IAN McAULEY. Labor’s superannuation changes: clever cosmetics but a failure on equity, public revenue and economics.

There is something wrong when “self-funded” retirees can enjoy a six digit tax-free income, while others who earn their income through their own efforts pay normal rates of income tax. But Labor’s proposals on dividend imputation would sustain that inequity, would compromise public revenue, and would divert Australians’ savings away from high-return quality investments.

The income tax paid by someone with an income of $100 000 a year is around $26 000.

That is, if one is earning that income in employment or in one’s own business. But it is possible for a so-called self-funded retiree to enjoy a similar income and pay no income tax. (So-called “self funded”, because those with high superannuation balances have been helped by generous tax breaks, and in some cases inheritances, to accumulate their financial wealth.)

It doesn’t require fancy accounting to enjoy that tax break. One can get a $100 000 tax-free income with the maximum $1.6 million in an account-based pension fund – usually a self-managed superannuation fund –  and another $300 000 or so invested outside superannuation, to supplement the fund’s income with a personal income just below the $18 200 tax-free threshold.

No reasonable person would consider this situation fair. Most Australians would see it as a rort, and most Australians, even many presently enjoying these privileges, would expect the government, or a party aspiring to government, to make the system fairer.

What looks particularly unfair is that untaxed superannuants, once they have lodged their tax returns with a zero tax liability, actually receive a payment from the Tax Office for imputation credits on franked dividends.

Scrapping that provision – allowing a refund of imputation credits to cover only tax actually paid – is an easy reform to sell. The $100 000 superannuants would still get their zero tax assessments, but they would not be refunded their imputation credits.

That’s the essence of Labor’s proposals announced by Bill Shorten and Chris Bowen.

It may pass the sniff test, but in terms of taxation principles, and more careful considerations of equity, it fails.

In effect, it would apply a 30 per cent tax to one class of pension income  – that is income from fully-franked shares – while leaving all other pension income untaxed.

Savvy holders of self-managed funds – and most are reasonably savvy – would soon shift their investments away from shares in Australian companies paying franked dividends.

Conservative investors would move to fixed interest, which will become more attractive as interest rates inevitably rise. Some would shift their behaviour from long-term investment in dividend-paying firms, to speculation in shares with prospects of high capital gains – adding another driver of instability to stock markets and providing lucrative commissions for stockbrokers. Some would invest in real-estate, setting off another boom and keeping housing unaffordable. Some would close their self-managed funds, and put their retirement savings into high-fee-low-return institutions paying allocated pensions – to the pleasure of the finance sector. At a time when the bad behaviour of the finance sector is in full display it’s difficult to understand why Labor is specifically targeting investors who have broken free of it.

In a short time, the government’s revenue stream would dry up, we would still have the injustice of self-funded retirees paying no tax, and dividend imputation, a useful reform introduced by the Hawke-Keating Government, would be compromised.

Imputation was designed  to avoid double-taxation of company profits – a reform that effectively gives Australian investors one of the lowest rates of taxation in the developed world (but don’t expect Mathias Cormann or Scott Morrison to acknowledge that). It was also designed to encourage Australians to invest in equities, so that the benefits of corporate prosperity could be spread, and to support the use of our savings to finance equity in Australian companies.

It was driven by an idea of shared prosperity. Australians needed a nudge to invest in equities. Otherwise Australians would go on putting their savings into low-yield fixed interest and into bricks and mortar, while leaving it to foreigners to invest in equities. As anyone even slightly familiar with finance knows, over the long term equities reliably outstrip almost all other classes of investment.

If Labor really wants to address the inequities in our retirement income system there are two simple solutions.

One, which is probably the most just, is to consider all of one’s income from a superannuation account in the pension phase as normal taxable income, to be added to other income for tax assessment. That would essentially obviate the need for people to continue to hold self-managed superannuation once they retire: all their savings would be in the same taxable pool. Combined with lower personal tax rates that would go a long way to restoring equity and contributing to public revenue.

The other, a little less elegant in terms of taxation principles, is to restore a flat rate of tax on earnings from funds in the pension phase: a 15 per cent tax (which is imposed in the accumulation phase) would provide about the same taxation revenue as abolishing imputation credits, and would not have the effect of diverting investments away from equities. Public revenue would be more secure, and of course there is no reason why the rate should not be higher – perhaps 32.5 percent to align with the middle-income bracket.

Both of these solutions would target high-wealth retirees, without the collateral damage of reducing the income of pensioners with small share portfolios.

Historically Labor has had an impressive record on income tax reform. It introduced an inflation-adjusted capital gains tax system (subsequently wrecked by the Howard Government), a fringe benefits tax, and dividend imputation. While some of these reforms were complex to the lay person (Treasurer Costello never could get his head around capital gains indexation), they were all designed with principles of equity and neutrality in mind.

By contrast with those earlier reforms this proposal reeks of cheap populism.


Ian McAuley is an Adjunct Lecturer in Public Sector Finance at the University of Canberra and a Fellow at the Centre for Policy Development.  He and Miriam Lyons in their work Governomics: Can we afford small government? put the case for a stronger and better-funded public sector, and present evidence of public support for higher taxes to fund public services.

He has a self-managed superannuation fund, and would (initially) pay more tax under Labor’s proposals. Under the measures he is advocating he would pay even more tax, have less opportunity to avoid tax, and would enjoy the pleasure of living in a fairer society which is adequately funding its public goods.


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3 Responses to IAN McAULEY. Labor’s superannuation changes: clever cosmetics but a failure on equity, public revenue and economics.

  1. Bob Mills says:

    Two comments on the scenarios painted here.

    Fixed interest rates would need to double to match fully franked dividend yields from shares in the major banks – which are to all practical purposes government guaranteed -and there are no signs of that happening anytime soon. Why would conservative investors halve their income again because they had lost the 30% icing on their cake?

    Australia’s equity markets have been seriously distorted by the imputation credits rort and there are good arguments that it has had quite perverse effects on corporate investment programs. If as Labor estimates, cutting imputation credits will pull about $5 billion into revenue, then investors chasing those credits must have pushed share prices significantly higher. For corporate executives, whose bonuses rely on rising share prices, the incentive to direct more revenue into dividends to attract share buying demand, rather than long term investments in products and services, staff development, R&D and higher productivity in general, is clear. The dividend policy of blue chips over the last decade at least is certainly consistent with this process.

    So the distortion of Australian investment markets from the dividend imputation rebate rort may well have been incubating consequences at least as dire as those from CGT and negative gearing rorts combined.

  2. Ian McAuley says:


    Thanks for your comments.

    They are valid arguments against imputation but not for Labor’s poorly-considered proposals.

    If, as you argue, imputation has been responsible for distortions, why should not imputation be abolished altogether – why should it be OK to allow those with net tax liabilities to claim credits but not others? There is an appalling asymmetry in Labor‘s proposals.

    Also Labor’s arguments rely on a false perception. They’re like saying that because an employer has paid one’s PAYG tax, the taxes have not been paid by the taxpayer.

    Your point about fixed interest is correct, but I know that many conservative investors do invest in fixed interest. Many people do not know the difference between real and nominal rates – and send themselves broke slowly. And less honest people can lend money to connected private companies at high rates – an illegal but common and almost undectable rort.

    What I didn’t mention in my article (I wanted to keep it simple) is the practice of selling shares just before ex-dividend date, and then buying them back ex-dividend, enjoying all the benefits of imputation (assuming dividend drop covers imputation credits), with the shareholder continuing to enjoy the benefits of imputation. A rort available only to large shareholders who can negotiate low brokerage.

    Interested in your response – through John’s blog or direct to me mcau (at) netspeed.com.au

    Ian McAuley

  3. Richard Barnes says:

    Ian, your arguments are undoubtedly correct. But I can’t help being swayed by the fact that Howard and Costello introduced the ability to use imputation credits to make one’s tax liability effectively negative and thus get cash back from the ATO, which gives me a Pavlovian antipathy towards it. It seems a sort of negative gearing.
    It would be helpful to have some solid data on who exactly would be affected by the proposed change, and to what extent, rather than photos of battlers who will ‘never vote Labor again’.

    Bob Mills has already outlined the challenge of weighing up the distorting effect of the status quo vs the distorting effects of Labor’s proposal. What I wonder about, and haven’t seen much discussed, is the distorting effects of the whole superannuation behemoth. More than $2 trillion now sloshing around the world in search of a profit-making home. This must surely be significantly propping up Australian shares in general, blue-chips in particular, etc, etc. What if that money were instead in consolidated revenue? – or better still in a hypothecated fund, paying solid interest, and being used to fund important infrastructure projects?

    (You won’t be surprised that I believe that Australia’s super system is not PJK’s greatest triumph, but in fact his greatest catastrophe, serving only to magnify in retirement the inequalities which people have suffered during their earlier years)

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