OPINION: Frankly, Bill Deserves some (Dis)credit
Labor’s franking credit policy is inconsistent and opportunistic while being framed as a fair and warranted policy proposition.
One of Labor’s flagship policies going into the upcoming election is their change to franking credit policy (AKA dividend imputation credits). Specifically, they will be removing the concession allowing for cash back on excess franking credits. What is most interesting about this policy is not so much who it will affect (the wealthiest retirees) or how much the federal government will gain ($6–8 billion per year), but how Bill Shorten and the Labor Party have framed the policy to be easily digested by voters in a way that is inconsistent and opportunistic.
Before getting ahead of myself, it’s important to have a grasp of exactly what franking credits are. The current corporate tax rate lies between 27.5% and 30% depending on a means test. This tax rate is applied to the profits of a firm, and some portion (typically over 75%) of the after-tax profits are then paid out to investors via dividends. These dividends are then ‘franked’ and individuals are able to declare this in their tax returns to reduce the amount of tax they pay at the end of the financial year.
So, for example, if Sarah received $70 in fully-franked dividends, she would declare $100 in her tax returns; the extra $30 is a franking credit that represents what the company has already paid in tax. If her effective income tax rate is 10% then she will owe $10 of this in tax; however, because the company has already paid $30 she is paid the difference of what has already been paid in tax ($30) minus what she owes in tax ($10), which is $20. This $20 is a cash refund. The effective result of dividend imputation is to remove the company tax on an individual’s dividend. Were Sarah to declare the $70 dividend as income without the franking credit of $30, she would end up being taxed $7, leading her dividend to be taxed twice, and Sarah being left $27 poorer in relevant terms.
For those with a larger tax bill, franking credits can still be used to offset tax; they just don’t get money back. For instance, if Sarah’s effective tax rate were 45%, she would owe $45 on her taxable income ($100). Her franking credit of $30 (the money the company has already paid for her) would decrease her tax bill to $15, but she doesn’t get any money back.
So, in summation, franking credits can be used not only to reduce your tax bill, but also to get cash back from the government, assuming that your investment earnings are relatively large, and your tax bill is relatively small.
The individuals who most benefit from this policy are retirees whose only source of income are superannuation earnings. In general, a retiree in this situation earning fully-franked dividends from their superannuation will receive cash back on excess franking credits regardless of their income, because superannuation is taxed at a flat 15%, and the corporation tax rate is currently higher than this.
Labor’s policy, in a nutshell, is to remove the ability of franking credits to generate cash refunds, but leave their ability to reduce tax bills unhindered. As of this election, Bill Shorten and the Labor party have called the cash refund component of dividend imputation a “gift” from the government.
But is this a fair representation from the Labor party? In a word, no.
A possible justification for it would be that by individuals receiving cash back, corporations are essentially not paying tax given that their tax is refunded to the individual, at least in part. However, given that Labor’s policy does not remove the deductible element of franking credits, this still holds true amongst those who are earning a large enough income; corporate tax is deducted from the amount of income tax paid. Consequently, given that corporate tax is treated as income tax once allocated to individuals, Labor’s proposed policy can be compared to not refunding the taxed income of those who are taxed in excess whether it be due to deductibles or particularly profitable weeks (as is prone amongst casuals).
In other words, cash refunds and deductibles from franking credits are, from an economic perspective, the same thing, but Labor’s policy sees the former case removed. Consequently, these so-called “gifts” would continue to be provided in the form of tax deductions, so it’s not as if Bill Shorten is arguing that they are all economically unjustifiable; just a small subset of them which affect a smaller group of people who are easier to estrange. This is something that any economist (or, indeed, anyone who has partaken in studies of the discipline) would label as arbitrary and is a sign that the policy is more about political expediency, than some notion of an economic ‘fair-go’.
So, frankly, Bill deserves some discredit. He’s framed the Labor Party’s franking credit policy as “closing a tax loophole” and “removing taxpayer gifts”, but really it’s just an inconsistent and opportunistic policy used to capture higher revenues at the expense of wealthy retirees. It comes in stark contrast to the party’s well-reasoned stance against negative gearing laws, making for an unpleasant decision in the upcoming election.
Tim O’Brien is a PPE Student, a Tutor with the UQ School of Economics, and was previously the Publications Director of the UQ Economics Society. He holds a particular interest in economic and distributive justice, much to the dismay of his friends and family who have to put up with it.
