Labor’s proposal to disallow imputation credits unless offset by other taxes is flawed on grounds of economic efficiency and equity. But it does try to deal with the terrible injustice that sees well-off retirees exempt from tax. That’s in contrast to the petulant complaints from lobby groups who offer no constructive alternatives to make the system fairer, and in contrast to the Coalition’s failure even to acknowledge the problem.
Linda and Robert
Let me introduce Linda and Robert, two Australian “baby boomers” born around 1950. They have enjoyed economic fortunes their parents, who grew up in the years of depression and war, could hardly have imagined.
Linda and Robert met at university, both beneficiaries of Commonwealth scholarships which paid their fees and a means-tested living allowance. After graduation well-paid professional employment came easily, and within a year they had saved enough for a 20 percent deposit on a house in one of the new suburban developments. It was a bit far out of town, but land was cheap and it was in the days when state governments were still paying for the expenses of subdivision – electricity, water and sewerage connections and local streets.
The mortgage was burdensome, particularly when interest rates rose in the mid 1970s. They remember a couple of frugal years – wringing the last few miles out of the FB Holden Linda’s parents had passed on to her. Inflation was high, but every year they got salary rises that covered inflation, and within a short time their mortgage was little more than a nuisance. In They were able to move to a more upmarket house in the mid 1980s and by the time they were in their early 50s they had paid off their mortgage.
Linda and Bob, like all of us in the years when are bringing up children, found saving to be difficult, but with the Hawke Government’s superannuation scheme, their employers helped them build up a nest egg.
That saving, although subsidised with tax breaks, would have been insufficient to provide for their retirement, but they both had modest inheritances, which they were able to put into a share portfolio and into superannuation.
Their biggest break came with privatisation and banking de-regulation. In what was one of the greatest transfers of wealth from the public sector to the private sector – a transfer of the collective assets in corporations as diverse as CSL and the Commonwealth Bank, all dramatically undervalued in their IPOs – Linda and Robert accumulated financial wealth beyond their wildest dreams. By the time they retired a couple of years ago they had, between them, about $4 million in savings – $3.2 million of which was in their self-managed superannuation fund (just at the threshold where income from superannuation is untaxed).
That $3.2 million, invested in shares with 5 per cent dividend yield, gives them a tax-free income of $160 000. In addition they each have about $400 000 in their own share portfolios, paying out another $20 000 a year. With one or two small tax-deductible donations, they bring their declared incomes down to the tax-free threshold of $18 000.
In all that’s a combined tax-free income of $200 000, on which a couple both earning $100 000 would normally pay almost $50 000 tax.
And it gets better, because each year they get a refund on franking credits which would be $85 000 if all their investment were in shares with franking credits. (In practice, because investors hold mixed portfolios, the refund would be significantly less.)
The big bad wolf
In a political climate where all messages must be dumbed-down to simplified bites, it’s hardly surprising that the Labor Party is able to campaign on a simple message that they will no longer allow so-called self-funded retirees to collect the additional bonus of franking credits. (“So-called”, because much of Linda’s and Robert’s financial wealth has come from taxpayer-funded benefits – university fees, infrastructure for their first house, superannuation subsidies, privatisations, and now that they’re almost 70 from private health insurance rebates.)
Disallowing franking credits, however, is a crude and inequitable way to overcome the gross inequities that have favoured wealthy retirees, and that have seen a huge transfer of income form the young to the old. I am among others who have written in Pearls and Irritations and elsewhere about the crudeness and inequity of Labor’s blunt proposal to abolish franking credits in such situations.
In terms of good public policy it fails on many grounds: it would encourage Linda and Robert to re-direct their savings away from Australian equities and into speculative investment (including housing) that contribute to financial market destabilisation; it may force them back into dependence on the financial sector; and it’s inequitable, because the very rich, with balances of $5, $10, $20 million, would have be largely untouched. In addition it would cause severe income reductions among people without superannuation and with modest levels of financial assets disqualifying them for the age pension.
A far more just reform would be to leave imputation credits untouched, but to make all income from superannuation in the pension phase (i.e. in retirement) subject to normal tax. Linda and Robert would pay their $50 000 tax (some by way of corporate tax on their dividends) and would not be pushed to re-arrange their portfolios into tax-avoidance schemes, at a cost to public revenue. And the very rich, presently privileged with a 15 percent concessional tax rate for balances above $1.6 million, would be brought into the net of progressive income tax.
One can hardly blame Labor, however, for campaigning on a crude message of “refunds of tax that has never been paid”. (Franking credits are actually refunds of company taxes that have been paid on behalf of shareholders.) Most Australians don’t understand dividend imputation, and right up to recent times the Coalition was peddling the lie that Australia’s corporate tax rate is 30 per cent, ignoring the benefits of imputation which brings the effective rate of corporate tax for Australian investors down to around 15 per cent. Worse, most journalists, including ABC journalists, hardly ever challenged then Treasurer Morrison on this lie. Labor has had to frame its policy in the dumbed-down framework set by the Coalition and by partisan or lazy journalists. (For an thorough description of the workings of imputation and a clear analysis of Labor’s proposals, see Josh Gordon’s recent contribution to Pearls and Irritations.)
But most condemnation must lie with those who complain about Labor’s proposals without even acknowledging how extraordinarily inequitable our taxation system has become in relation to highly-privileged wealthy retirees. Lobby groups for older Australians have done nothing but grizzle, without offering alternative suggestions on how these inequities can be addressed, and opportunistically the Coalition has joined the chorus.
This is in contrast to more thoughtful commentators who have criticised Labor’s policy while acknowledging the problem of breaks for well-off retirees. Simon Cowan of the right-leaning Centre for Independent Studies has thoughtful criticisms of Labor’s policy, while acknowledging that in privileging retirees with tax breaks, at the expense of younger working Australians, we have it 180 degrees out of line with good public policy. “It has created a class of well-off individuals who pay no tax at all” he writes, but we’re not hearing that acknowledgment from Coalition.
Labor’s policy is flawed, but it’s in the right direction, and if they achieve office they may find a more equitable and economically responsible way to achieve the same ends. By contrast the behaviour of the Coalition, and the lobbies captured by the ungrateful rich, is despicable.