Why did the government wanted to remove the dividend imputation system?
A. According to the article written by Professor Peter Swan, provide three arguments that he supports the current Australian imputation system.
B. Why did the government wanted to remove the dividend imputation system?
Investors will be the losers if
imputation system goes
• PETER SWAN
• THE AUSTRALIAN
• APRIL 06, 2015 12:00AM
Last Tuesday the Treasury announced in its discussion paper that the
Abbott government was considering amending or abolishing Australia’s
tax imputation system.
Since 1987, Australian taxpayers have only been taxed once on corporate
income, not the double taxation that investors in many other countries have
had to put up with (New Zealand, Chile and Mexico remain the exception).
Our franking credit based tax system has undoubtedly given Australia one of
the best and fairest systems of corporate taxation in the world, despite our
still very high tax rates.
New Zealand, for example, with the same system as ours has maximum tax
rates at about 33 per cent, compared with ours in excess of 47 per cent.
In the same discussion paper, the Treasury reports that $19 billion in franking
credits is distributed annually to Australian shareholders, with another $10bn
paid to companies for future distribution.
Annual dividends to the value of $44.33bn, with grossed up value of
$63.33bn,1 precisely generates the reported franking credits of $19bn at the
notional value of 42.86c per dollar of franked dividends.
If the relevant taxpayer is in the modest 37 per cent marginal tax bracket
($80,000-$180,000) category, the incremental tax currently paid is $23.43bn
on this income. Hence, for such taxpayers, the cost over and above franking
is about $4.43bn.2
1 $63.33bn. = $44.33bn. + $19bn of franking credit. 2 $4.43bn. = $23.43 – $19bn.
If double taxation were reintroduced, the after corporate tax dividend income
on which personal tax would be payable is $44.33bn, yielding $16.4bn in
incremental tax revenue.3
Thus, the total paid on dividend income rises from $23.43bn to $35.4bn
($16.4bn plus the $19bn of cancelled credits) which is an increase in the tax
take of 51 per cent. The effective marginal tax rate on dividend income rises
from 37 to 56 per cent, a staggering rise of 19 percentile points.
If a person were receiving $100,000 a year in franked dividends and 37 per
cent is their marginal tax rate, they would be paying $37,000 per year in
personal tax, leaving a modest after-tax dividend income of $63,000.
After the change, personal tax is levied on the $70,000 of after-corporate-tax
income, leaving only $44,100 in after-tax dividend income as the marginal
tax rate is still 56 per cent.4
If the investor is in the 47 per cent marginal tax bracket the devastation is
even worse. Their current after-tax dividend income is $53,000 and with the
loss of the corporate tax rebate of $30,000 (i.e., franking credit) on the gross
income of $100,000 his after-tax income falls to only $37,100. The increase
in tax is $15,900.5
Since his total tax paid is $62,900, the effective marginal rate has risen from
47 per cent to 63 per cent, comparable to France with the world’s highest tax
rate on distributions.6
In present value terms at the average corporate return of 12.77 per cent per
annum, since July 2001 this $19bn annual loss to local shareholders amounts
to a decline in value of $148.79bn for franking shares worth approximately
$500bn, a potential massive hit to stock values.
The discussion paper points out, correctly, that imputation encourages
Australian investors to invest more in Australian stocks and less in foreign
stocks than they otherwise would in a world in which inefficient double
taxation of dividends is universal. Given that information is vital for
successful investment and that most information is local, the home bias
means that both Australian firm and investor returns are higher when more
Australians invest locally. Imputation, like aspirin, brings many benefits.
3 $16.4bn =$44.330.37 4 $70k(1-0.37) = $44.1k, 5 Under the current imputation system: credit=$30K, dividend=$70k, taxable income=70+30=$100k, net tax
after credit=$47-30=$17k (a). Under double taxation: tax=70*0.47=$32.9k (b). Increase in tax=(b)-(a)=$15.9k. 6 Net increase in tax paid = (b) 32.9k + lost credit 30k = $62.9k.Includung the lost credit, tax rate increases to
The discussion paper is keen to bring about more foreign investment in
Australia by lowering the corporate tax rate. Under imputation, Australian
investors gain no benefit from any lowering and in general, imputation does
little to encourage foreign investment.
Here the discussion paper is quite schizophrenic — while wanting more
corporate investment in Australia, it would like to remove imputation as this
would lower Australian investment in ourselves!
If any tax savings were used to lower the corporate tax rate such that the
overall level of investment were preserved, all it has achieved is a worsening
of Australian tax efficiency while making most Australian investors worse
Unfortunately for all those advocating a massive tax grab of $19bn, revenue
gains would soon prove illusory. Australian companies would soon shift their
corporate activities and tax base to tax havens. Imputation provides a strong
motive to pay tax locally.
When imputation was introduced in 1987 there was a sizeable increase in
dividends distributed so as to harness imputation credits. This would soon be
reversed if the tax grab lobbyists have their way. Companies with poor
investment prospects would invest more in a wasteful fashion, weakening
Australia’s investment performance.
Imputation means there is no tax benefit from taking on more debt. Reduced
gearing that occurred with the introduction of imputation would be replaced
by sizeable gearing-up.
If there is no, or limited, equity capital, there will be no or negligible
dividends, but highly indebted companies become much more susceptible to
collapse during recessions. Abolishing overtaxed dividends is perfectly legal,
and we all pay the costs of corporate collapse.
That $19bn tax grab is soon converted into an additional $19bn in wasteful
activities, while the entire corporate sector takes a significant hit from which
recovery will be difficult indeed.
Peter Swan is professor of finance at the UNSW Business School.