Tax Reform – Page 2 – Digital Finance Analytics (DFA) Blog

After all the talk, what is the Turnbull government actually doing for small business?

Treasurer Scott Morrison continues to warn about the decline of Australia’s global competitiveness if the centrepiece of the 2016–17 federal budget – a company tax rate cut – is not passed.

However, such tax cuts are not necessarily the best approach for the government to support small business. They need other – more immediate – forms of support, our research shows.

What’s being proposed?

The 2016-17 budget reflected the Turnbull government’s catchphrase of “jobs and growth”. From a small-business perspective, the budget wanted to:

… boost new investment, create and support jobs and increase real wages, starting with tax cuts for small and medium-sized enterprises, that will permanently increase the size of the economy by just over 1% in the long term.

In 2014, Australia had the fifth-highest company tax rate among OECD countries, albeit average in the Asia-Pacific region. Local investors benefit from lower taxes on dividends through Australia’s dividend imputation system, which passes credits onto them for corporate taxes already paid.

The Abbott government later succeeded in lowering the tax rate for small businesses with a turnover of less than A$2 million from 30% to 28.5%. The Turnbull government’s plan would eventually reduce the rate for all companies to 25% by 2026-27. It’s a phased implementation over the next ten years, starting with an immediate cut for small companies to 27.5%.

However, 70% of small businesses are unincorporated. This means their owners add profits to their personal income for tax purposes. While the government has promised an increase in their tax offset percentage, it plans to retain the cap of A$1,000.

All small businesses will benefit from the simplification of tax rules for stock, GST and depreciation. But the government’s plan introduces three levels of concessions for small businesses. This complicates the definition of what these small businesses are.

Definition disputes

Defining small business goes beyond an academic debate.

With little consensus on typical turnover numbers – these range from A$2 million to A$25 million – a better indicator could be the Australian Bureau of Statistics definition of small businesses as those with fewer than 20 employees. And 97% of the 2.1 million businesses trading in Australia fit this definition.

It is risky, though, to simplify the definition into one blunt instrument that ignores differences in industry, life cycle and high-volume versus high-worth sales. A more nuanced approach is needed to ensure relief for the businesses that need it most.

However, the major political parties seemingly remain focused on turnover as a measure of what is and isn’t a small business. The government’s plan extends the upper limit for the turnover of small businesses to A$10 million by 2016–17, which covers some of the 3% of Australia’s non-small businesses.

Meanwhile, Labor has argued for immediate support for tax cuts to small businesses with a turnover of less than A$2 million.

Lifting the turnover threshold for all small businesses from A$2 million to A$10 million in the short term will increase the number of businesses that can access some tax concessions by 90,000. And it may improve economic growth as larger firms receive some relief.

What small businesses actually need

Small businesses need immediate and certain tax relief in the short term. They struggle with an uncertain business environment.

But, in the longer term, our research shows increased competition, a lack of market demand and red tape are but a few of the issues small businesses deal with. They highlighted statutory and regulatory compliance, as well as tax planning and compliance, as major issues for them.

More than tax rates, complex tax requirements and regulations are issues causing small businesses substantial distress. The Australian Tax Office’s research supports this: more than 70% of surveyed clients viewed their tax affairs as complex. And the World Bank’s ease of doing business index ranks Australia 25th in terms of ease of paying taxes.

The immediate tax relief for small businesses is tied up in proposed legislation surrounding the government’s ten-year tax plan, which is unlikely to find enough support to pass the parliament in its current form. The uncertainty and complexity that have ensued from the political conflict over tax have negative effects on the small business landscape.

Innovation is likely to suffer under such uncertain conditions. The government’s plan recognises that:

Small businesses are the home of Australian enterprise and opportunity and they are where many big ideas begin.

In addition to ideas and passion, small businesses need resource availability, appropriate capabilities and market access to innovate. The plan proposes measures that satisfy some of these criteria, but more focus on finding ways to minimise bureaucracy to provide time to focus on innovation is needed.

The role of government is undeniable in such initiatives. Even if one argues that tax relief is a temporary reprieve, this cash injection can jump-start small business innovation and growth.

Should the two major parties fail to find common ground on the government’s company tax cut, the stalemate will continue – and leave small businesses in the lurch.

Authors: Martie-Louise Verreynn, Associate Professor in Innovation, The University of Queensland; Thea Voogt, Lecturer in Tax Law, The University of Queensland.

Leveraging Will Survive Corporate Tax Reform – Moody’s

Moody’s says analysts from a major bank believe that reducing the top corporate income tax rate from 35% to 20% will slow the average annual increase of US industrial company debt over the next 10 years from nearly 5% without a tax cut to roughly 2% with the tax cut.

However, what happened after the slashing of the top corporate income tax rate from 1986’s 46% to 1987’s 40% and, then, to 1988’s 34% questions whether prospective tax cuts will more than halve the growth of corporate debt over the next 10 years.

Nevertheless, business borrowing is likely to be noticeably lower if business interest expense is no longer tax deductible. Such tax-reform induced reductions in business borrowing will be most prominent among very low grade credits and during episodes of diminished liquidity, extraordinarily wide yield spreads for medium- and low-grade corporates, and exceptionally high benchmark borrowing costs.

The top corporate income tax rate probably will be cut from i 35% to either the 20% proposed by House Republicans or to the 15% offered by Trump’s team. Assuming, for now, the continued tax deductibility of corporate interest expense, a lower corporate income tax rate increases the after-tax cost of corporate debt. However, a reduction by the corporate income tax rate may add enough to after-tax income to more than offset the burden of a higher after-tax cost of debt. In addition, today’s relatively low corporate borrowing costs will mitigate the increase in the after-tax cost of debt stemming from a lowering of the corporate income tax rate.

Corporate debt sped past GDP and revenues despite tax cuts of 1987-1988
Thus, a lowering of the top corporate income tax rate probably will not have much of a discernible effect on corporate borrowing. Despite the lowering of the corporate income tax rate from 1986’s 46% to 34% by 1988, the ratio of debt to the market value of net worth for US non-financial corporations rose from 1986’s 38.6% to a mid-1994 high of 51.1%. Moreover, from year-end 1986 through year-end 1989, non-financial corporate debt advanced by 9.6% annually, on average, which was much faster than the accompanying average annual growth rates of 7.2% for nominal GDP and 7.0% for the gross value added of non-financial corporations.

The supposed de-leveraging effect of corporate income tax cuts was further challenged by how debt outran both the economy and business sales despite still elevated corporate borrowing costs. For example, Moody’s long-term Baa industrial company bond yield barely fell from 1986’s 10.73% average to the still costly 10.55% of 1987-1989, while a composite speculative-grade bond yield actually rose from 1986’s 12.44% to the 13.05% of 1987-1989.

It should be noted that the increase in the after-tax cost of debt was greater following 1987’s corporate income tax cut because of the much higher corporate bond yields of that time and yet corporate debt still grew rapidly. In stark contrast, recent yields of 4.74% for the long-term Baa-grade industrials and 5.96% for speculative-grade bonds are substantially lower, which, in turn, lessens the degree to which corporate income tax cuts discourage balance-sheet leveraging.

What economists and tax experts think of the company tax cut

From The Conversation.

Prime Minister Malcolm Turnbull and the Treasurer Scott Morrison are still trying to sell their plan to cut the company tax rate to 25% by 2026-27. The current rate is 30% and has been since 2001.

The tax cut was introduced in the 2016 federal budget. The government indicated small to medium businesses turning over less than A$10 million would pay a company tax of 27.5% initially. The company turnover threshold for the tax cut would then increase over time from A$10 to $25 million in 2017-18 to A$50 million in 2018-19 and finally A$100 million in 2019-20.

But before any of this happens, the government needs to convince the senate crossbenchers to pass the legislation. It seems the government hasn’t won over tax experts and economists with this policy, here’s some articles that explain why.

Don’t expect an instant wage increase

In a national press club address Malcolm Turnbull justified the tax cut by saying, “company tax is overwhelmingly a tax on workers and their salaries.” It follows that cutting it would increase salaries right?

However there’s a whole lot of decisions businesses need to make before they even consider raising wages. It’s not just as simple as the government makes out, as professor John Freebairn from the University of Melbourne notes:

Individuals benefit from lower corporate tax rates with higher market wages. But the higher wage rates will take some years to materialise, and the magnitude of increase attributed to the lower corporate tax rate, versus other factors, is open to debate.

Businesses would need to consider the savings of international investors, what resources the business might need, what the return for investors would be on these. All of this before it would consider a wage increase for its workers.

The enlarged stock of capital, technology and expertise per worker becomes a key driver of increased worker productivity. In time, more productive workers are able to negotiate higher wages. Via this chain of decision changes, employees benefit from the lower corporate tax rate.

Any modelling on how much a tax cut could be worth to our economy is up for debate

Modelling is sensitive to whatever assumptions the government makes and these assumptions can be oversimplified. ANU principal research fellow Ben Phillips points out that tax reform like this inevitably has winners and losers and is influenced by powerful lobby groups.

In thinking about tax reform it is important to keep in mind that the gains from modest tax reform are not likely to be a revolution in Australia. The models themselves only estimate relatively small gains from tax reform.

Here’s a little something to bear in mind when hearing any figures thrown around on how much a company tax cut could be worth:

Over the past 25 years Australia’s living standards have increased by around 60% whereas the sorts of gains estimated from tax reform are expected to be little more than 1 or 2%. It remains important that in securing such modest gains we don’t ignore fairness.

The benefit to the domestic economy won’t be that big

The idea behind the cut is that companies will be motivated to provide jobs and other economic benefits because they are receiving a tax break. In theory this kind of tax should boost the economy in the long term, but as John Daley and Brendan Coates from the Grattan Institute explain it’s not that simple.

In Australia, the shares of Australian residents in company profits are effectively only taxed once. Investors get franking credits for whatever tax a company has paid, and these credits reduce their personal income tax. Consequently, for Australian investors, the company tax rate doesn’t matter much: they effectively pay tax on corporate profits at their personal rate of income tax.

The Grattan researchers point out that if companies pay less tax then they might reinvest what they save, but in practise most profits are paid out to shareholders. So the tax cut won’t have much of an impact on domestic investment.

They also pick holes in the Treasury’s modelling on the tax cut’s boost to Gross National Income (GNI).

Treasury expects that cutting corporate tax rates to 25% will only increase the incomes of Australians – GNI – by 0.8%. In other words, about a third of the increase in GDP flows out of the country to foreigners as they pay less tax in Australia. And because most of the additional economic activity is financed by foreigners, the profits on much of the additional activity will also tend to flow out of Australia.

It doesn’t make much of a difference

Another argument for cutting Australia’s company tax rate is to deter companies from shifting their profits to other countries where the tax rate is lower. Recently President Trump promised to cut the United States federal corporate tax rate from 35% to 15%.

Antony Ting, associate professor at the University of Sydney notes most countries have been reducing their company tax rates over the past two decades. This hasn’t changed the incentive for multinationals to avoid taxes.

The tax-avoidance “success” stories of multinational enterprises such as Apple, Google and Microsoft suggest this argument is weak. The fact is that the profits these multinationals shift offshore often end up totally tax-free.

A FactCheck by Kevin Davis, research director at the Australian Centre for Financial Studies, reviewed by economist Warwick Smith, says there’s no point to comparing Australia’s company tax rate with other countries anyway.

Australia’s dividend imputation tax system means that any comparison of our current 30% rate with statutory corporate tax rates elsewhere is like comparing apples and oranges.

Small and medium businesses actually lose out

Due to the way the proposed company tax cut is structured, foreign investors get a windfall while local employers including small and medium businesses cop a cost because they remain uncompensated.

Economist Janine Dixon from Victoria University modelled how the cut would play out.

Local owners of unincorporated businesses are taxed at their personal tax rate. Because of Australia’s dividend imputation system, Australian shareholders in incorporated business are also taxed at their personal rate, not the company tax rate.

She explains that 98% of small businesses (employing four or fewer people) are wholly Australian owned and because of this are indifferent to the cut, but 30% of large businesses (employing more than 200 people) have some component of foreign ownership.

An increase in foreign investment is generally understood to be a driver of wage growth. This is the basis for the argument that at least half of the benefit of a cut to company tax flows to workers… We find that benefit to foreign investors will exceed the total increase in GDP. In the domestic economy, benefits to workers will be more than offset with a negative impact on domestic investors and the need to address additional government deficit.

Other things are just as important

Even if some businesses are keen for a tax cut, meaning more money in the kitty, it’s how these businesses spend this money that counts.

Jana Matthews from the Centre for Business Growth at the University of South Australia says many CEOs are uncertain about what to do in order to grow their business and are fearful of making the wrong decisions.

We need to focus as much attention on the management education of founders, CEOs and MDs [managing directors] of medium-sized companies as we do on providing them with more money. Once they learn how to grow their companies, they will definitely need money to become the engines of growth, and they will certainly hire more people, creating the jobs we all want.

Author: Jenni Henderson , Editor, Business and Economy, The Conversation

An original Republican tax plan offers Trump a radical tool for corporate tax reform

From The Conversation.

Major US companies have long been known to specialise in profit shifting to tax havens to reduce their tax bill. This erosion of the corporate tax base is thought to lead to rising inequality and deprives countries of important revenues to spend on public services.

So what can be done? Donald Trump is being encouraged by leading House Republicans – led by Kevin Brady, chairman of Washington’s tax-writing Ways & Means committee, and speaker Paul Ryan – to introduce a Destination-Based Cash Flow Tax, or DBCFT. This tax plan has been pushed forward by leading Berkeley economist Alan Auerbach and scholars at the Oxford Centre for Business Taxation.

It sounds complicated – and has an awful acronym – but there is something in this plan that offers an alternative.

The DBCFT doesn’t go after a firm’s profits in the normal sense, as the current corporate tax regime does. Instead of taxing corporate income (revenue minus costs) it taxes sales at their point of destination or consumption.

Another key part of the new tax is that monetary flows across a multinational corporation’s international network of subsidiaries (that would include tax haven locations) are border-adjusted. This means that export sales, for example Ford selling cars overseas, would be excluded from a firm’s tax base, but imports, such as the purchase of raw materials from abroad, would be included. What this boils down to is that the tax looks like an export subsidy, and at the same time, an import tax. In many ways therefore it looks like a backdoor attempt to improve the US’ large current account deficit – which formed a major part of Trump’s presidential campaign.
Trump on the campaign trail. EPA/LARRY W. SMITH
Radical Change

The House Republicans highlight several key attractions of this new and radical tax.

They argue that it would allow the US to reduce its federal corporate tax rate to around 15-25% – from 35% currently – which would bring it in line with China and much closer to the UK. The hope is also that it will deter firms from stashing profits in tax havens, and minimise the role of aggressive transfer pricing manipulation – the practice of buying and selling goods between divisions of the same multinational as a means to reduce the corporate tax bill. It should also deter firms from relocating their legal domicile to countries like Ireland and Bermuda – so called corporate inversions.

Current tax arrangements offer companies an advantage if they raise money through debt. However the DBCFT would have the effect of removing that incentive by eliminating deductions for interest payments. This means in theory that firms would be more likely to favour stock markets when raising capital. There is a potential twin advantage here: lower debt ratios would make the US economy more resilient in the face of external shocks, while equity markets are given a further boost.
Bullish for Wall Street? Numenor1965/Flickr, CC BY-NC-SA
The theory seems appealing, but the truth is, nobody really knows if it will work. It might not even be compliant with the World Trade Organisation (WTO). This is a step in to the unknown; there could be multiple unintended consequences. Not since the early 20th century, when bilateral tax treaties between countries were introduced, has there been such sweeping reform to international taxation as this policy change would initiate.

Progressive?

There is an argument that the new tax could have a progressive outcome. Because payroll costs could also be deducted from its calculation, this should shift the tax burden more firmly on to shareholders, and away from workers. Concerns with the existing system are that workers end up paying a fair chunk of the corporate tax bill, through lower wages and benefits.

However, consumers might not get off lightly. The DBCFT may well have the effect of increasing consumer prices on imported goods, leading to higher energy and food prices. This would disproportionately hurt the poor, meaning the tax’s progressive credentials might not bear scrutiny.

In order for the tax to work, proponents argue that the dollar will have to appreciate in value to offset the effects of the border-adjustment. This is because exports are tax free but imports incur tax. Hence US exports will appear more attractive to foreign consumers and imports will appear more expensive to US consumers. But whether exchange rates will move is an open question, as ever.
Consumer power? EPA/ANDREW GOMBERT
This really is a highly contentious and ambitious proposal for tax reform. The US’ international competitors – and of course tax haven locations – may see it as a hostile move. It will encourage firms from abroad to locate their production in the US. On the other hand, proponents argue that the policy is “incentive compatible” – in simpler terms, it will force other countries to adopt a similar policy. This would, in effect, dismantle the standard tax haven business model and send shockwaves throughout an industry that specialises in tax avoidance.

That is an intriguing prospect, but interest groups such as the Tax Justice Network in the UK would argue that the key to a better functioning corporate tax regime is for countries to be more open with one another in terms of information exchange for tax purposes. This would include multinational companies reporting their financial statements on a country by country basis instead of consolidating them. Countries would then be able to clearly define their corporate tax base and decide themselves what tax rate to levy.

The EU is currently discussing the introduction of a Common Consolidated Corporate Tax Base to partially achieve this. This would not eliminate the tax havens, but it may go a long way towards enhancing transparency, leading to greater scrutiny of the world’s biggest multinational enterprises and changing their behaviour in terms of profit shifting.

In some ways this is the longer, harder road. The appeal of the Republican proposal would be to force the issue, but it is desperately hard to predict, or manage, the consequences if this tax is enacted.

Author: Chris Jones, Senior Lecturer in Economics, Aston University

Government slammed for lip service on affordability

From Australian Broker.

The national discussion about housing affordability and boosting supply is how politicians make the public think they care without acting, one leading academic has said.

“People have been pushing this line that new supply is going to suddenly generate housing affordability outcomes for five or six years, but if you draw a graph of supply and prices they’re going up together,” the chair of urban and regional planning and policy at the University of Sydney, Peter Phibbs, told News.com.au.

“If politicians were really interested in putting downward pressure on property prices, there are other things they could do.”

Scrapping federally-controlled negative gearing concessions – which Phibbs said was the “single most important” method for combating affordability issues – has been rejected by the new NSW Premier Gladys Berekilian.

As well as this, the government could also adjust tax settings by doing away with stamp duty or introduce a more efficient land tax, he said.

By focusing on fixing supply, politicians could be seen as taking action while in fact doing nothing at all, Phibbs said.

“If you leave it to the market, it’s an incredibly blunt tool. It’s like trying to put a bushfire out with a garden hose.”

While the government knows the topic of housing affordability is important for voters, the issue will never be seriously prioritised, he said, especially while politicians act in the interests of owner occupiers and property investors.

“What will probably change in Australia is a lot of people that in previous generations would be homeowners, are no longer going to be. We’ll end up with more renters than homeowners and that’s probably when we’ll see some real change from governments,” he said.

“But until then, the politics just don’t work.”

Is The Era Of Multinational Companies Passing?

From The Economist.

AMONG the many things that Donald Trump dislikes are big global firms. Faceless and rootless, they stand accused of unleashing “carnage” on ordinary Americans by shipping jobs and factories abroad. His answer is to domesticate these marauding multinationals. Lower taxes will draw their cash home, border charges will hobble their cross-border supply chains and the trade deals that help them do business will be rewritten. To avoid punitive treatment, “all you have to do is stay,” he told American bosses this week.

Mr Trump is unusual in his aggressively protectionist tone. But in many ways he is behind the times. Multinational companies, the agents behind global integration, were already in retreat well before the populist revolts of 2016. Their financial performance has slipped so that they are no longer outstripping local firms. Many seem to have exhausted their ability to cut costs and taxes and to out-think their local competitors. Mr Trump’s broadsides are aimed at companies that are surprisingly vulnerable and, in many cases, are already heading home. The impact on global commerce will be profound.

The end of the arbitrage

Multinational firms (those that do a large chunk of their business outside their home region) employ only one in 50 of the world’s workers. But they matter. A few thousand firms influence what billions of people watch, wear and eat. The likes of IBM, McDonald’s, Ford, H&M, Infosys, Lenovo and Honda have been the benchmark for managers. They co-ordinate the supply chains that account for over 50% of all trade. They account for a third of the value of the world’s stockmarkets and they own the lion’s share of its intellectual property—from lingerie designs to virtual-reality software and diabetes drugs.

They boomed in the early 1990s, as China and the former Soviet bloc opened and Europe integrated. Investors liked global firms’ economies of scale and efficiency. Rather than running themselves as national fiefs, firms unbundled their functions. A Chinese factory might use tools from Germany, have owners in the United States, pay taxes in Luxembourg and sell to Japan. Governments in the rich world dreamed of their national champions becoming world-beaters. Governments in the emerging world welcomed the jobs, exports and technology that global firms brought. It was a golden age.

Central to the rise of the global firm was its claim to be a superior moneymaking machine. That claim lies in tatters. In the past five years the profits of multinationals have dropped by 25%. Returns on capital have slipped to their lowest in two decades. A strong dollar and a low oil price explain part of the decline. Technology superstars and consumer firms with strong brands are still thriving. But the pain is too widespread and prolonged to be dismissed as a blip. About 40% of all multinationals make a return on equity of less than 10%, a yardstick for underperformance. In a majority of industries they are growing more slowly and are less profitable than local firms that stayed in their backyard. The share of global profits accounted for by multinationals has fallen from 35% a decade ago to 30% now. For many industrial, manufacturing, financial, natural-resources, media and telecoms companies, global reach has become a burden, not an advantage.

That is because a 30-year window of arbitrage is closing. Firms’ tax bills have been massaged down as low as they can go; in China factory workers’ wages are rising. Local firms have become more sophisticated. They can steal, copy or displace global firms’ innovations without building costly offices and factories abroad. From America’s shale industry to Brazilian banking, from Chinese e-commerce to Indian telecoms, the companies at the cutting edge are local, not global.

The changing political landscape is making things even harder for the giants. Mr Trump is the latest and most strident manifestation of a worldwide shift to grab more of the value that multinationals capture. China wants global firms to place not just their supply chains there, but also their brainiest activities such as research and development. Last year Europe and America battled over who gets the $13bn of tax that Apple and Pfizer pay annually. From Germany to Indonesia rules on takeovers, antitrust and data are tightening.

Mr Trump’s arrival will only accelerate a gory process of restructuring. Many firms are simply too big: they will have to shrink their empires. Others are putting down deeper roots in the markets where they operate. General Electric and Siemens are “localising” supply chains, production, jobs and tax into regional or national units. Another strategy is to become “intangible”. Silicon Valley’s stars, from Uber to Google, are still expanding abroad. Fast-food firms and hotel chains are shifting from flipping burgers and making beds to selling branding rights. But such virtual multinationals are also vulnerable to populism because they create few direct jobs, pay little tax and are not protected by trade rules designed for physical goods.

Taking back control

The retreat of global firms will give politicians a feeling of greater control as companies promise to do their bidding. But not every country can get a bigger share of the same firms’ production, jobs and tax. And a rapid unwinding of the dominant form of business of the past 20 years could be chaotic. Many countries with trade deficits (including “global Britain”) rely on the flow of capital that multinationals bring. If firms’ profits drop further, the value of stockmarkets will probably fall.

What of consumers and voters? They touch screens, wear clothes and are kept healthy by the products of firms that they dislike as immoral, exploitative and aloof. The golden age of global firms has also been a golden age for consumer choice and efficiency. Its demise may make the world seem fairer. But the retreat of the multinational cannot bring back all the jobs that the likes of Mr Trump promise. And it will mean rising prices, diminishing competition and slowing innovation. In time, millions of small firms trading across borders could replace big firms as transmitters of ideas and capital. But their weight is tiny. People may yet look back on the era when global firms ruled the business world, and regret its passing.

Soaring property prices put sophisticated investors in harm’s way

From the Sydney Morning Herald.

Investors whose wealth has increased through soaring property prices and rising assets face being pushed into riskier financial products as they gain sophisticated investor status, experts say.

While it may seem like an attractive option for investors to attain a “sophisticated investor” certificate allowing them to participate in complex share placements, exotic bonds and exclusive private equity deals, experts are calling for an urgent rethink of the criteria.

“There are alarming levels of financial illiteracy across all Australian demographics,” says Mark Brimble, chair of the Financial Planning Education Council and lecturer at Griffith University.

“We can’t just assume that because someone has a certain value of assets and income that they understand these products.”

As it stands, investors with net assets – including their residential property – of $2.5 million and/or a gross income of least $250,000 a year for the last two years qualify for an SI certificate signed by an accountant. This enables them to participate in pre-IPOs, IPOs and receive tax benefits for investing in Early Stage Innovation Companies (ESICs), among other things.

But as house prices have soared – the median in Sydney is up 65.9 per cent since 2012 and Melbourne is up 48 per cent – it is much easier for people to qualify for this status.

“These criterion were meant to be a significant hurdle for people,” says Peta Tilse, managing director of Sophisticated Access and founder of Cygura, a centralised online platform for sophisticated investor certification and validation.

“But it’s become very outdated and thanks to the booming property market, including the family home, opens that sophisticated investor door right up,” says Ms Tilse.

The Australian Securities and Investments Commission (ASIC) offers client consumer protection to retail investors where financial advisors deliberately miscategorise their clients or when companies fail to properly disclose their businesses. However these protections are not available to sophisticated investors.

Another law, established in 1991, automatically upgrades an investor from retail to wholesale or sophisticated if they invest $500,000 or more in one particular product.

“It’s a law not many people know about and it was made when the average full time earnings were $19,000 per year, rather than the $80,000 now,” says Ms Tilse.

The government shouldn’t use super to help low-income savers

The Gratton Institute says compulsory superannuation payments help many middle-income earners to save more for retirement, but super is simply the wrong tool to provide an adequate support for low-income earners. Their analysis shows top-up measures targeted at helping this group save for retirement are poorly targeted and an expensive way to do so.

Australia’s superannuation lobby wants the government to define in law that the purpose of Australia’s A$2 trillion super system is to provide an adequate retirement income for all Australians. The government disagrees: it confirmed instead that the purpose of super is to supplement or substitute for the Age Pension.

The government is right: super can’t do everything. Income from the superannuation of low-income earners will inevitably be small relative to the value of the Age Pension. The government boost to super aimed at low income earners is not tightly targeted. And fees will eat up a material portion of government support provided through superannuation.

With the Age Pension and Rent Assistance, government already has the right tools for assisting lower income Australians.

Government provides two super top-ups for low income earners

The Low Income Superannuation Contribution (LISC), introduced by the Labor government in 2013, puts extra money in the accounts of low-income earners who make pre-tax super contributions. Under the LISC, those earning less than A$37,000 receive a government co-contribution of 15% of their pre-tax super contributions, up to a maximum of A$500 a year.

The Abbott government was set to abolish the LISC, but the Turnbull government now plans to retain it, renaming it the Low Income Superannuation Tax Offset (LISTO), at a budgetary cost of A$800 million a year.

The super co-contribution, introduced by the former Howard government in 2003, puts extra money in the accounts of low-incomes earners who make post-tax super contributions. It boosts voluntary super contributions made by low-income earners out of their post-tax income by up to A$500 a year, at a budgetary cost of A$160 million a year.

Super can’t help many low income earners

Superannuation is a contributory system: you only get out what you put in. And low-income earners don’t put much in.

Their wages, and resulting super guarantee contributions, are small and their means to make large voluntary contributions are even smaller. Their super nest egg will inevitably be small compared to Australia’s relatively generous Age Pension.

For example, a person who works full time at the minimum wage for their entire working life and contributes 9.5% of their income to super would accumulate super of about A$153,000 in today’s money (wage deflated), making standard assumptions about returns and fees. If the balance were drawn down at the minimum rates, this would provide a retirement income of about A$6,500 a year in today’s money.

By contrast, an Age Pension provides a single person with A$22,800 a year. For someone who worked part time on the minimum wage for some or all of their working life, super would be even less, but the Age Pension would be pretty much the same.

Top-ups are not tightly targeted to those that need them

The LISC and the super co-contribution aim to top up the super and thus the retirement incomes of those with low incomes. But our research shows about a quarter of the government’s support leaks out to support the top half of households.

Whereas eligibility for the pension is based on the income and assets of the whole household, including those of a spouse, eligibility for superannuation top ups depends only on the income of the individual making contributions. That means the top ups also benefit low-income earners in high-income households. A far better way to help low-income earners is to increase income support payments such as the Age Pension.

Super top ups provide some help to households in the second to fourth deciles of taxpayers. But they do very little for the bottom 10% of those who file a tax return.

These households, many of which earn little if any income, only receive about 7% of the benefits of top ups. A further set of households file no tax returns – typically because welfare benefits provide most of their income. Very few of them receive any material super top up.

Super fees erode super top ups

Super fees will erode a sizeable share of the funds in the super accounts of low-income households, as a result of super top ups. Our research shows that super fees levied on most workers receiving the LISC erode between 20 and 25% of the value of the extra funds at retirement. This finding is consistent with previous Grattan work on super fees.

But super fees do not usually erode super top ups as much as they erode contributions to super in general. Fees eat up a higher proportion of the super savings of people with low balances because most fees have a fixed component that’s the same whatever the account balance. In effect the personal super contributions of low-income earners absorb that fixed component, which is typically the same whether or not government tops up the account.

However for those with very low super savings and sporadic employment, fixed fees can erode the value of their super top ups. That’s because at some point in their lives, their super balances can drop close enough to zero and fixed administration fees eat into the value generated by the top up.

Many Australians face low incomes and irregular work. They may not be able to contribute enough to their super to make up for fixed fees. Lucy Nicholson/Reuters

Some top up is still needed for low income earners

Superannuation compels people to lock up some of their earnings as savings until retirement. High-income earners are compensated for this delayed access because their contributions are only taxed at 15%, rather than their marginal rate of personal income tax.

Without the LISC, which reduces the tax rate on their compulsory super contributions to zero, those earning between A$20,542 and A$37,000 would receive relatively little compensation for locking up their money in superannuation. The 15% tax on contributions would be only slightly less than their 19% marginal tax rate.

And for those earning less than A$20,542, the absence of a LISC would take them backwards when they made super contributions taxed at 15% rather than keeping the money in their pocket tax free.

Reflecting these concerns, the LISC, reborn as LISTO, appears crucial to gaining support in the Senate from Labor or the Greens for reforms to super tax breaks. Continuing the offset is a reasonable price to pay to unwind billions of dollars in unnecessary super tax breaks.

Better ways to provide adequate retirement incomes for low-income earners

However super top ups should not be expanded. It is too hard to target them tightly at those most in need, and super fees can eat up their value.

Instead, a targeted boost to the Age Pension would do far more to ensure all Australians have an adequate retirement. But there is an even better way to improve the retirement incomes of those most in need.

As previous Grattan research shows, retirees who do not own their own homes are the group at most risk of being poor in retirement. A A$500 a year boost to rent assistance for eligible seniors would be the most efficient way to boost retirement incomes of the lowest paid, at a cost of A$200 million a year. Only 2% of it would flow to the top half of households, with net wealth of more than A$500,000.

By contrast, a wholesale A$500 boost to all Age Pension recipients would cost A$1.3 billion, with half the benefit going to households with net wealth of more than A$500,000, mainly because the home is exempt from the Age Pension means test.

In defining an objective for Australia’s superannuation system, the government is right that super is not a universal pocket knife. Super top ups are a costly way to ensure that every Australian enjoys an adequate retirement.

Authors: John Daley, Chief Executive Officer, Grattan Institute; Brendan Coates, Fellow, Grattan Institute; William Young, Associate, Grattan Institute

From The Conversation

$500,000 non-concessional cap scratched

According to the Financial Standard, the Federal Government has reworked its 2016 Budget measures on superannuation to drop the $500,000 lifetime non-concessional cap and alter several other policies.

Treasurer Scott Morrison announced the changes this morning and said the government will replace the $500,000 proposal with a new measure to reduce the existing annual non-concessional contributions cap from $180,000 per year to $100,000.

The move will cost government revenue $400 million over forward estimates but Morrison said introducing eligibility for non-concessional contributions to those with less than $1.6 million in superannuation limits the cost of this change over the medium term.

He added: “In order to fully offset the cost of reverting to a reduced annual non-concessional cap, the Government will now not proceed with the harmonisation of contribution rules for those aged 65 to 74. While the Government remains supportive of the increased flexibility delivered by this measure, it can no longer be supported as part of this package, without a net cost to the Budget.”

Under the reworked package, individuals aged 65 to 74 who satisfy the work test will still be able to make additional contributions to superannuation. Morrison said this will encourage individuals to remain engaged with the workforce which is of benefit to the economy more generally.

Individuals aged under 65 will continue to be able to “bring forward” three years’ worth of non-concessional contributions in recognition of the fact that such contributions are often made in lump sums. The overwhelming bulk of such larger contributions are typically less than $200,000, Morrison said.

“Individuals with a superannuation balance of more than $1.6 million will no longer be eligible to make non-concessional (after tax) contributions from 1 July 2017. This limit will be tied and indexed to the transfer balance cap,” he said.

“This ensures that we focus the entitlement for after tax contributions to those Australians who have an aspiration to maximise their superannuation balances and reach the transfer balance cap in the retirement phase, where a zero tax on earnings applies.

“These measures mean that with their annual concessional contributions, Australians will be able to contribute $125,000 each year and, if taking advantage of the non-concessional “bring forward”, up to $325,000 in any one year until such time as they reach $1.6 million.

“While noting that less than 1% of superannuants now reach the proposed transfer balance cap of $1.6 million, these improvements will mean Australians will be given a clear and better opportunity to realise their aspiration to build their balance to the limit of the transfer balance cap.

“In addition, the commencement date of the proposed catch-up concessional superannuation contributions will be deferred by 12 months to 1 July 2018 to ensure the full cost of changes to non-concessional contribution arrangements are met over both the forward estimates and the medium term.”

Morrison added these measures will ensure that 96% of Australians remain better off or unaffected by the Government’s superannuation reforms “that will introduce greater flexibility and sustainability to our retirement income system.”

The Association of Superannuation Funds of Australia (ASFA) said it supports the government’s revised superannuation package announced this morning and urges the Parliament to pass the changes as soon as practical, in order to provide certainty for people saving for their retirement.

ASFA interim CEO Jim Minto said: “ASFA has long advocated for both a lifetime cap on non-concessional contributions and a limit on the total amount tax free in retirement. The revised superannuation proposals address both issues.

“The key message for savers is that they should have confidence in their super.”

Industry Super Australia chief executive David Whiteley said the policy shift was a “workable compromise.”