Tax Reform – Digital Finance Analytics (DFA) Blog

Is Negative Gearing The Next Target?

Interesting to see the momentum now turning to discussion of whether the Government intends to tackle negative gearing having U-turned on the tax cuts.

As The Conversation put it, there are two things the prime minister needs to get into his head about tax. One is that saying he won’t make any further changes no longer works. The other is that negative gearing doesn’t do much to get people into homes.

Australia’s Treasury has begun publishing estimates of the cost of the present unfocused system of negative gearing. Its latest, released last week, puts the cost at $2.7 billion per year, to which should probably be added a chunk of the $19 billion per year lost as a result of the capital gains concession.

Albanese is normally cautious. But as he is showing us right now with his rejigged Stage 3 tax cuts, there are times when he is not. If he really wants to throw everything he has got at building more homes, he knows what to do.

http://www.martinnorth.com/

Go to the Walk The World Universe at https://walktheworld.com.au/

Today’s post is brought to you by Ribbon Property Consultants.

Stage 3 Tax Revamp: A Speck In The Ocean?

Lots of noise this week about the revamped stage 3 tax cuts. It’s worth remembering first that 2 in five Australians pay no tax because they do not earn enough, so this is change is certainly not going to impact every household.

Anthony Albanese had repeatedly committed to delivering stage 3 as legislated by the Coalition – but told the National Press Club on Thursday, “When economic circumstances change, the right thing to do is change your economic policy. That’s what we are doing.”

At one level of course this is another broken promise – just like the superannuation tax cap which came in last year. Presumable the calculus is more people will benefit than not, and it’s a long time to the next election, so people will forget. We will see.

http://www.martinnorth.com/

Go to the Walk The World Universe at https://walktheworld.com.au/

Paying Tax And Interest Through The Nose In A Deep Per Capita Recession!

The Australian Bureau of Statistics (ABS) has released the June quarter National Accounts, which were an unmitigated disaster and confirmed that Australia is in a deep per capita recession.

The economy as measured by real GDP grew by only 0.2% in the September quarter, driven by increased government consumption and capital investment over the quarter and badly missing economists’ expectations of a 0.4% print: Growth over the year was 2.1%, less than population growth over the same period. While the population surge earlier in the year has supported demand overall, it is now rolling over and will not provide the same support in 2024. Or as Luci Ellis, at Westpac put it The Australian economy limped along in the September quarter.

Real per capita GDP has fallen for three of the past five quarters, with the March quarter revised up to flat. Accordingly, GDP per capita fell 0.3% over the year. Expenditure by households was dead flat over the September quarter and would have fallen by around 0.7% per capita. By contrast, growth in both household consumption and GDP over 2023 slowed due to sustained cost of living pressures and higher interest rates. Household consumption would have fallen even further had the savings rate not fallen to just 1.1%, which is the lowest level since December 2007.

The savings rate is now well below the ‘par’ of 6.5% and notionally implies a draw-down on the ‘additional savings’ accumulated during the pandemic – estimated at around $260bn – running at about $12bn a quarter. In total, about $43bn, or 16.5% of this reserve now looks to have been drawn down. Of course these are not equally spread across households, with many now having no buffers at all.

As Westpac put it. the policy drag on Australian households is clearly biting.

Why a proposed capital gains tax could mean tax cuts for most New Zealanders

As part of a major review of New Zealand’s tax system, the government’s Tax Working Group recommended a comprehensive capital gains tax. New Zealand is one of few countries without a capital gains tax, and the proposal has generated outrage, via The Conversation.

Commentators have described the proposed tax as a “mangy dog”, “an envy tax”, an “attack on the kiwi way of life” and “offensive to New Zealand values”.

Digging deeper beyond the headline-grabbing rhetoric, some commentators have expressed concern the proposed tax will have a detrimental impact on the economy by distorting investment decisions and creating an excessive administrative burden on taxpayers and the Inland Revenue Department (IRD). There are also claims about the lack of fairness in taxing “hard earned gains” that have been built up for retirement.

Missing from the debate is the fact that a capital gains tax should reduce income taxes for most New Zealanders.

A fair tax system

The debate strikes at the heart of two essential elements used to assess the quality of a tax: equity and efficiency.

In order to be equitable, a tax should treat people with similar economic situations in a similar way. This is called horizontal equity. Equally, taxation should fall more heavily on those who have the ability to pay. This is referred to as vertical equity.

These are the principles set out by the great Scottish economist Adam Smith in his 18th-century magnum opus The Wealth of Nations. In order to evaluate the tax proposals, New Zealand’s Tax Working Group used Smith’s principles of fairness alongside two distinctly New Zealand frameworks: Te Ao Māori (Māori worldview) and the Living Standards Framework. These two frameworks have been developed to guide policy makers toward the objective of inter-generational well-being, including the effect of policy on growing inequality and non-economic factors such as social and environmental capital.

Not taxing capital gains results in a failure to achieve both horizontal and vertical equity.

Taxing passive gains

Currently, in New Zealand, some income is taxed and some is not. The income that is taxed is typically derived from personal services (“hard work”) and from investments of capital (interest, rent and dividends). The income that is not taxed is typically derived from market movement, such as capital gains on assets.

On the whole, we have a counterintuitive approach to taxation in New Zealand where we tax “hard work” and fail to tax gains that accrue passively. Two people in similar situations are taxed differently. A person who invests in a small business that produces goods and services pays tax on all their profits, while another who invests in property that accumulates passive gains, does not.

In a world where the accumulation of capital through passive gain is increasingly being held by a smaller group, the need to tax those gains is becoming more urgent.

Statistics provided by the Tax Working Group indicate the taxation burden is flat across all income groups. This means our tax system does not operate according to Smith’s ability-to-pay principle. We have progressive tax rates but those in the highest income deciles enjoy much of their income in the form of tax-free capital gains. New Zealand’s failure to tax capital gains is inequitable.

Tax efficiency

The claims that a capital gains tax is inefficient centre around administrative issues and investment distortions. The first claim has some merit – new taxes usually result in additional administration, especially early on. The second has no merit whatsoever.

For New Zealand’s economy to thrive, greater investment in the production of goods and services is required. However, these investments are often risky. And they are taxed when profitable. Hence it is a far more attractive investment proposition to invest in low-risk assets that attract little or no tax, such as land.

Contrary to popular belief, land investment, in itself, is not a productive activity. The land is there regardless of who owns it. Someone may conduct productive activity on the land, such as farming or building houses, but the ownership itself does not produce goods or services. A capital gains tax would reduce distortion in investment choices, not increase it.

If tax applies to gains on investment in assets as it does to business profits, it will encourage investment decisions based on where the greatest return can be made, not where tax-free gains are derived. The lack of capital gains tax has been distorting investment decisions for decades.

Impact on economy

In the longer term, it would be a positive outcome to attract some investment out of property and into production of goods and services, regardless of any possible adjustments that might occur in the short term.

And the tax cuts? Missing from this debate entirely has been recognition of the Tax Working Group’s recommendation that the additional tax collected from a capital gains tax should be used to reduce income taxes. This is not a “tax grab” but a reallocation of the tax burden.

If the government were to implement the recommendations of the Tax Working Group report, most New Zealanders would find themselves with an increase in their after tax income. Greater equality would seem to be more consistent with kiwi values than the status quo.

Author: Alison Pavlovich, Assistant Lecturer in Taxation, Massey University

Yet Another Nail In The Investment Property Coffin

The AFR has reported the Turnbull government is planning a crackdown on capital gains tax concessions for property investors to seize the mantle on housing affordability and provide revenue to help replace soon-to-be dumped budget cuts.

Given most property investors are benefiting more from rising capital gains than offsetting costs from negative gearing, this is a significant change of tune.

The policy backflip, to be unveiled in the May budget, comes after more than a year of savaging Labor’s proposal to halve the capital gains discount as an assault on badly needed investment.

It is understood the policy being worked on within government would be confined to property investment, and not apply to all investments such as shares, as Labor’s plan would. Neither would the Coalition policy target negative gearing, as Labor is doing.

Options being worked on include following Labor in halving the 50 per cent discount on capital gains tax to 25 per cent, or reducing it by another amount. The other is adopting a phased model in which the discount would increase the longer the property was held. A property would have to be held for several years before the investor was eligible for the full 50 per cent discount.

However according to the Real Estate Conversation, such a move is unlikely.

This morning Malcolm Turnbull and finance minister Mathias Cormann dismissed the reports.

“We do not support the Labor Party’s plans to increase capital gains tax,” the Prime Minister said in a press conference.

Turnbull also said the government was not considering to “outlaw negative gearing.”

The Property Council of Australia urged caution amid the conflicting reports.

“Increasing capital gains tax runs the risk of reducing the incentive to invest at a time when Australia needs to build new housing to cater for our growing population,” said Ken Morrison, Chief Executive of the Property Council of Australia.

“While there are conflicting media reports this morning, we urge the government to be extremely cautious if it is considering changing the CGT discount,” he said.

Morrison pointed out that the capital gains tax discount is intended to compensate for natural growth in asset prices due to inflation.

“The CGT discount is recognition that you should not tax people for inflation – inflation-driven capital growth is not real growth and investors should not be taxed for it,” he said.

Morrison said the construction cycle is already past the peak, and any disincentive to build should be considered carefully.

“The industry has passed the top of the construction cycle,” he said.

“The risk for the government is that if it moves too far, it runs the risk of tightening housing supply and adding further pressures to housing prices.”

After all the talk, what is the Turnbull government actually doing for small business?

From The Conversation.

Treasurer Scott Morrison continues to warn about the decline of Australia’s global competitiveness if the centrepiece of the 2016–17 federal budget – a company tax rate cut – is not passed.

However, such tax cuts are not necessarily the best approach for the government to support small business. They need other – more immediate – forms of support, our research shows.

What’s being proposed?

The 2016-17 budget reflected the Turnbull government’s catchphrase of “jobs and growth”. From a small-business perspective, the budget wanted to:

… boost new investment, create and support jobs and increase real wages, starting with tax cuts for small and medium-sized enterprises, that will permanently increase the size of the economy by just over 1% in the long term.

In 2014, Australia had the fifth-highest company tax rate among OECD countries, albeit average in the Asia-Pacific region. Local investors benefit from lower taxes on dividends through Australia’s dividend imputation system, which passes credits onto them for corporate taxes already paid.

The Abbott government later succeeded in lowering the tax rate for small businesses with a turnover of less than A$2 million from 30% to 28.5%. The Turnbull government’s plan would eventually reduce the rate for all companies to 25% by 2026-27. It’s a phased implementation over the next ten years, starting with an immediate cut for small companies to 27.5%.

However, 70% of small businesses are unincorporated. This means their owners add profits to their personal income for tax purposes. While the government has promised an increase in their tax offset percentage, it plans to retain the cap of A$1,000.

All small businesses will benefit from the simplification of tax rules for stock, GST and depreciation. But the government’s plan introduces three levels of concessions for small businesses. This complicates the definition of what these small businesses are.

Definition disputes

Defining small business goes beyond an academic debate.

With little consensus on typical turnover numbers – these range from A$2 million to A$25 million – a better indicator could be the Australian Bureau of Statistics definition of small businesses as those with fewer than 20 employees. And 97% of the 2.1 million businesses trading in Australia fit this definition.

It is risky, though, to simplify the definition into one blunt instrument that ignores differences in industry, life cycle and high-volume versus high-worth sales. A more nuanced approach is needed to ensure relief for the businesses that need it most.

However, the major political parties seemingly remain focused on turnover as a measure of what is and isn’t a small business. The government’s plan extends the upper limit for the turnover of small businesses to A$10 million by 2016–17, which covers some of the 3% of Australia’s non-small businesses.

Meanwhile, Labor has argued for immediate support for tax cuts to small businesses with a turnover of less than A$2 million.

Lifting the turnover threshold for all small businesses from A$2 million to A$10 million in the short term will increase the number of businesses that can access some tax concessions by 90,000. And it may improve economic growth as larger firms receive some relief.

What small businesses actually need

Small businesses need immediate and certain tax relief in the short term. They struggle with an uncertain business environment.

But, in the longer term, our research shows increased competition, a lack of market demand and red tape are but a few of the issues small businesses deal with. They highlighted statutory and regulatory compliance, as well as tax planning and compliance, as major issues for them.

More than tax rates, complex tax requirements and regulations are issues causing small businesses substantial distress. The Australian Tax Office’s research supports this: more than 70% of surveyed clients viewed their tax affairs as complex. And the World Bank’s ease of doing business index ranks Australia 25th in terms of ease of paying taxes.

The immediate tax relief for small businesses is tied up in proposed legislation surrounding the government’s ten-year tax plan, which is unlikely to find enough support to pass the parliament in its current form. The uncertainty and complexity that have ensued from the political conflict over tax have negative effects on the small business landscape.

Innovation is likely to suffer under such uncertain conditions. The government’s plan recognises that:

Small businesses are the home of Australian enterprise and opportunity and they are where many big ideas begin.

In addition to ideas and passion, small businesses need resource availability, appropriate capabilities and market access to innovate. The plan proposes measures that satisfy some of these criteria, but more focus on finding ways to minimise bureaucracy to provide time to focus on innovation is needed.

The role of government is undeniable in such initiatives. Even if one argues that tax relief is a temporary reprieve, this cash injection can jump-start small business innovation and growth.

Should the two major parties fail to find common ground on the government’s company tax cut, the stalemate will continue – and leave small businesses in the lurch.

Authors: Martie-Louise Verreynn, Associate Professor in Innovation, The University of Queensland; Thea Voogt, Lecturer in Tax Law, The University of Queensland.

Leveraging Will Survive Corporate Tax Reform – Moody’s

Moody’s says analysts from a major bank believe that reducing the top corporate income tax rate from 35% to 20% will slow the average annual increase of US industrial company debt over the next 10 years from nearly 5% without a tax cut to roughly 2% with the tax cut.

However, what happened after the slashing of the top corporate income tax rate from 1986’s 46% to 1987’s 40% and, then, to 1988’s 34% questions whether prospective tax cuts will more than halve the growth of corporate debt over the next 10 years.

Nevertheless, business borrowing is likely to be noticeably lower if business interest expense is no longer tax deductible. Such tax-reform induced reductions in business borrowing will be most prominent among very low grade credits and during episodes of diminished liquidity, extraordinarily wide yield spreads for medium- and low-grade corporates, and exceptionally high benchmark borrowing costs.

The top corporate income tax rate probably will be cut from i 35% to either the 20% proposed by House Republicans or to the 15% offered by Trump’s team. Assuming, for now, the continued tax deductibility of corporate interest expense, a lower corporate income tax rate increases the after-tax cost of corporate debt. However, a reduction by the corporate income tax rate may add enough to after-tax income to more than offset the burden of a higher after-tax cost of debt. In addition, today’s relatively low corporate borrowing costs will mitigate the increase in the after-tax cost of debt stemming from a lowering of the corporate income tax rate.

Corporate debt sped past GDP and revenues despite tax cuts of 1987-1988
Thus, a lowering of the top corporate income tax rate probably will not have much of a discernible effect on corporate borrowing. Despite the lowering of the corporate income tax rate from 1986’s 46% to 34% by 1988, the ratio of debt to the market value of net worth for US non-financial corporations rose from 1986’s 38.6% to a mid-1994 high of 51.1%. Moreover, from year-end 1986 through year-end 1989, non-financial corporate debt advanced by 9.6% annually, on average, which was much faster than the accompanying average annual growth rates of 7.2% for nominal GDP and 7.0% for the gross value added of non-financial corporations.

The supposed de-leveraging effect of corporate income tax cuts was further challenged by how debt outran both the economy and business sales despite still elevated corporate borrowing costs. For example, Moody’s long-term Baa industrial company bond yield barely fell from 1986’s 10.73% average to the still costly 10.55% of 1987-1989, while a composite speculative-grade bond yield actually rose from 1986’s 12.44% to the 13.05% of 1987-1989.

It should be noted that the increase in the after-tax cost of debt was greater following 1987’s corporate income tax cut because of the much higher corporate bond yields of that time and yet corporate debt still grew rapidly. In stark contrast, recent yields of 4.74% for the long-term Baa-grade industrials and 5.96% for speculative-grade bonds are substantially lower, which, in turn, lessens the degree to which corporate income tax cuts discourage balance-sheet leveraging.