Money Finance News Take ‘left’ and ‘right’ politics out of tax reform
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Take ‘left’ and ‘right’ politics out of tax reform

dividend imputation
The economic criteria for good tax reform are clear – it's the politics that's murky. Photo: Getty
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The backlash against Labor’s proposal to end cash refunds on dividend franking credits came swiftly, with a predictable series of “class war!” headlines in the News Corp papers on Wednesday.

But as The Australian Financial Review‘s US correspondent John Kehoe noted in a tweet, the same papers have also tried the opposite line: “Yesterday it was ‘class warfare’, today a hit on low income earners. Which is it?!”

Opponents of the reform are attempting to shoe-horn it into a wider narrative about ‘Labor’s lurch to the left’.

That’s a pity, because the economics of tax reform are well established and transcend the tribal politics of ‘class’, ‘left’ and ‘right’.

Good vs bad

Economists have long known that there are good and bad taxes as far as economic growth is concerned, and getting the right mix of taxes is as important as the overall level of taxation in the economy.

‘Bad’ taxes are either very expensive to collect, such as import duties on online purchases, or distort economic activity, such as stamp duties that help keep empty-nesters in homes that would better house young families.

The current system of dividend imputation fits the ‘distorting’ category.

The returns on big blue-chip stocks such as BHP or Telstra are inflated by franking credits, leading investors to bid up the price of their shares, and results in a misallocation of capital within the economy.

As David Murray, who headed the government’s Financial System Inquiry in 2014, told the ABC on Wednesday: “We pointed out in our report that dividend imputation had a consequence of distorting the allocation of funds in the financial system.”

That’s bad for growth overall, but it has another distorting effect.

The $11.4 billion in tax revenues that Labor expects to recoup over four years if it wins government is money that for years has been mostly flowing to wealthier Australians.

As the Grattan Institute notes: “The wealthiest 20 per cent of retirees own 86 per cent of shares held by older Australians outside of super. And among self-managed superannuation funds (primarily held by wealthier retirees), half of the refunds are currently going to people with balances over $2.4 million.”

That might be good for their estate-planning needs, but it is bad for ‘jobs and growth’.

That’s because those billions in refunds push more of the tax burden onto younger, less wealthy Australians who have a higher propensity to consume.

Weak household consumption growth is holding the economy back, and it is doing so because of low wage growth, high levels of private debt, and personal income taxes that have grown too large in relation to the overall tax take (see chart below).

The changes to dividend imputation made by John Howard and Peter Costello – like their changes to capital gains tax and superannuation taxes – have been very generous to older and wealthier Australians for nearly two decades.

It might be uncomfortable for some to hear, but younger Australians are working just as hard as previous generations but with no prospect of the same financial gains across their lifetimes.

The asset-driven wealth miracle enjoyed by the baby boomers was a historical one-off – it cannot be repeated.

In this context, the issue of intergenerational equality is the real issue, not some 20th century notion of ‘class’.

A reasonable level of equality, as both the OECD and the IMF have argued in the past few years, is not just a ‘desirable’ feature of a growing economy – it is one of its key determinants.

That’s why cries of ‘class war’ are so unhelpful.

Any tax reform proposal, from whichever side of Parliament, can be judged by much less ideological criteria: Do they help the economy grow? Do they broaden the tax base? Do they shift revenue collection from distorting to less-distorting taxes? And do they strike a productive balance of ‘equality’.

Judged on those criteria, Labor’s dividend imputation plan passes muster in a way the Coalition’s company tax cut plan did not – that plan would have pushed more of the burden onto struggling households, not less.

In a perfect world economists would prefer wholesale tax reform that puts more emphasis on land taxes and GST revenues, and less on income and company taxes.

Until then, however, we need to start judging reforms based on what’s right for Australia, rather than on outdated cries of ‘class war’ from the noisy few.

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