Showing posts with label dividend imputation. Show all posts
Showing posts with label dividend imputation. Show all posts

Saturday, June 27, 2020

We should get a fair share of foreign investors' profits

Australia has been a recipient of foreign investment in almost every year since the arrival of the First Fleet in 1788. Yet for much of that time the idea of foreigners being allowed to own so much of our businesses, mines, farms and land is one many ordinary Australians have found hard to accept.

For older Australians, the thought of “selling off the farm” to foreigners makes them distinctly uncomfortable. Why can’t we do it ourselves and own it ourselves?

The short answer is, we could. But had we chosen that path we wouldn’t be nearly as prosperous today as we are. As the Productivity Commission reminds us in a paper published this week, you need money to set up a business, let alone a whole industry.

That money has to be saved by spending less than all your income on consumption. And had we been relying solely on our own saving, we’d have been able to develop much less of this vast continent than we have done. So, from the days when we were a British colony and had no say in the matter, we’ve invited foreigners to bring their savings to Australia and join us in exploiting the golden soil and other of nature’s gifts with which our land abounds.

Total foreign direct investment – that is, where the foreigner owns enough of the shares in a company to have some control over its management – is now worth about $1 trillion. The largest sources of direct investment are, in order, the United States, Japan and Britain. In recent years, of course, most of the action – and the angst – comes from China.

The less poetic way to put it is that Australia has been a “net importer of capital” for more than two centuries. It’s thus not so surprising that, despite whatever reservations ordinary Australians may have, the dominant view among our politicians, business people and economists has been that we must keep doing whatever it takes to attract the foreign investment we need to keep the economy expanding strongly.

For many years it was felt that we always run a deficit on our balance of trade in goods and services with the rest of the world, so we always need to attract sufficient net inflow of foreign capital to be sure of financing that trade deficit – as well as covering all the regular payments of dividends and interest we need to make to the foreigners who have invested in local businesses or have lent us money.

This mentality made sense in the days when we had a “fixed exchange rate” – when the government, via the Reserve Bank, set the value of our country’s currency relative to other countries’ currencies – particularly the British pound and, later, the US dollar – and changed that value only very rarely in situations where it couldn’t be maintained.

The point is that when you choose to fix the price of your currency, you do have to worry about getting sufficient net inflow of foreign capital to cover the deficit on the “current account” of the “balance of payments”. Should you fail to attract sufficient inflow, you’re forced into the ignominy of cutting the price you’ve fixed.

Now, this problem went away a long time ago. In 1983, after we’d been having a lot of trouble keeping our exchange rate fixed and our balance of payments in balance, we decided to join most of the other advanced economies in allowing the value (or price) of our currency to float up and down according to the strength of the rest of the world’s demand for the Australian dollar (the Aussie, as it’s called in the foreign exchange market) relative to the supply of it.

From that day, the two sides of our balance of payments – the current account and the capital account – were in balance, the deficit on one matched exactly by the surplus on the other, at all times. How? Because the price of the Aussie adjusted continuously to ensure they were.

The “balance of payments constraint”, which had worried the managers of our economy for so long, just evaporated. But here’s the point: the attitude that we must always be doing as much as we can to attract as much foreign investment as possible continued unabated.

There’s this notion that, in the now highly competitive, globalised financial markets, if poor little Australia doesn’t try really, really hard, we’ll miss out.

This, of course, is the reasoning behind the unending push by big business for us to cut the rate of our company tax. Our system of “dividend imputation” means Australian shareholders have nothing to gain from a lower company tax rate. The only beneficiaries would be foreign shareholders because they aren’t eligible for “franking credits”.

We’re asked to believe that how well the level of the nominal rate of our company tax compares with other countries’ rates is the main factor determining whether we get all the foreign investment we need. Not even how the tax breaks we offer compare matters much, apparently.

I don’t believe it. It’s a try-on. As the Productivity Commission’s paper reminds us: “Foreigners invest in Australia because of our fast-growing and well-educated population, rich natural resource base, and stable cultural and legal environment.”

Just so. Mining companies flock to Australia because we have the high-quality, easily-won minerals and energy they need. The idea that global companies such as Google or Amazon would give Australia a miss because our company tax rate’s too high is laughable. Especially when they’re so adept at minimising the tax they pay in advanced countries.

We should take a more hard-nosed, business-like attitude towards foreign investors such as the miners, which make huge profits but employ very few workers. When state governments fall over themselves building infrastructure for them and offering royalty holidays and other inducements, it matters greatly how much company tax they pay before they ship their profits back home.

Monday, March 27, 2017

Company tax cut has a not-so-dirty little secret

Throughout their whole push for a cut in the company tax rate, there's been a key factor the business lobbies and government politicians simply haven't wanted to mention: our unusual system of dividend imputation.

That's because it so greatly weakens their case and questions their motives.

But that's not all. It's set to turn the limited reduction in company tax we're likely to get into tokenism: the cut will be of little benefit to the businesses receiving it, little net cost to the budget and little benefit to "jobs and growth".

Australia's problem isn't fake news, it's fake government. The coming company tax cut will be a classic case. But it will make the medium-term budget projections look a lot healthier.

Paul Keating introduced full dividend imputation in 1987 to eliminate the double taxation of company dividends. Domestic shareholders are given "franking [tax] credits" worth 30¢ in the dollar on those dividends that have already been taxed at 30 per cent in the company's hands.

Dividends are taxed at the shareholder's marginal tax rate, but less their franking credits. Should they not owe enough tax to extinguish the credit, the balance is refunded to them.

The effect of this for Australian shareholders and super funds is to render company tax little more than a withholding tax, like the income tax businesses withhold from their workers' pay packets.

This means the only significant continuing purpose of company tax is to tax foreign shareholders.

Since the franking credit rate moves up or down with the rate of company tax, Australian shareholders have little or nothing to gain from a cut in the company tax rate. Only foreign shareholders – present or prospective – would benefit.

When you remember how often the nation's chief executives make speeches claiming to have only their shareholders' interests at heart, it makes you wonder why the big business lobby has been so insistent on the need for lower company tax.

One possibility is they see their interests as managers as differing from their local shareholders'. Another is that outfits such as the Business Council of Australia are dominated by executives who owe their allegiance to foreign bosses and owners.

It hasn't suited the government to admit that its promised $48 billion, 10-year phase-down of company tax holds no benefits for local shareholders, only foreigners.

So anxious are the econocrats promoting lower company tax to avoid thinking about the implications of imputation that Treasury got caught overstating the (remarkably modest) benefits in its modelling. A rival modeller had to point out the error.

Smoke signals from Canberra suggest that all the government will manage to get through the Senate is a reduction to 27.5 per cent in the tax rate applying to companies with turnover of less than $10 million a year.

In other words, only small and medium incorporated businesses will get a cut.

Trouble is, almost all the shareholders in such businesses – many of them owner-managers – would be locals, not foreign investors, meaning they're already eligible for dividend imputation and so have little to gain from the lower tax rate.

In which case, their behaviour – their enthusiasm for creating "jobs and growth" – is unlikely to change.

But get this: since almost all the shareholders of small and medium-sized companies get franking credits, the reduced measure's net cost to the budget (less company tax collections, offset by a corresponding reduction in franking credits) is likely to be minor.

It's only when you're handing tax cuts to the foreign shareholders in much bigger companies, as originally planned, that the (mainly unfunded) cost starts to mount up in later years.

So if the smoke signals are right in predicting that, once the government's got the most it can get through the Senate, it will ditch the rest of its original plan, this will greatly improve the 10-year projections of the budget balance.

That's particularly so because the 10-year phase-down was partially funded by the tax increases announced in last year's budget: the further huge hikes in tobacco excise, the cut back in super tax concessions and the crackdown on multinational tax dodgers.

Further smoke signals say that, once the government's got through the Senate what it can of the unpassed, "zombie" spending cuts from its disastrous 2014 budget, it will abandon the remainder.

That will have quite an adverse effect on the 10-year budget projections – which is the very reason it has refused to kill the zombies until now.

Penny dropped? The time to kill off the zombie savings is when you're also killing off your grand plan to cut company tax to 25 per cent.