The Government on Monday handed down its Re:Think tax discussion paper, which is expected to trigger significant debate in coming months.
But what does it mean for investors?
Below we highlight six key issues the paper indicates could be a focus of Treasury’s leanings in their eventual advice to Government. They could lead to change down the track, with significant implications for investors and savers.
1. Changes needed to Australia’s unfair savings system
There’s been a lot of focus on the superannuation system and negative gearing, but Australia’s savings regime – outside of super – is arguably unfair. As the report notes, the tax treatment of savings is “very complex and distorts savings choices”.
While the family home is tax exempt, savings deposits in financial institutions are taxed at the full marginal rates. There is also no recognition of the costs of inflation. Inflation currently exceeds interest rates paid on deposits, which means investors are actually going backwards, yet that gross interest is still taxed.
We also need to look at tax exemptions on certain Government bonds as occurs in some countries overseas such as the US and UK. It doesn’t seem right that you can invest in a bond in a pension without paying tax; yet you pay the marginal tax rate if you own bonds in your own personal name. That doesn’t encourage long-term savings outside super.
2. Income growth to be significantly lower
The report says that in the coming decade, annual income growth for Australians will be 1 per cent lower than it was during the previous decade. That is significant. The good times and the national income growth from the resources boom are over.
Australia needs a lot of work to boost labour productivity in non-mining sectors of the economy to sustain the growth in income that we have become accustomed to.
So in addition to an ageing population, we have two forces that could hurt consumption: the slowing growth (and income) profile of the economy; and (as we mentioned above), the negative impact taxation and inflation has on savings (outside super).
Income and consumption could fall significantly unless we adjust tax rates on savings outside of super.
3. Australia’s taxation system is highly inefficient and expensive
One of the starkest numbers in the report was the ATO estimate that compliance costs associated with the tax system is in the order of $40 billion a year. That is a staggering 2.5 per cent of GDP.
The cynic would say that taxation advisors and accountants in this country are making fortunes based on the complexity of the taxation system. It is in their interests to keep it complicated. Yet accounting groups are advising the Government on the structure of the taxation system.
4. Negative gearing is helping to push up property prices
The report also noted that deductions claimed for investment properties as a proportion of gross rental income have increased over the last 15 years and are now greater than gross rental income.
We think that suggests that negative gearing is a clear force in impacting movements in residential property prices. There is some connection between excessive gearing by investors and excessive tax breaks for investors in driving up residential property prices.
It also highlights that there is very little reinvestment by negative gearers back into the underlying property. Rather than reinvest in their property, they tend to use the equity to buy additional property. If owners have not maintained their properties then the underlying quality of rental stock will decline in 10 to 15 years’ time.
5. Australia’s franking system now relatively unique
The report pointed out that Australia’s dividend imputation (franking credit) system is fairly unique in the world. It noted that many European countries such as the UK, Germany, Finland and Norway, ended their imputation system in the 2000s to comply with EU free trade laws. Only a “small group” of OECD countries, including Australia, now operate a full dividend imputation system.
6. The home is Australians’ biggest asset
Australian households hold some 43 per cent of total household assets in the value of the family home. Today the value of homes is more than three times greater than the value of super and so it remains the major asset of households. What’s more, around two thirds of properties have no mortgage and this suggests that substantial wealth has accrued to house owners. While the report does not suggest that a residence should be taxable it does flag the risk that it may well become notionally recognised as an investment asset for the means testing of social security payments.