Shorten’s Tax Plan Straight out of the Keating Playbook: Greenwood

Bill Shorten’s proposed changes to the dividend imputation system, it appears, comes straight out of Paul Keating’s playbook.

Keating was the architect of dividend imputation, and Shorten proposes to take the system all the way back to how Keating designed it, when it became law in 1987.

The proposal also opens the door for Labor to support tax cuts for business, though it appears only small business would benefit.

Bill Shorten is proposing major changes to the tax system around divident imputation. (AAP)

To explain, you have to go back to 1987.

As part of his sweeping reform of the Australian economy, Keating did away with an anomaly that meant shareholders receiving dividends paid double tax.

In other words a company made a profit, paid tax and paid dividends to shareholders who paid tax again. Double tax.

Dividend imputation was a scheme created by Paul Keating back in 1987. (AAP)

Keating’s dividend imputation system changed this. A company that paid its full rate of tax would pay a dividend that had a tax credit attached to it (called a franking credit). You sometimes hear the term fully franked dividend – well this is where a company paid its full rate of tax and passed the tax credit through to shareholders.

Today the top company rate of tax is 30 percent. So take a person who earns between $87,000 and $180,000 a year. Their marginal tax rate is 37 percent. So if this person receives a fully franked dividend, in simplistic terms, they pay an effective 7 percent tax on that dividend (37 percent minus 30 percent).

But, again in simplistic terms, if a superannuation fund pays 15 percent tax – then the chances are it might have some tax credits left over if a large proportion of its investments are in Australian shares, which many self-managed superannuation funds are.

Again, think about the 30 percent tax credit on dividends, minus the 15 percent tax the fund pays. Clearly some of those excess tax credits may be used to offset tax on interest from cash deposits or rents on properties, but some super funds still end up with more tax credits than they have tax liabilities.

Shorten has pulled his latest tax solution straight from the Keating economic playbook. (AAP)

In 2000 Peter Costello, as treasurer, expanded the dividend imputation system to allow taxpayers with excess imputation credits to receive a refund cheque back from the Tax Office.

But Costello did something else. He allowed people in the pension phase of superannuation to pay no tax at all. So people in the pension phase of superannuation, running their own fund, could arrange their investments (lots of fully franked shares) to maximise the refund they get back from the government each year.

And it’s this that Bill Shorten is winding back.

Shorten says the measure will reap $59 billion over 10 years. But he also says people will pay no more tax. And this is where Bill is using semantics. Around 200,000 super funds benefit from this scheme.

John Howard and his treasurer Peter Costello made changes to the dividend system in 2000. (AAP)

They, technically, will pay no more tax. But they also lose money because tax refund cheques they currently receive would stop coming. That’s where the reported $59 billion over 10 years comes from.

The arguments will come thick and fast that this is class warfare – that Labor is changing rules to attack the wealthy. But it might not just be the wealthy affected.

Labor’s own maths suggests the move affects more taxpayers than imagined. Labor says the policy will not apply to 92 percent of the 12.8 million Australians who lodge annual tax returns. But it does apply to 8 percent – more than a million taxpayers.

But there’s potential even more are affected.

Prime Minister Malcolm Turnbull and Treasurer Scott Morrison alienated many of their own constituents – self managed superannuation fund investors – before the last Federal Election by placing a limit of $1.6 million as a super fund’s tax free threshold.

Taxes will continue to dominate the agenda for Malcolm Turnbull heading into the next election. (AAP)

Though you would expect them to claim Shorten has embarked on class warfare, to turn this into a political fight, another solution could be to pinch the Labor policy and enact it themselves. Labor could barely disagree.

Remember this though: Bill Shorten says he is targeting self-managed superannuation funds. But in fact he is in fact targeting all super funds, especially those in pension phase, because every super fund is entitled to claim these franking credits.

Just one example I looked at this morning: Australia’s largest superannuation fund, Australian Super. Bill Shorten is a former director of this fund, so he would know it well.

In 2015 it paid net tax of $1.21 billion on benefits accrued as a result of operations of $21.1 billion (an effective tax rate of just over 5 percent). During that year it claimed $65.6 million in imputation and withholding tax credits, which it was quite entitled to do. In this case, Australian Super’s imputation credits did not exceed its total tax liability, so it paid tax.

But in a super fund where the tax credits are greater than the liability – think allocated annuities or allocated pensions – they will most likely receive a refund cheque back, which they then use to boost members’ returns. After all, they are likely to have shares, which pay a fully franked dividend, which they are currently entitled to claim back.

A giant allocated annuity fund with billions of dollars in it – effectively a super fund in pension phase – is one tax payer. One taxpayer out of the million taxpayers affected by Bill Shorten’s changes.

But that allocated annuity fund might have thousands of people invested in it – people who are lower and middle income earners, who rely on that fund for their retirement income. And Shorten’s move has the potential to reduce their returns.

Which is why the unintended consequence of Bill Shorten’s plan will hit many, many more people with lower returns than he will ever give a hint about in his speech today.