It’s not every day a policy emerges from Canberra that will add $11.4 billion to the tax coffers over four years, but that’s exactly what Labor’s proposed changes to ‘dividend imputation’ would do.

When that kind of money is changing hands, you know there’ll be a furious political fight, and Treasurer Scott Morrison did not disappoint on Tuesday calling the move a “cruel and brutal blow to pensioners and retirees”.

To judge whether he’s right, voters need to know who the changes will affect and whether the tax concessions Labor plans to abolish were good policy in the first place.

Labor’s starting point is that “more than 92 per cent of taxpayers do not receive a cash refund for excess imputation credits, and won’t be affected at all by this change”.

So where is all that money coming from?

The answer is from people who hold shares directly, or through a self-managed superannuation fund, and who receive franking credits on those shares “in excess” of the tax payable on their other sources of income.

What’s a franking credit?

Australian companies pay dividends to their shareholders after they’ve paid company tax – currently 30 cents in the dollar for large companies such as banks, miners and telcos.

Company tax, as University of Sydney tax expert Micah Burch points out, is basically a withholding tax – since the ATO doesn’t know who’ll get the dividend, it takes 30 cents in the dollar up front.

When ‘dividend imputation’ was set up by the Hawke/Keating government the idea was to avoid taxing the same dollar twice.

So having taken 30 cents out, the ATO would refund some of that money to any shareholder whose marginal tax rate was lower than 30 per cent.

At present, for example, a young retail worker might have a few BHP shares, and have a top marginal tax rate of 19 cents in the dollar.

The ATO would therefore send them a refund of 11 cents at tax time for every franking credit (30 cents minus 19 cents). 

If that retail worker finished law school and got a highly paid job, their top tax rate would be 45 cents in the dollar, so they would not get a refund. However, they would get to knock 30 cents off their tax bill for every franking credit they’d received. 

In both those cases, the individual has a tax bill that is larger than the franking credits generated by ‘a few’ BHP shares.

Where it gets tricky is if the person owns a lot of shares and therefore has franking credits worth more than their entire tax bill.

The Howard/Costello government changed dividend imputation law in 2001 so as to pay the shareholder whatever portion of their franking credits they could not use.

In the extreme case, people with no taxable income at all would get a cheque from the ATO for the full 30 cents credit on every ‘fully franked’ share they owned.

At face value, then, you might wonder who these poor people are – people with no taxable income must be on Struggle Street, right?

Actually, no.

‘No taxable income’ does not mean they have no money.

Another change made by the Howard/Costello government was to make distributions from superannuation accounts tax free. We pay tax when we put money in, and there is a small tax on earnings within the fund as it grows, but zero tax is applied to the retirment income it finally pays out (up to balances of $1.6 million).

That change was exacerbated by some short-lived, but very generous increases in the amount of money the well-off could sweep into their super accounts.

Famously, in one year Peter Costello invited people to put a cool million into their super without facing any non-concessional tax hits.

The end result is that plenty of Australians have zero ‘taxable income’ in retirement, yet very large income streams to live on.

If those individuals hold franked shares, either directly or through a self-managed super fund, they can also receive a nice franking credit refund at the end of the tax year.

That’s where the $11.4 billion is “leaking” out of the tax system, as Labor puts it.

Some retirees who are not well off will also get franking credit refunds, and there is no doubt the Coalition will dig out their stories to explain why this tax change is unjust – and for them, of course, it will be.

But their stories will not be typical.

The Hawke/Keating version of imputation, that Labor now wants to restore, was about reducing tax bills so that tax was not paid twice on the same dollar. 

By contrast, the Howard/Costello changes created a situation in which wealthy owners of SMSFs in particular could avoid paying tax on that dollar even once.

The question that really needs to be answered is not ‘is this policy fair?’ so much as ‘how did they get away with that for so long?’