Thursday, October 11, 2018

Australian Corporation Tax

The Australian government has lowered the rate of corporation tax on small businesses and planned to lower the rate on larger businesses too. The latter was blocked by the Senate. The main reason put forward for reducing the tax seems to be increasing international competitiveness, though this is less important for small businesses that mainly don't have international investment in them. Today, the news is that the government wants to bring forward by several years the reduction to 25% for small businesses as a pre-election vote winner. Labor, by contrast, opposes this cut (they withdrew their policy to repeal the previous cut) and wants to raise all sorts of taxes on investment.

As an Australian investor in public companies I didn't used to care too much how high the corporation tax was. This is because when a company pays tax and then pays a dividend, Australian investors get a "franking" credit for the tax paid by the company, so there is no double taxation. Foreign investors usually can't use these credits, hence the argument to partly level the playing field  by bringing down the rate of the tax. If a company doesn't distribute profits and the share price increases and I sell my shares and pay capital gains tax, then there is double taxation. But the long-term capital gains tax is only half the normal income tax rate and so this isn't too bad (Labor want to reduce this discount too). Additionally, the price paid for listed shares takes into account that profits are taxed, which helps mitigate the impact of the tax on the rate of return that investors receive. Australian investors, though, are willing to pay more for Australian shares than international investors are, given their differential tax treatment.

Actually, I like getting franking credits, because after I deduct investment costs like margin interest they reduce the tax on my salary.

But as I think about setting up a private company, I increasingly like the idea of lowering the corporation tax. Profits that are re-invested in the business, rather than paid out as dividends, are greater if the tax rate is lower. Of course, this applies to listed companies too, and cutting the tax rate should raise the price of shares in a one time move. The more that we have existing investments rather than are buying new investments the more we should like increases in share prices... On the other hand, ot all the extra profits from lowering the tax rate will actually be realized. Market equilibrium should mean that after the rate of return increases, firms invest more, lowering the pre-tax rate of return. This mechanism is much like how stock market investors will buy shares raising the price and reducing the expected rate of return again. But lower taxes on investment are economically more efficient.

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