Franking credits should be axed
Australia’s dividend imputation system promises to remove ‘double taxation’ but, in doing so, it has created problems of its own that are now more damaging than the concern they were supposed to solve.
When a business pays a dividend it comes from income that has already been taxed by the corporation and it goes to the pocket of shareholders where it is taxed again. This is double taxation. Franking credits, attached to dividends when companies have paid tax in Australia, are designed to correct this problem and, as a system, it works.
Dividend imputation costs $20bn in forgone tax a year and the ATO pays more than $3bn in cash to investors under the scheme. What was once a tweak to laws to solve a small complaint has morphed into a giant transfer of wealth from business to selective shareholders. Typically, older, richer Australians benefit from the system.
In an environment of zero global interest rates its impact has grown, distorting the operation of markets and the decisions of management. Since imputation inflates the value of dividends, people want them and companies comply. The result is that the share market is now a cash box for retirees rather than a way of business to raise capital.
Despite record profitability, non mining investment has collapsed – it is at its lowest level since the recession of 1991 – because business is spending all its cash paying off shareholders rather than investing in new projects.
Companies that shouldn’t be paying dividends are– witness Arrium or QBE in recent years – while others boast payout ratios far too high to be sustainable, for example, Woodside. Since dividends are worth more to locals and management is happy to oblige them, foreign capital is less likely to invest in Australia. Over time, imputation could raise the cost of capital, not lower it.
The imputation system does have some good qualities, for example, it encouraging companies to pay taxes, but the unintended consequences of the scheme far outweigh its benefits. The money saved, about $20bn a year, could fund a cut in the company tax rate that would benefit all shareholders without generating the distortions that imputation is clearly creating.
