Dividend imputation – $20bn for the taking

Today’s Age and SMH column – on the great business tax mix switch – imputation for a 19% company tax rate.

REMEMBER Kevin Rudd’s mining tax? It needed some tweaking in industry’s favour, but even then it would have hauled in massive revenue without harming investment, which is the holy grail of tax policy. So, the government planned to use it to fund a bonanza of sensible giveaways including lowering the company tax rate from 30 to 25 per cent.

When the miners invested in a scare campaign with even higher rates of return than their mines, the rest of the business community had to answer that great question in life posed most recently at the Spice Girls’ performance at the London Olympic closing ceremony: ”Tell me what you want, what you really, really want.”

When push came to shove, few businesses and even fewer business associations campaigned for the package even though it was far and away the best break they were likely to get in a good while. It just wasn’t what they really, really wanted.

And so, here we are again, two years on, with business still seeking lower company tax. Government has put the challenge to business again saying it will cut company tax, but only if the Business Tax Working Group (BTWG), comprising business, unions and tax experts, can identify which business tax concessions should be removed to fund it; the problem is, without ”Mining Tax Mark 1” the choices are much harder.

However, the removal of a single business tax concession could fund company tax reductions down to about 19 per cent. The dividend imputation scheme introduced in 1987 ended the double taxation of company profits by relieving Australian shareholders of personal tax payments on their dividends to the extent that their companies had already paid company tax.
Paying tax twice seems daft and unfair. But it costs a bomb – which raises that Spice Girls question. Is it ”really, really” the best thing we could be doing with more than $20 billion in tax revenue? It would be hard to forgo that kind of money in business tax without doing some economic good by lowering business’s cost of capital, but, by god, dividend imputation does it. Let me explain.

If dividend imputation lowers the cost of capital, it does so by increasing the demand for Australian shares and thus raising their price. But foreigners don’t benefit from imputation credits. So, abolishing dividend imputation to fund company tax cuts lowers tax on foreigners and increases it on domestic shareholders. And because Australian shares are such a small part of foreign investors’ portfolios, foreigners are much more responsive to changes in after-tax returns than Australian investors.

For instance if, in response to the changes, foreign investors raised their allocation to Australian equities from 3 to 4 percent, that’s a third more foreign investment; while domestic shareholders would be far less responsive. What I’m proposing would even come with its own compensation package for those domestic shareholders that wanted to put their money elsewhere – they’d be able to sell out at new price highs.

This isn’t just theory. Econometric studies of the introduction of imputation in 1987 suggest that it didn’t increase share prices. Conversely, when British pension funds were recently stripped of similar imputation credits, foreign buyers snapped up the few shares offloaded by British funds with negligible price falls.

The BTWG knows all this, observing: ”In small open economies like Australia, the marginal investor is likely to be a foreign investor.” Which calls into question ”whether dividend imputation is likely to significantly lower the cost of capital for Australian companies”.

Put more bluntly, $20 billion of business tax revenue does not stimulate investment. One could do as much good for the economy by dispatching random cheques to Australian households. No wonder that, as they compete to attract each others’ capital, European countries have moved away from dividend imputation.

Then, in the next breath, the BTWG argues that dividend imputation is outside its remit, that its terms of reference seek to quarantine its deliberations to the business tax system. Call me quirky, but I’d say that dividend imputation is part of the business tax system.

So, I’ll tell you what I want, what I really, really want. I want the BTWG to consider these arguments and put them to government – preferably as recommendations, but, failing that, as clear observations rather than asides.

Do I expect our beleaguered government to jump on such an insight right away? No. But in Australian policymaking, such an insight has usually been the foundation for real progress, if not immediately, then over a few electoral cycles as the inevitable crises rob governments of politically easy options and as political parties jockey to persuade us they’ve got a serious reform agenda to keep us, ahem … moving forward.

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Paul frijters
Paul frijters
9 years ago

Yep, agreed. The home bias created by the imputation distorts local investment incentives too: joint ventures abroad look that much less attractive than putting the money in the local share market.

whyisitso
whyisitso
9 years ago

Looking back 25 years I find it amazing that taxation in Australia allowed the double taxation of one source of income. To advocate the return of double taxation is equally amazing.

A wonderful thing is “opportunity cost”. I think the average rate of personal income tax is somewhere between 20% to 25%. Thus the government is forfeiting 75% to 80% of “opportunity” revenue. Even more really, because once 100% of tax is applied to income, and some people have assets, there is still an “opportunity cost” of practically the full amount of that private wealth that is not subject to a wealth tax in a given year. That is, if we had a wealth tax each year of say 10%, the remaining 90% untaxed is an “opportunity cost”.

Of course you leftists who run this blog will say I’m being ridiculous. I say that to advocate the return of an unjust double tax rightly abolished a quarter of a century ago is just as ridiculous.

Paul Frijters
Paul Frijters
9 years ago

the right-left lens in this case is not very useful, because it all depends on whose perspective you take: from the perspective of international investors, they are currently being taxed twice on investments into Australia. Those damned bolshewiks in Aussie-land directly discouraging foreign investments, they will no doubt think! If you equalise the tax rates you can also lower them, something they would surely consider a right-wing thing to do!.

john r walker
john r walker(@annesanders)
9 years ago

Would this proposal have any effects on the net return for shares in Superfunds?

john r walker
john r walker(@annesanders)
9 years ago
Reply to  Nicholas Gruen

Thank you. It just seems to me that the returns on compulsory super are already rather ordinary, but that is another subject.

john r walker
john r walker(@annesanders)
9 years ago
Reply to  john r walker

We also have a bit invested in the canberra anglican development fund …. consistently better returns and it helps build things like aged care facilities.

whyisitso
whyisitso
9 years ago

At least international investors know the rules, even if they are unjust. At least they hope they do. The problem for international investors is the sovereign risk they take when the rules are changed after they invest, such as the recent case of the fishing trawler, the owners of which have practically lost their entire investment. You use the word “bolshewiks” advisedly. Confiscation without compensation is something Labor governments are well practiced at. I well remember the Wran government confiscating mining royalty rights in the Hunter Valley without compensation decades ago.

Of course property rights is one of those strange fascistic notions of rightists, those disgustingly selfish people who fully deserve what they don’t get.

David Walker
David Walker(@d-w-griffiths)
9 years ago

At a political economy level, dividend imputation created two important lobby groups for its own retention – local shareholders, and the companies they own.

I have long found Nick’s argument on corporate tax convincing – and indeed I ran a project at CEDA to bring it to public attention. But …

It is clear that there is no appetite in corporate Australia to pursue this argument. The main reason is that corporate Australia does not want to upset its own shareholders. A subsidiary reason is the fear that if such a policy is implemented, local corporates might lose more through the abolition of imputation than they would gain through rate-lowering. Depending on your view about the tax incidence literature, the real constituency for Nick’s suggested policy shift is probably workers. But it will be hard to convince them, or even the ACTU, that this is the case.