HENRY TAX REVIEW: Swan’s sweetener for the rich: Maley

Kevin Rudd and Wayne Swan are making the biggest political gamble of their lives – they’re wagering that cuts to the company tax rate and extending the current superannuation system will buy them enough political support to counter the howls of protests from the miners over the resource super profits tax.

Swan yesterday signalled that all its sweeteners – the cut in the corporate tax rate to 28%, which will kick in earlier for small businesses and the new infrastructure fund which will build new ports, roads and railways – were off the table unless the resources tax was implemented.??

And having geared up for a major biff with the unions, Rudd and Swan are anxious also not to pick a fight with high income earners.??

As a result, the Rudd government has ignored all of Henry’s recommendations for changing those tax measures that benefit high income earners.??

Take superannuation. The Rudd government confounded all expectations that it would increase the 15% tax that applies to super contributions. This concessional tax treatment is extremely beneficial to high income earners, and the Henry review recommends hitting high income earners with a higher tax on their super contributions. It argues in favour of treating super contributions as part of income, and taxing them at the employee’s marginal tax rate. ??But the Rudd government has decided to ignore Henry’s recommendation. It wants to expand the superannuation system by lifting super contributions from 9% of income, to an eventual 12%. Its only effort to make the system fairer to low income earners is to pay up to $500 each year into the super accounts of low income people who either get no benefit from the super tax or, even worse, pay a higher tax rate on their super contributions than they do on their normal income.??

Swan yesterday justified his decision to countermand the Henry recommendations by saying that it was important to maintain continuity in the super system. Henry, he said, wanted to shift the benefits of the tax concessions away from the top half of income earners to the bottom half. In contrast, he claimed, the government had decided to “build up the bottom half”.??

Similarly, Swan has also shied away from implementing Henry’s recommendations on changing the capital gains tax on shares and property.??The Henry report is highly critical of the current capital tax scheme, noting that the wealthy get a disproportionate benefit from the concessional arrangements under which only 50% of capital gains are taxed.??

The report notes that in the 2008-09 tax year, the bottom 20% of taxpayers earned about 4% of total dividend payments and 5% of net capital gains. In contrast, the top 10% of taxpayers picked up more than 60% of dividend payments and capital gains. Capital gains are further advantaged because they’re only taxed when the shares are sold and the profits are realised.

So there’s a big incentive for shareholders to sell shares when they’re facing a loss, and to defer paying tax by holding on to shares when they’ve made big profits.??

But the situation is even worse when it comes to rental properties. Because investors are able to deduct all expenses (less rents received) against their other income, investors who borrow heavily are able to achieve significant tax benefits.??

According to the Henry review, these tax arrangements are driving investors to gear up to buy investment properties. The report estimates that around 70% of investors who own rental properties now pay more in interest than they receive in rent, up from around 58% a decade ago.??

According to the Henry review, “the different treatment of capital gains as against other savings income and related expenses is an important driver of these opportunities. This creates significant distortions in how rental properties, in particular, are financed and for the rental property market.”??

Instead of giving huge tax breaks to shares and property, Henry wants to level the tax on all savings, including interest earned on bank deposits. Under the Henry recommendations, investors would have to pay capital gains tax on 60% of their capital gains, rather than 50% at present. But at the same time, investors would be benefit from lower taxes on the interest they earn on their bank deposits.??

According to Henry, this approach “would reduce the large differences in effective tax rates across different savings vehicles…For an individual on the top marginal tax rate, the real effective tax rate on interest income would fall from around 80% to 50%.”?

There’s no doubt that Henry has come up very cogent argument for levelling the tax treatment on various forms of savings, and for reducing the incentive for people to gear up in order to cut their tax bill. But with Rudd and Swan focusing all their energies on the upcoming battle with the big mining companies, there’s little chance they’ll be implemented any time soon.

This article first appeared on Business Spectator.