Sunday, August 25, 2013

What value franking credits for the punters?

My thanks to Leigh Dall'Osto for her Facebook post of email comment from barefoot investor Scott Pape on the coalition PPL policy and also congratulatons on the birthday success of Plan B! The issue was on complexity of policy related to imputation credits to fund the rather generous coalition policy is an impost on self funded retirees. 
At risk of stuffing up I will have a go here. The dividend imputation system was introduced by PJ Keating to eliminate ‘double taxation’ of company profits. Where a company has paid tax on profits and an investor receives a dividend from those taxed profits the tax that has already been paid at the current 30% rate is credited to the investor. This creates different circumstances depending on the tax rate of the investor and the ‘franking credits’ created are particularly valued within superannuation where the tax rates are below the company tax rate.
The proposal here is to cut the general company tax rate from 30% to 28.5% but then to impose a 1.5% levy on any taxable company profits Above $5 million. The issue is that as a ‘levy’ and not a ‘tax’ that 1.5% will not flow through to investors as an imputation tax credit. I think that is what Scott Pape hasn’t made clear and also that it has some effect on not just retirees but all investors in Australian equities, but maybe I am equally opaque? 
How significant is that effect? Well if you are an average person in a default balanced super fund such as QSuper you may typically have about 30% in Australian equites. Based on some broad simplistic assumptions of 5% dividend yields fully franked it may reduce the total income yield return to the fund by about 0.03% -0.05% (percentage points)  depending on assumptions re other fund investments. That will be higher for retirees in a pension phase but is not going to be the most critical issue to consider in your retirement funding and you should probably be more worried about management fees.
The most critical aspects of this PPL proposal are equity, productivity as well as cost but the detail of this particular funding aspect is really rather secondary I reckon.

Consideration of this particular aspect belongs in broader tax reform. Nicholas Gruen has previously suggested that the company tax rate can be cut to 20% if imputation is abolished with consequent reductions in the cost of capital and economic benefits. Would that make investors better or worse off? Dividend imputation - $20bn for the taking

Update from Joshua Gans:  Is the Coalition’s Paid Parental Leave Scheme fair?


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