Should Australia pay for lower company tax by abolishing dividend imputation?

Vale Australian dividend imputation? Some say a company tax cut from 30% to 20% is possible without it.

Australian investors were furious when told the 1.5% Paid Parental Leave levy part financing the Government's PPL policy would be un-franked. How would they react to abolition of imputation altogether?

Assume company tax drops from 30% to 20%, with no imputation. Under current personal tax rates, Australian investors' total tax on franked dividends would increase by between 10.2 and 20 percentage points. Lower income earners are worst affected. Super fund earnings tax increases between 17% (accumulation phase) and 20% (pension phase). See chart.

Foreign residents' tax on Australian franked dividends drops 10 percentage points (33%).

Chart. Cutting company tax from 30% to 20% and abolishing dividend imputation: who pays? *

* In this chart, personal tax rates include personal income tax, the Medicare levy, the NDIS levy, and the deficit levy.

Source: Geoff Carmody & Associates.

Why tax Australian shareholders more to finance tax cuts to foreign shareholders?

There is no equity case, especially for lower income Australians.

Is this efficient? Certainly, efficiency questions abound.

Is restoring our pre-1985 double income taxation of dividends efficiency-enhancing? If other countries persist with this, should Australia?

What behavioural responses are likely?

Increased foreign investment here might follow. Many support this – yet complain about the high $A. Does Australia face a dearth of capital inflows? Why is the $A strong and rising?

Cutting company tax and abolishing imputation – combined with high and increasing personal tax rates – encourages reduced dividends and higher corporate retentions. Shareholders exploit capital gains tax discounts to realise income from corporate investments. Is this efficient?

One commentator suggests this response is a 'nice thing'. Foreign investors 'compensate' Australian shareholders for their increased tax on dividends by buying their shares at higher prices (presumably due to increased corporate retentions). Show me the arithmetic.

Before 1985 Australia had neither capital gains tax nor dividend imputation. Assuming we must have an income tax (not my preference, incidentally), objective analysts saw this as a major inefficiency in our tax 'system'. The behavioural effects noted above were evident. What's changed?

Incidentally, mixing a non-franked 1.5% PPL levy and a franked 28.5% company tax will be very messy, costly, with unintended effects (eg, 'leakage' of the PPL levy burden to other companies). Better to fully frank the PPL levy (or, much better, avoid the need for it altogether), especially if it's temporary.

It's asserted the banks are pushing for imputation abolition. It's claimed deposits are treated less favourably than dividends. Really? Full imputation of dividends means they are income-taxed just like interest-earning deposits. Company tax on dividends, as a withholding tax, may occur earlier than interest income tax. Income tax still double-taxes income from saving, however invested, but that's another battle.

Are capital gains tax discounts for assets held longer than a year the problem? These discounts don't apply to interest on deposits. So what? Banks are companies too. Their share prices have had a very good run.

Cutting company tax is well worth considering, but within a comprehensive tax reform package, allowing for interactions with other parts of our tax 'system'.

Financing company tax cuts by abolishing imputation, with no other reforms, is neither efficient nor equitable. It restores the pre-1985 'double income taxation' of dividends, and the problems evident at that time.

Taxation of Australian resident dividend income from overseas, and foreign resident dividends generated here, are indeed problems. Mutual recognition negotiations between sovereign tax jurisdictions are needed, not forcing Australian residents back to the inferior pre-1985 double tax model.

Mutual recognition is an inherent difficulty for sovereign national income tax systems grappling with international dividend flows. If countries relied much more on consumption or expenditure-based taxes, this problem would be greatly reduced. Tax would be levied in the country where consumption occurred. International tax shifting concerns would diminish as well.

Australian imputation is not the problem. Its absence elsewhere, and difficulties securing international agreements recognizing income tax paid in other jurisdictions, are the problems.