Local investors have dodged a nasty tax bullet

As volatility continues to rattle markets, local investors should take comfort from the fact they’ve avoided a bitter tax pill.

Traders work on the floor of the New York Stock Exchange. (Spencer Platt/Getty Images/AFP)

Wall Street has resumed its decline, signalling that the interest rate asset value adjustment is not yet complete and VIX index meltdowns are set to continue. But there is still some good news for long-term investors around Australia: they have dodged a nasty bullet.

The large corporate tax cuts advocated by government politicians, including the Prime Minister and the Treasurer would have dealt another blow to those saving for retirement and retirees relying on shares for income. Australian retirees can be thankful that the crossbenchers and the ALP are blocking the legislation.

The government argued that Australia must reduce its corporate tax rate to follow the US and that would create jobs, growth and investment.

Frankly, I think that is baloney given the collateral blows to retirees and I was delighted that at this week’s Melbourne Mining Club Orica chief Alberto Calderon broke rank with other chief executives and bodies like the Business Council and warned about blindly following the US in our tax strategy.

Calderon used careful, measured words to suggest a much better direction for a tax revolution that really would create jobs. The Calderon plan follows the recommendations I have been advocating, so, as you would expect, I agreed with him. I will return to the Calderon plan later.

First, let’s look at how the government’s tax cut legislation was aimed at making life more miserable for retirees and then deeper at what is happening in the US as a result of the tax cuts.

Commonwealth Bank’s half-year report illustrates the planned retiree/superannuation saver blow but the same principles apply to all banks and most large Australian companies. The bank’s cash earnings per share in the half year were $2.72 and it paid a dividend of $2.00 or 73.5 per cent of the cash profit.

That dividend was fully franked on a basis of a 30 per cent tax rate so if the tax rate followed the US and became 21 per cent (the government’s plan was actually for a smaller reduction) the franking credit would fall by almost a third, so the dividend would be worth a lot less.

So, the purists would say that the Commonwealth Bank could increase its dividend by the amount of the tax cut. But if it did that then there would be no money for investment or job creation.

The whole basis of Turnbull and Morrison advocating lower corporate tax revolves around workers getting more money, more jobs and more investment. But much of that money comes out of the pockets of retiree’s and superannuation savers.

While in the US the tax cuts are working, the American situation is totally different. They don’t have franking credits.

Over a long period, US profits have been rising yet wages haven’t budged much. Part of the reason for this is that American workers have been exposed to competition from Chinese and other low-cost workforces as part of globalisation. But research by Jonathan Tepper shows that in the past when the American economy turned around after a downturn there were wage increases. But this time around there has been an enormous concentration in corporate bargaining power.

Tepper says that between 1996 and 2016 the number of listed companies in the US fell by about 50 per cent from more than 7,300 to less than 3,600. That means that employees don’t have the same choice of employers and their bargaining power is reduced.

Major industries including breweries, tech, airlines and insurance have very few major players. However, the latest tax cuts in the US spurred wage rises from corporations but I suspect that the demand for labour in the US has risen so spectacularly that there is now a squeeze and many companies are making a pre-emptive strike. And without franking credits there is not the same pressure to give the tax cuts back to shareholders.

Orica managing director Alberto Calderon. (Colin Murty/The Australian)

Calderon confirms that if companies did not increase their dividends to match the fall in tax then retirees that rely on imputation credits would be hit. The Orica chief suggests that there are complementary and alternative ways to encourage local and offshore companies to invest in Australia. He suggests Australia creates targeted incentives such as accelerated depreciation and other capital allowances plus research and development incentives. To have a major CEO go against his peers to adopt a commonsense approach I find encouraging.

If we do want to reduce the company tax rate then we will need to do it as part of a total change in tax. We would also need to reduce individual taxes and probably alter the tax mix with a greater reliance on GST. Those sorts of fundamental changes are simply not available to us and at this point.

Meanwhile, I am a supporter of franking credits although most countries in the world have not followed us. Franking credits eliminate the double taxation of profits and it is a very fair system. Australian investors need to keep fighting for it.

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