Franking credit removal hurts all Australians

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Recently there have been a number of bold tax policy announcements from Mr Shorten and the ALP.  I have been proponent of tax reform for years, and have always said that the tax system should encourage effort, encourage diligence, and encourage people to strive for a better life for themselves.  There are multiple things embedded within our tax system that fundamentally pushes back on these principles.  The introduction of the imputation system was a way for Australians to structure their personal financial situations to try to get ahead, to encourage us to invest.  Prior to this, investments in the stock market was only something that was afforded by a select few.  These days, 37% of Australian adults invest in securities (2017 ASX Investor Study). 

The mechanics of the imputation system has changed over the years, depending on what the economy has called for.  Originally franking credits were a non-refundable tax offset, only reducing a tax liability by the amount of tax already paid by the company that had originally earnt the profit.  By 2000, this was changed to a refundable tax offset, meaning that should the franking credits exceed the tax liability raised by the shareholder, then the difference was refunded.  Mr Shorten’s proposal is to change franking credits back to a non-refundable tax offset. 

Doesn’t seem too bad right?  Especially how it’s being sold to the public?  Surely the only people that will be worse off from this will be the wealthy right? Wrong.  Very wrong.  Let’s break down the numbers.  The Company tax rate is 30% (27.5% for small business).  Individual tax rates go above that once taxable income gets to $37,000 (32.5% + Medicare levy).  Therefore, the only people that will receive less money are those on less than $37,000.  These are people that would have these tax refunds factored in to their family budget.  Family budgets that aren’t huge and exorbitant to start with.  Certainly not how its being sold to the public, and certainly not who Mr Shorten has claimed to be targeting. 

Mr Shorten has announced that there is an exemption for anybody in receipt of a government pension prior to March 2018.  I thought we were meant to be encouraging people to get off the government pension?  There are too many things in the Australian taxation system that act as disincentives for bettering your financial system; steeply accelerating marginal tax rates, multiple taxes/levies that only come in at certain levels of income (medicare levy surcharge, reductions in private health insurance offsets, div 293 tax, excess super contribution tax, temporary budget repair levy, etc) 

All of these points are widely publicized and widely written about, but one thing that is remarkably silent is the affect on each and every superannuation fund in Australia.  Nearly every Australian has a superannuation balance.  On average, a large portion of superannuation (both SMSF and industry funds) are invested in shares on the ASX.  So really, its not that 37% of Australians own shares, its more like 100% of Australians own shares either directly or indirectly.  So how would the removal of franking credit refunds affect superannuation?  Pension phase super funds have a tax rate of 0% so they’d obviously lose their franking credit refunds, but an accumulation phase superannuation fund has a flat tax rate of 15%, so (depending on the investment mix of the superannuation fund), these funds could very well lose some portion of refund also.  Those readers with a sharp eye will point out that a diversified portfolio could still mitigate this “loss of franking credits” by investing in things other than shares.  Yes this is correct, although increasingly difficult in an aging population and therefore an increasing pension phase (tax rate 0%) base. 

Mr Shorten did point part of this out, but he limited his point to Self Managed Superannuation Fund members that were in pension phase.  As we just established, all superannuation fund members, regardless of phase, will be affected negatively from this change. 

So what does this mean for long term superannuation?  Those in pension phase will run out of their superannuation balance sooner, creating a greater strain on the government pension system.  Those in accumulation phase will accumulate less over the years in preparation for retirement, creating a greater strain on the government pension system.  But additionally, and perhaps worst of all, shares will become a less attractive investment.  Basic economics is pretty straightforward here; any investment that becomes less attractive to the market decreases in value.  Therefore, it is very likely that the entirety of the Australian Share market would experience a sharp decline should Labor achieve government. 

These events are scary enough in isolation.  When combined with the other ALP tax related proposals it is beyond terrifying.  In addition to causing a drop in the share market, using up pension balances sooner and making it harder for people to grow superannuation balances in accumulation phase, the culmination of the other policies could see the following: 

  • Drop in house prices (cause by the removal of negative gearing) 
  • Increases in rent (caused by the removal of negative gearing) 
  • Increases in taxes paid on capital gains (caused by the removal of the general discount for capital gains) 
  • Decrease in the level of advice received by individuals (caused by the cap in deduction allowed for financial advice) 
  • Increase in tax paid from family trusts (caused by the imposition of a family tax withholding rate, consequently undoing decades of tax planning and creating an increased strain on small and micro businesses’ financial position 

All of these things fail to create a fairer tax system for all Australians.  Instead they end up hurting middle-class Australians, who pay the lions share of Australia’s tax burden already.  Changes to the tax system should be encouraging people to work harder, promote economic growth, champion saving for retirement and reward those who do the right thing.  None of the proposed policies do this. 

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