Under the classical tax system, company tax of $30 would be paid and the dividend payment of $70 would lead to a further $31.50 of tax for a shareholder on a 45% tax rate, for a total tax take of $61.50.
Now while that is a hypothetical comparison which ignores overseas tax rate levels and other tax system features, it does indicate that focusing on the 30% “headline” rate can lead to bad policy. And labelling the tax withheld as “corporate” tax rather than as a “withholding” tax on behalf of shareholders creates a misleading image when international comparisons are made.
Why do our business leaders not acknowledge the illusory nature of the 30% headline rate? One reason may be that for some companies the headline rate is actually the true rate. For foreign shareholders, franking (tax) credits cannot be used, so that foreign companies may perceive Australia as having a higher than average corporate tax rate.
And for Australian companies with foreign shareholders, a cut in the headline rate would be advantageous to those shareholders. Whether that loss of tax revenue, but increased interest in Australian equity investments by foreigners would be a good outcome for Australia is an open question.
Another reason why business leaders have this myopic perspective may be that the imputation tax system induces them to act in ways which they would not otherwise do, but which are actually in the best interests of shareholders.
Imputation removes tax incentives for excessive leverage – at least for companies which are profitable. It also induces high dividend payout rates, thus reducing the ability of hubristic managers to retain earnings and invest in pet projects without having to face the discipline of raising outside funds.
Yes, we could almost halve the headline company tax rate without budgetary costs by abolishing imputation. But that is not an obviously good strategy – and would create significant angst among investors who have structured their investments around capture of franking credits.
Far simpler that we recognise the truth that a 30% headline corporate tax rate under dividend imputation is actually nowhere near that large an impost on business.
Kevin Davis is Research Director of the Australian Centre for Financial Studies and a Professor of Finance at University of Melbourne (on leave in 2012) and a visiting Professor at Monash University. This article first appeared on The Conversation.
