squabbling over tax? Simple for us all to understand, neutral, unavoidable, sublimely administratively straightforward to collect and very progressive. The third way answer to all our prayers or not I asked myself?

dorinny
11 years ago

“So switching the favouritism from Oz shareholders to foreign shareholders would give Australia’s businesses much lower cost access to capital.”

this is an interesting theory, but how exactly would we reduce tax on foreigners? would they have to lodge a tax return in Australia, or claim the credits in their foreign tax returns? as I understand, most foreign investors already claim the credits (since there are numerous bilateral agreements in place already) – so will there be a real effect on foreign investment if we were to abolish DI for Australians? and what would this do to our share prices? as you know, expected future cash flows are already priced into the shares, and therefore, abolishing DI would systematically reduce the value of the Australian share market, thus, increasing the cost of equity capital.

“I could imagine that your tax would similarly increase the bias towards debt, which people who know more than me say would be a bad thing.”

Debt is not a “bad” thing; it is just more expensive than equity finance. But sustainable debt is actually one of the best ways to add value to a company. Actually, gearing up is the easiest way to get wealthy for both individuals and business; as long as you can avoid financial distress.

“While a transaction tax would disincentivise the break up.”

what kind of transaction tax? on what basis would it be imposed?

dorinny
11 years ago

Also I too would support scrapping imputation for a sharp cut in company tax. I wouldn’t support paying the parliamentary counsel to draft the legislation (all three lines) for a 2% cut.

I think this would be more costly to the government, since the majority of business in AU are SMEs, and most companies do not pay dividends.

derrida derider
derrida derider
11 years ago

“people hate taxes where they have no opportunities to avoid them by changing their behaviour” – Bruce @11

Bingo. Ken Henry, long before he became a Secetary, once noted that if people didn’t scream how it was unfair, retrospective, economically damaging, costly to comply with, etc whenever you closed a loophole then that was prima facie evidence that you hadn’t in fact succeeded in closing it.

Corin
Corin
11 years ago

Nick, the list is a bit of Gruen shopping list of things you’ve argued for for a long while, which given it’s your piece is totally fair enough. In my view the main faults of the Henry Review are nothing to do with the Henry Review but the terms of reference. Clearly over the next 15 to 20 years we’ll see a large likelihood of a higher GST unless politics gets in the way. It also seems like Henry wants to get involved with climate policy and in fact he probably should have been allowed to do so, well if it wasn’t for the politics of doing so. I mean the Henry Review could have improved the ETS (or any derivative) in my view.

Corin
Corin
11 years ago

Don’t you think the rationale for a higher GST is also that the tax take will probably rise slightly due to the boomers retiring and the health system being under more stress. In those circumstances, perhaps we don’t want higher income tax as a per cent of GDP but may be a slightly higher GST would be better. I would probably want lower income tax so long as it was progressively cut, so would want a significantly higher GST (like 5% instead of say 2%). But I also accept that politically we’re more likely to see a GST at 12% than 15% even if there was greater potential for tax cuts to income and payroll and company tax.

observa
observa
11 years ago

The points you all make here are valid and poignant ones but they suffer from a lack of seeing the wood for the trees or perhaps the light on the hill I’ve seen and how they can come together in a simple overall design. Now in saying that I recognise that’s a big statement as I smile knowingly at where you’re all coming from and where you need to travel to see what I’ve seen. So, I’ve either seen what you can’t or won’t for whatever reason, or I’m as mad as a hatter or imbibing substances I shouldn’t. Bear with me somewhat skeptically in the white coats twirling the keys to the asylum or rehab centre and I’ll see if I can reverse engineer the questions I presumably know the answers to, assuming they make sense to you all and feel free to challenge the reasoning.

Before I continue I’ll direct you here
http://www.harryrclarke.com/2010/07/09/julia-oops/
for my comments on the typical failure of left/green quantitative control measures and the main reason for that. Essentially I’m a market green as will become clear as we go along. Now that may raise some immediate hackles but to that I’d say the umpire has clearly spoken, from the collapse of the Soviet experiment, to Copenhagen and now locally with the abandonment of Rudd’s ‘GMI’, the pink batty debacle and Gillard’s latest dumping of all those fast-tracked green inspectors, etc. Their failure was in choosing clumsy, lumpy, quantitative control measures(ie quantity) over the purer, infinite spectrum of carefully constituted price and hold that thought as I show you how price can and should be properly constituted (our ideal CM) That’s not to say that I don’t appreciate the integrity of purpose of left green quants, but rather the efficacy of the means by which they wish to acchieve the GMI I spoke about. To balance the ledger I’m somewhat critical of the market side of politics for not recognising that GMI(ie the broad environment), or perhaps just paying it lip service.

Back to that first principles question- Why not raise ALL taxation via the CO2E mechanism? After all it ticks an awful lot of boxes. Simple to understand and administer, neutral, unavoidable and progressive. See how it floors so many of the issues you raise here. Neutral as to debt or equity, foreigner or local, private, business, charitable or religious use. The perfect secular state tax and slays the housing affordability side effects of the current CM. No tax on human exertion, entrepreneurship and ingenuity, which presumably we all need with the bright green future. No stamp duty or capital gains friction to the expedient exchange of capital necessary for rapid technological change. Soaks the high income earner and the wealthy and the very life blood of capital, thereby favouring labour. Furthermore it solves the problem of an international race to the bottom with income/company taxes. What more could we ask for, given the threat of AGW? Take that to Cancun and they’ll all see the immediate answer to all their prayers perhaps?

Yes it ticks an awful lot of boxes for a lot of perceived problems and political perspectives but there’s still a snag or two, chief among them were the problems a global ETS threw up. It still doesn’t give countervailing market power to the natural environment and Nic’s still worried about growing inequality and wealth and wants his death duties perhaps. Like the ETS it could still encourage knocking over Asian rainforest for palm oil, and seeing food agriculture tragically turned into biodiesel and ethanol. To overcome that you need to recognise we have to add resource taxing more generally to the mix and consider what resources and how we’ll treat their pricing impact via taxation. Also Nic’s problem with the filthy rich and that conspicuous consumption he and others are concerned about. I’ll leave you to throw in any problems you have with the path so far and think about where to from here.

observa
observa
11 years ago

“people hate taxes where they have no opportunities to avoid them by changing their behaviour”
and not that I’d considered it before but I’m quietly chuckling at having that natural propensity covered sublimely too.

dorinny
11 years ago

Foreigners pay company tax. They notice the difference between paying 30% and 19%.

What I’m really curious about, is how would a tax that favours foreigners be implemented. Are you suggesting that company tax be slashed and only foreigners get access to the franking credits?

This would seem to be a lot more costly to the government – the company tax cut would have to be significant for any effect on foreign investment (as you say, 19% as compared to 30%), and as I pointed out before (but correct me if I’m wrong), the majority of business in Australia is a SME, most of which do not pay dividends – less than 2000 domestic companies are actually listed on the ASX, while there are over 1.7 million companies registered, and around 14,000 new registrations every year – our firm alone registers on average 50 new companies a year.

And this is just the number of companies registered – if the company tax dropped so significantly, I’m positive that many partnerships and sole traders, and even trading trusts, would incorporate themselves to get a benefit from the lower tax rate – further cutting government revenue.

So…. in conclusion on this point, I don’t believe that getting rid of DI in place of a lower company tax, which somehow favours foreigners, would be less costly for the government.

Maybe you are suggesting that somehow, foreigners would receive a ‘refund’ of tax whenever a dividend is declared.. I just don’t see how this could be practically applied. This is why I suggest that your theory is ‘interesting’ but practically flawed.

Now about GST – can someone please explain why this needs to be increased? Do you really believe that a 5% increase in tax (in other words, a 5% increase in CPI – because effectively, all prices will increase by that amount in the first year alone), will be followed by a 5% increase in net wages? Increasing the GST will make the cost of living less affordable for people who do not get any monetary benefit from a tax cut (such as those on welfare or very low income earners who don’t pay any tax anyway).

There is nothing progressive about an increase in GST, and it would be extremely difficult for a government to sell this idea to the general voting public. The only reason Howard was able to achieve this is because he was replacing a whole range of broad-based taxes, levies, duties or what have you, with of far simpler system.

Maybe I’m just missing something here..

Tim Quilty
Tim Quilty
11 years ago

I thought you could get foreign tax credits to some extent for company tax paid in other countries? I’ll admit my theory in this area is a little sketchy, but there are plenty of foreign tax credits flowing through trust distributions and direct foreign shares…

Grant Musgrove
Grant Musgrove
11 years ago

Agreed Nicholas, so:

A REITs are required to distribute now, so yes.

Pigouvian taxes yes, yes

But, a tax review as if politics doesn’t exist. More in print by way of discussion papers would probably be of benefit to treasury and future governments.

observa
observa
11 years ago

So Nic is still busy contemplating an international race to the bottom with company and income tax to which I’d suggest you can’t beat zero for both, not to mention that wretched problem of defining and measuring income in suitable fixed time periods and sheeting that home to the income earning unit. Essentially thousands of pages of Tax Act that’s now degenerated into- Give us a ring and we’ll tell you how we feel about what it is you and all those expensive legal eagles and accountants are up to. Much easier to tax at the resource consumption/production stage and I forgot to mention how that positively advantages saving over consumption, another problem we apparently have at present judging by those worrisome debt levels. So far I’ve left that all to carbon and now resource taxing more broadly although ‘we’ haven’t settled on the mix.

However Nic has raised the spectre of death duties, which are really incident specific wealth taxing but it’s more than that. The whole notion of wealth tax is inextricably linked to individual resource use and the sense that at some stage, an individual owes more than the average social payee, due to their high command of resources being an exponential debt for the social contract that facilitates that. Hence the current enthusiasm for resource rent taxing for which I’m a complete convert with provisos and certainly not for quick fix deficit tax grabs by bankrupt quants. Remember we are all fiscal conservatives now.

In essence we want private property to prevent the tragedy of the common but don’t want the ultimate tragedy of too few privates enjoying the lot. In that sense death duties doesn’t fit the bill. Apart from being an ugly tax- think grim reaper and bowling ball complete with ATO vulture atop shoulder and you’ll get the picture here. In any case we have tried it and found it wanting as it could be planned for which immediately begat gift duties to try and overcome, whilst it hit hardest those that died unexpectedly, namely young. If you didn’t like the teary story of young Kev and family being evicted from the farm then switch off to death duties right now, which still leaves more regular wealth taxing like an annual net wealth tax (ANWT henceforth)

Now Nic raised his extraordinary social resource clawback (ie essentially wealth taxing via death and gift duties) while I would advocate more regular extraordinary clawback via ANWT but we might both have overlooked some important reasoning behind wealth taxing in general. Perhaps 2 extreme constitutional marketplaces(CM) will elucidate the problem. CM1 with our 40 yr old very successful Morgan Sachs type trader sitting on his many millions of carbon credits and derivatives watching them rocket in scarcity value and my CM2 with a similarly wealthy John Walmesley and his Earth Sanctuaries empire and alas both struck down in their prime. Now while Nic might have no qualms belting our Morgan Sachs chap with his death duties, he might have some serious qualms about the Walmesley family having to flog off a few sanctuaries to the Tuscan box developers to foot the hefty bill. Bit black and white but it does raise the issue of why you’d want to wealth tax certain resources in the first place, bearing in mind that Great Moral Imperative (GMI) of the environment. The answer for me was you wouldn’t. If by hard work or no an individual holds large wealth in trust for us all, now and for future generations then it should be exempt from social wealth clawback.

The logical next step was to comprehend exactly how to go one further. Not only the steady-state protection of the individual natural environment holder but the incentive to give true countervailing market power to actually restore and increase it, when our current CM gave Walmesley a snowball’s chance in hell of even surviving. The answer lay not only in judicious consideration of the raisondetre of wealth taxing but how to treat land as an important resource for resource taxing purposes. One more keystone was missing for an overarching conceptual design of our ideal CM, given the obvious current realities.

dorinny
11 years ago

as they would on shares in foreign companies that also pay company tax and as foreigners always have done on earning dividends from Australian companies

I’m not familiar with the specific tax return mechanisms or tax legislation of other countries; I can only comment on issues relating to Australian income tax – and I know that Australia has various bilateral tax arrangements with other countries, which allow Australians to claim a tax credit/offset in their tax returns on foreign dividends received (where foreign tax was paid). I would assume, that the foreign investors can do the same with regard to Australian dividend income.

So if DI were to be abolished, then yes, foreign investors would receive more net income (dividend) in their pocket, but then they would also have to pay tax on 100% of this income at their marginal tax rate, which would effectively mean they have less $ after they pay the double taxation. $1 profit after tax = $0.81 dividend; taxed in foreign investor’s hands @ 19% = $0.66 net of tax. Compared to $0.70 under the current (DI) system (as I said, I assume that Foreign s/h can claim the tax credits where a bilateral tax agreement is in force).

It’s not pretty, but then dividend imputation is an incredibly expensive waste of money.

I believe that cutting 11% off current company tax would be a greater waste of money, given my points above, that most company profits in AU are not distributed to shareholders.

dorinny
11 years ago

Tim, you are correct – australian tax payers can claim a foreign tax credit in their returns.

Yes, there are some of those things courtesy of tax treaties etc. And they complicate the picture, you’re right. I don’t think they undermine the basic story though which is that all these things considered, foreign capital is still very mobile at the margin for a small country.

The problem with economics is that practical applications of theories are completely disregarded. In theory we should ignore the actual tax legislation…

When Albert Einstein died, he met three New Zealanders in the queue outside the Pearly Gates. To pass the time, he asked what were their IQs. The first replied 190. “Wonderful,” exclaimed Einstein. “We can discuss the contribution made by Ernest Rutherford to atomic physics and my theory of general relativity”. The second answered 150. “Good,” said Einstein. “I look forward to discussing the role of New Zealand’s nuclear-free legislation in the quest for world peace”. The third New Zealander mumbled 50. Einstein paused, and then asked, “So what is your forecast for the budget deficit next year?” (Adapted from Economist June 13th 1992, p. 71).

observa
observa
11 years ago

And speaking of obvious current realities, couldn’t have put it better myself, before I press on-
http://blogs.the-american-interest.com/wrm/2010/07/12/the-big-green-lie-exposed/

It’s important to add land here as an obvious resource to be taxed, but unlike most calls for land taxation, it’s imperative to tax it on the basis of useage rather than market value, now we implicitly understand Spaceship Earth, rather than the unending frontiers of Henry George’s day. There must be no social impost on natural environment held in private trust, for to tax it at all would immediately encourage it’s development for financial return. Therefore no council or utilities rates nor any land tax must be levied on natural environment but rather a resource tax levied non land from zero for natural land, higher for agriculture, up to a maximum rate for total building/bitumen/concrete cover. In our satellites and Google Earth we now have the new technology to so administratively and economically effective. Trust me, councils already use these tools now to check for approved building structures, largely to control and expand their rates base.

A further reasonable sophistication would be to proportionately allocate the sealed roads and footpaths, etc particularly to city dwellers for the purpose of land use taxation and we can think of other man-made cover that it might well be necessary to tax at the maximum rate, namely private and public dams, mining areas and tailing dams and the like until such time as they are fully rehabilitated. That way say irrigators on the MDB will be more circumspect about constructing large shallow dam areas vis a vis the Snowy dams where the tax burden is spread across many users. In that sense it may be fair that users of MDB water below large shallow dams like the Menindie Lakes, have to bear maxm land tax on the dams as well as resource taxed water costs, perhaps also allowing for reasonable estimates of concomitant, unnatural evaporation. These sorts of considerations should come to bear fully on all in our ideal CM as they make those myriad ‘free market’ consumption and investment decisions.

Then all that’s left to do is to give Gaia true countervailing market power to its destruction and utilisation for our wants. An ANWT exemption for all wealth held as natural environment and one more trick to cause resources to be seriously allocated not only for its protection, but also its rehabilitation and expnasion a la the Walmesley Earth Sanctuaries model. You get an imputation tax credit from your ANWT obligation for any such expenses. Welcome to the market empowerment of the most powerless in our current inherited CM. The first inhabitants and perhaps those who just have their physical labour to sell. As it stands the allocated aboriginal lands are economic backwaters with their inhabitants living on handouts, whereas in my ideal CM they are in the box seat to take advantage of some serious new investment demand coming their way. Apparently they already have the best skills to take full advantage of that.

Well Nic did ask for a mouthful- ‘What have I left out. What else should be here?’ but when you boil it all down not that much or that hard to implement. Switch to complete reliance on CO2E and resource taxing, with land resource taxed from nil for natural to a maxm for man-made and an ANWT for the top end of town with a couple of exemptions which as one commenter notes has a certain timeless appeal and Gaia would approve. However let me be clear here that this is an overall conceptual design and I haven’t ventured to suggest the appropriate mix and balance. No individual could possibly know that and we’d all have different opinions on relaince upon particular incidence. That’s for the political process but it’s important that we agree on the overall winning concept and then set to work to achieve that. A bit like the new parliament house where we agree on the design and then the plethora of architects, engineers, trades, etc set to work hammering into shape. It’s what we do best and the question is should this suit a Labor or Liberal Govt in its overall design? If you can’t tell which then perhaps it’s well worth the doing by either.

John Passant
11 years ago

Henry described DI as an example of national neutrality some time ago, and said from memory that he favoured that approach. So he has changed his view.

Non-residents don’t pay CGT (except on land holdings and land rich companies). They don’t get the franking credits. So I AMA assuming that for Australian companies with foreign residents as major shareholders the pressure is on them to retain the profits and increase the share price rather than distribute dividends. Or maybe then the tax rate (CGT and others) in the home country becomes significant.

dorinny
11 years ago

Most non-residents DO get franking credits (if there is a tax treaty in place); and the largest foreign investment in AU is from UK and USA, which does have a tax treaty.

Good point though about CGT not applicable on gains from share disposal. Even more reason to keep DI in place (as abolishing DI would drive prices down).

dorinny
11 years ago

Touché, Nicholas! :)

Patrick
Patrick
11 years ago

I think people are getting a bit carried away by the tax treaty thing and it is pretty far off the topic.

Very generally speaking the UK and the US and Australia all grant a foreign tax credit for foreign withholding tax levied on a dividend recieved by a resident. No treaties required in the general case. The credit is only available where the dividend is taxable in the country of receipt. (otherwise there would be negative taxation which is unlikely unless you are a superfund).

If the dividend is franked, then there is no withholding tax as a matter of Australian law. Consequently there is no FTC in the country of receipt (the dividend hasn’t legally borne any tax so there is no tax to credit).

What the treaties do, as relevant here and without overcomplicating it, is reduce the rate of withholding tax. In our case the base rate of dividend withholding tax levied on a dividend which is paid to a non-resident is 30%. Under the US/UK treaties it is generally 15-5% depending on the recipient, and nil for qualifying wholly-owned groups. Obviously if the dividend is franked this is irrelevant since it won’t be subject to the withholding tax in the first place.

For the sake of clarity, although it is not really relevant here, the US also grants in some cases an FTC for the underlying corporate income tax, but this is because they (more so than any other country) tax the underlying corporate income. Franking credits are irrelevant here.

In specific circumstance Australia also taxes underlying corporate earnings, in which case Australia also grants (again, unilaterally and without a treaty) an FTC for the foreign corporate income tax paid.

TO boil all that down, the average US/UK/Japanese institutional investor is looking at 5% withholding tax. It should be fairly obvious that they aren’t getting full value for the franking credits and won’t be upset to lose them.

OTOH, Nick, you are right that institutional investors rarely price franking credits. This is for no more complicated reason than that their personal metrics don’t!! However, tides are moving the other way – IIRC one of the Cooper Review recommendations was after-tax reporting which will increase the super fund bias towards franking credits massively.

Tom_Beebe
Tom_Beebe
11 years ago

Try this:

1. All persons residing in the U.S. shall come together in units for the purpose of reporting all income from any source, each item to be identified by payer’s and payee’s tax number. Members of a unit need not be related, need not reside together, and a unit may consist of as few as one person. With equality as the primary goal, this act established units to be taxed, so that all persons, whether related or not, legally here or not, are taxed equally.
2. Each year congress shall set by legislation a “minimum wage” and a “tax rate”.
3. The following income shall not be subject to taxation:
• An amount equal to a year’s earnings at the minimum wage rate, for each adult (age 20-65) member of the unit, decreasing 10% per year to 50% at age 15 and increasing 10% per year to 150% at age 70.
• All payments for what is classified as necessary health care for all members of the unit including medical care, any pharmaceuticals prescribed by a recognized health care professional, vision and hearing aids, and membership fees for health-enhancing entities such as gyms or other exercise facilities. Health care insurance premiums may be deducted but not health care expense paid for by such insurance.
• All educational expenses including day care for young children or legally incompetent persons, that portion of state and local taxes identified as spent on education, that portion of parochial school tuition, fees and other expenses identified as going for non-sectarian education, tuition, fees and educational materials for private school education at any level, and a per-diem allowance for students traveling more than 50 miles from primary residence for education.
• All income saved into an identified account from which investments may be made.

This encourages growth of the tax base, thus growth of the government’s ability to pay for its responsibilities, by fostering health care, education and investment, all of which contribute to growth of income, taxable to support legitimate government purposes.
4. The “tax rate” shall be applied to any income over and above the deductions listed above, regardless of amount. It seeks the elusive concept of fairness by taxing at the same rate all “disposable” income.
5. There shall be no federal tax on corporations or other business entities. Products made in the USA will be more competitive in the world market by eliminating taxes as part of their cost All taxes will be directly, and transparently imposed on those who have always paid them, the consumer.
6. The Office of Management and Budget shall compute revenues to be expected using the newly set tax rate and minimum wage, applied to the previous year’s reported incomes. No expenses in excess of that amount may be authorized or made by the federal government without approval by 75% of each house of Congress. It sets the Federal budget to produce a surplus in times of economic expansion and a deficit in times of contraction to promote economic stability.
7. At the request, by legislation duly enacted by a municipality having greater than 100,000 inhabitants or a state, a surtax may be imposed on citizens of that municipality or state which shall be applied in a manner exactly as applied for the Federal tax. It recognizes disparity in cost of living among various locations. It facilitates sufficient sources of revenue for states and municipalities.
8. For units whose deductions exceed total income, the Federal Government shall make payment equal to the tax rate multiplied by the shortfall in income, as shall municipalities and states. This addresses aid to the truly needy.

Robert Merkel
11 years ago

Nick, I’m unconvinced by your defence of the luxury car tax. It’s a dumb, arbitrary tax that doesn’t apply to, say, Rolex Submariners, bottles of Chateau Petrus, or maxi yachts. If one were to suggest the taxation of sumptuary, might I suggest that all three of these (particularly if one consumed the wine while on the yacht wearing the watch) are more deserving of taxation than, say, a BMW 3 Series.

While I take your point about tax avoidance, but if you want to go after the wealthy with additional taxes, the big fish are surely land taxes and wealth taxes in some form or other (the most painless of these probably being death duties if you’ll pardon the pun), not piddly little nuisance taxes on a few luxury goods.

Robert Merkel
11 years ago

Nick, it’s no more than an annoyance, but it’s a symptom of the cack-handed way we tax transport.

New cars are safer than old cars – both for their occupants and third parties. They emit far less carbon monoxide, sulphur dioxide, nitrous oxide, particulates, and other lethal pollutants (statistically, air pollution, of which vehicles produce a large fraction, causes as many premature deaths in greater Sydney as car crashes do nationally). Furthermore, large cars are generally worse on all of these counts except occupant protection. Of course, a car that’s not being used doesn’t pose a risk to anyone.

So, given all that, the tax system should discourage the use of cars, and if they are to be used, encourage the use of small, new cars rather than large, older ones.

Australian government policy, as a whole, has precisely the opposite effect.

It encourages the purchase of locally-built, large cars over imported small ones. It encourages the purchase of imported, large, inefficient four wheel drives over imported, more efficient passenger cars. The FBT rules encourage – in some cases, virtually mandate driving.

The sooner we shift costs away from purchasing new cars, and onto driving them, the better off we will all be.

Patrick
Patrick
11 years ago

I dislike the LCT partly because it is a tax and partly because I actually agree with Rob Merkel. Even though I am about as climate sceptic anti-government as its gets here I can’t see why we wouldn’t want to tax road usage more than car purchase (as per RobM) and even though I love large engines and would passionately hate such a tax, I can’t for the life of me see any technical or non-opinion poll reasons why we wouldn’t tax engine size not car value.

Especially since the motor car industry is perhaps the most tangible (and rapid) example of a sustained ‘trickle-down’ effect, ever. Put simply, nearly every feature of modern cars that makes them inestimably safer than their predecessors of not so long ago was once a ‘luxury’ item. Off the top of my head the only real exception is probably seat belts, and even there pre-tensioners and height adjustment were once ‘luxury’ items.

observa
observa
11 years ago

Well there being no objections I take it we’re all agreed then and it’s just a matter of tapping up Julia Tone and Bob and telling them to get their act together. Not quite as silly as it sounds if you read between the lines. The Greens are all for straight carbon taxing now the global ETS pipedream has been exposed, while Labor has suddenly seen the resource taxing light as well as reducing company tax and presumably the Libs won’t need much cajoling on zero company and income tax, among all the other drawbacks to unleashing the ingenuity and unfettered might of ‘free market’ capital and labour upon the environmental challenge ahead. They’re almost up to pace with yours truly. Build a better mousetrap and the world will beat a path to your door, but if they don’t, they’ll quickly find Oz becoming the new headquarters of their international companies. No company or income tax, but just pay their carbon and resource footprint tax? Whaddya reckon? Won’t take them long to work out they’re a bunch of Kodaks in a digital world and get with the program in that regard.
That just leaves the consideration of more contentious wealth taxing for the top end of town. Discount that ugly, incident specific death duties/gift duties morass and that leaves you with the more sensible, pay as you go ANWT with environmental twist, an eminently saleable proposition for the abandonment of income taxing. Unlike income, wealth is eminently more difficult to hide and can be easily measured as market or insured value, whichever is the greater. It must all be sheeted home to an owner (hold that thought for the present), lest it be ‘found’ unowned, in which case a sensible social rule would be for the finder and ATO to share it equally, lest a lot of it have no apparent owners. Declaring wealth for ANWT purposes may be seen as intrusive, but in reality no more so than the current intrusiveness of identifying an income earning unit and their concomitant income. Besides most of us throughout the lifecycle now will have to make such a declaration at some time for Centrelink asset testing purposes and if it’s good enough for our pollies to declare their interests it’s good enough for all of us. Now while I’ve said certain wealth (ie held as natural environment) should be exempt for ANWT purposes, clearly that escape clause should not apply for Centrelink asset testing purposes. OK to hold it in trust for us all but not if you want us to especially materially support you in doing that. Nevertheless it makes sense for us all to be able to take an environmentally acceptable breather from ANWT at different times and stages of the lifecycle.
Speaking of lifecycle wealth taxing clearly needs to allow for different stages of the lifecycle as well as impacting on the level of social support at different stages. Clearly a wealth tax threshold needs to be set differently for an 18 year old vs a 65 year old in that regard and wealth should be allowed to be allocated among dependants too, or perhaps shared with any individual by mutual agreement if it reduces Centrelink drawdown. These are the considerations of any wealth tax design which brings me to an interesting point John Quiggin raised some time back. Essentially it concerned the grey, fuzzy area of amorphous wealth that could be accessed by the select few. In other words it didn’t strictly fit the black and white, public or private divide. It goes to the core point of how far you’d want to go in sheeting home ALL wealth to private or public ownership. He was particularly concerned with the ability of the wealthy few to free ride or access the apparent amorphous wealth accumulation of the posh private schools, but the same might apply to allocating the wealth of the Catholic Church, the local Mosque or the odd Sanitarium or Mutual/Cooperative business model. How far should we go in allocating such wealth for ANWT purposes and creating the ideal secular State is a good question for you all, if you get John’s point.