Category: Tax Reform

Super and personal tax tweaks will drive more people into the property market

From The Conversation.

Australia’s federal government clearly sees its program of annual reductions in the company tax rate as the core element in its plan for “jobs and growth”.

There is now a large – though by no means uncontested – body of evidence to support the contention that reductions in company tax rates can support faster rates of GDP growth and higher wages. It does this by stimulating higher levels of investment and hence higher levels of labour productivity.

But there is very little evidence supporting the favouring of small businesses over large in this regard. The significant preference which both this budget and its predecessor have extended to small businesses appears to owe much more to a desire to bow before small business than to any unambiguous economic rationale.

Small businesses have accounted for only 18% of the increase in employment over the most recent five years for which data are available, while firms with more than 200 employees – which the ABS defines as “large” – have accounted for 52% of the increase in total employment over the past five years, despite accounting for less than 32% of total employment. And large businesses are more likely to engage in “innovative activities” than small ones, especially ones with four or fewer employees.

In other words, if the government wanted to cut company taxes in a way that was most likely to result in increased job creation or higher levels of innovation (assuming that cutting company taxes would have that effect), it should have cut company taxes for large companies ahead of small ones. But that would have been exceedingly difficult, politically, in the current climate.

Mixed messages

The other key element of the government’s ten year enterprise tax plan is the increase in the tax threshold for the second-top marginal rate from $80,000 to $87,000. The government says this will prevent “average full time wage earners … from moving into the second highest tax bracket”. But when you consider the difference between gross and taxable incomes, and that most people use deductions to reduce their taxable income, $87,000 is far from average.

The budget seems to be saying to people with taxable incomes of less than $80,000 – if you want to pay less tax, get yourself a negatively-geared property investment.

The budget is also arguably saying the same thing to people with taxable incomes of more than $250,000, people who have already contributed $500,000 to superannuation over the course of their lifetimes, or people who already have at least $1.6mn in their superannuation accounts. The message is if you put any more into superannuation, we are going to tax you more, but if you put it into a negatively-geared property investment, we won’t touch you, because (in the words of the Treasurer’s Budget Speech), “that would increase the tax burden on Australians just trying to invest and provide a future for their families”.

I am quite comfortable with the budget’s proposed changes to superannuation arrangements. But I can’t see why people – even wealthy people – who are “just trying to invest” through superannuation should be singled out for less generous tax treatment, while people who are doing exactly the same thing through negatively geared property (or other) investments should remain unscathed.

The Treasurer reportedly toyed with the idea of limiting “excesses and abuses” of negative gearing, with caps on claims. This would have more or less exactly paralleled what the budget seeks to do with regard to superannuation.

The decision not to go down that path was reportedly “a political – and not an economic – move”.

But it has, and will have, economic consequences.

Combined with the Reserve Bank’s latest cut in official interest rates, the budget’s decisions and non-decisions with regard to income tax cuts, superannuation and negative gearing are likely to encourage more Australians to borrow more money in order to invest in the property market. At a time when Australia has one of the developed world’s highest ratios of household debt to GDP or personal income, and amongst the developed world’s most expensive residential real estate.

Author: Saul Eslake, Vice-Chancellor’s Fellow, University of Tasmania

Three critical tests for Budget 2016: how does it fare?

From The Conservation.

There are three critical tests for this year’s budget. Is it serious about repairing Australia’s ongoing structural budget deficits? Does it make much of a difference to economic growth? And is it fair?

Budget repair

Over the last year, the bottom line got worse. The long-promised return to surplus receded another year over the horizon. This is the seventh time a budget has forecast a drift back to surplus over the following four years while the outcome for the current year showed minimal improvement over the year before.

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Also consistent with the history of the last seven years, most of the damage was done by “parameter variations” – changes in the economy that meant the budget didn’t live up to previous expectations.

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The government has made much of the need to repair the budget through spending reductions rather than tax increases. Overall, however, forecasts assume that most of budget repair will be the result of increasing revenues as a share of GDP. A large component is that nominal wages are expected to rise, leading to higher income tax collections, known by budget nerds as “fiscal drag”, and commonly referred to as “bracket creep”.

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There’s plenty of room for things to keep going wrong. The largest risk is that nominal wages may be lower than forecast.

Last week the Australian Bureau of Statistics reported much lower inflation than expected. On the day of the federal budget the Reserve Bank responded by cutting interest rates, implying a real risk that unusually low inflation will persist. If it does, then income tax collections will be hit, hurting the budget bottom line, particularly in the last year or two of the budget estimates.

This presents an interesting challenge for Treasury. If an election is called towards the end of this week, then it must release PEFO – the Pre-election Economic and Fiscal Outlook – by around May 20. With inflation lurching south, PEFO may significantly revise the budget bottom line, which will inevitably raise perceptions – probably unfairly – that the government is not firmly in control of economic management.

The other big risk is that export prices fall short of forecasts. The budget assumes an iron ore price of US$55 per tonne. This is close to recent prices, but they were US$40 a tonne just six months ago. If the price drops back US$10 to US$45 per tonne, budget balances are expected to be A$4 billion a year worse off.

Specific measures don’t do much collectively to improve the budget bottom line. As with each of the last seven years, there are substantial gross tax increases and spending reductions, but other decisions largely offset these. Overall, specific measures drag on the budget outcome by $5 billion for the coming year, but improve the last estimated year (2019-20) by $6 billion.

Jobs and growth

The key selling point for the budget is “jobs and growth”. However, there are questions about whether the budget initiatives will matter much to the economy within the next four years.

The largest single initiative is a cut to the corporate tax rate, particularly for small-to-medium businesses. The tax rate will be cut from 28.5% to 27.5%, and by 2019-20 this will apply to businesses with up to $10 million in turnover, up from the current limit of $2 million.

This will doubtless be popular with hundreds of thousands of small businesses. However, given Australia’s dividend imputation scheme, the tax change makes no difference to the amount of tax levied on profits paid out to Australian business owners. A lower tax rate only matters to the budget and the economy when businesses re-invest retained earnings.

However, the overall effect will be small. The tax changes are supposed to reduce tax collected in 2019-20 by A$2 billion – by definition, money retained in businesses and re-invested. This compares with total corporate investment in capital of about A$120 billion a year, and much more in paying for additional staff. The tax change is small beer in comparison.

There may be a larger tankard of beer in reducing tax rates for foreign corporates. But they will receive no benefit until after 2020-21 – well after the next two elections. And recent work has cast doubt on how much of the economic benefit will ultimately benefit Australians.

It is stretching things to believe that other measures will turbo-charge the economy. The budget contains relatively little new infrastructure spending.

Instead there are a lot of plans to do more planning. The most promising economic feature may be a new Youth Jobs PaTH package. This replaces work for the dole with a training, internship and subsidised employment pathway that is at least a little closer to what the literature recognises as best practice.

Fairness

Despite its jobs and growth packaging, the boldest moves in the budget were about fairness. Wide-ranging reforms to superannuation are a big move in the right direction. The current system is poorly targeted, with most of the tax concessions going to the top 20% of taxpayers who need the least help in saving for retirement.

Under the reforms, the top 4% will pay about A$2.6 billion more tax in 2019-20, offset by an additional A$1.8 billion tax concessions for the bottom 28%. These are material changes very different from the tinkering at the edges that has characterised superannuation reform over the last decade.

More controversially, the budget raises the 37% income tax threshold from $80,000 to $87,000. This gives the top 20% of income earners an extra $315 a year.

The fairness of concentrating tax relief on this group depends on the date of comparison. Genuinely middle-income earners (on $45,000 a year) have lost a greater percentage of their income in tax because of bracket creep since the Coalition took office. However, the change in percentage of income paid in tax is more or less the same for all income groups since 2011-12, because lower-income groups received more benefit from carbon tax compensation.

Conclusion

Budget 2016 was much like many of its predecessors over the last seven years. Budget repair was put off till later, and the net impact of budget decisions was small.

Although much was made of individual initiatives, these are unlikely to make much difference to economic growth in the next four years.

Although fairness, like beauty, is in the eye of the beholder, this budget will be easier to defend than some others in recent times.

Authors: John Daley, Chief Executive Officer, Grattan Institute; Danielle Wood, Fellow, Australian Perspectives, Grattan Institute

Government pitches for ‘integrity’ in tax and super: experts respond

From The Conversation.

In its 2016-17 budget the federal government has released a raft of new measures that it says will help modernise and build integrity into Australia’s tax and superannuation systems.

Small business will be the biggest beneficiary of the measures, while high-income earners building their super for wealth creation will be targeted to help the government raise A$2.9 billion.

From July 1 this year, businesses with turnover of less than $10 million per annum will pay a reduced tax rate of 27.5%. The same rate will only kick in for large companies (with turnover of $1 billion or more) in 2023. The tax rate for businesses both big and small will only hit the headline 25% rate in 2026.

The instant asset write off for small businesses will be extended to businesses with turnover of up to $10 million per annum, and the government will undergo a trial of simpler business activity statements.

The government claims these tax measures will contribute to a 1% increase in GDP, according to Treasury modelling.

There’s little in the way of tax cuts for individuals however, apart from a move on bracket creep that will increasing the upper limit for the middle income tax bracket that pays 37 cents in the dollar from $80,000 to $87,000 per year.

As expected, the government will increase the tax paid on super contributions by those on incomes of $250,000 or more from 15% to 30%. A range of other caps and reductions in concessions aimed at high-income earners will deliver the government revenue to extend the low income super tax offset. This will allow those on incomes of $37,000 or less to receive a refund of tax paid on concessional contributions up to $500.

And in a bid to help women who have career breaks, the government will introduce “catch-up super contributions” that will allow unused concessional contributions to be carried forward for up to 5 years for those with super balances of $500,000 or less.

A new “Diverted Profits Tax” will hit companies found shifting profits offshore with a tax rate of 40%. This is expected to raise $200 million by 2019. The government will also increase penalties for large companies that lodge their tax returns late, and fund a “tax avoidance taskforce” that’s expected to help the government raise $3.7 billion over the next four years. It will also strengthen protection for whistleblowers who report tax avoidance.

There will be four annual 12.5% increases in tobacco excise from 2017, which will help the government raise $4.7 billion. This measure will be backed up with a $7.7 million “strike team” to crack down on illegal tobacco activity.

Our experts respond below.

What changes will be made to superannuation tax?

Helen Hodgson, Associate Professor, Curtin Law School and Curtin Business School

The superannuation package will deliver a significant redistribution through scaling back the tax concessions available to people with high superannuation balances and/or the capacity to make substantial contributions to superannuation. The measures, with the exception of the lifetime cap, will commence from 1 July 2017.

The good news is the restoration of a tax offset for low income earners with income of less than $37,000 pa. The new Low Income Superannuation Tax Offset (LISTO) is very similar to the LISC: although the method of calculation is different, it will reduce any tax paid by the fund by up to $500 as long as a concessional contribution has been made during the year.

As expected, the concessional contributions cap has been reduced, although the new contribution is cap of $25,000 is at the higher end of the predictions. This is effectively reduces the current cap by $5,000 pa for people under 50, and $10,000 for people over 50. This cap can also be rolled over to assist people who have interruptions to their workforce participation, as long as their superannuation account balance is less than $500,000.

An associated measure will allow additional tax deductions for people who may not have been able to access the cap. This could arise where an employer will not allow salary sacrificing, or where a person has some income from paid employment but the balance of their income is from self employment. In such cases a person could not claim a tax deduction on topping up their superannuation so that additional contributions were treated as non-concessional contributions. This measure will allow consistent treatment across contributions.

The work test is being withdrawn so that people aged over 65 will no longer have to show that they are gainfully employed, which will allow either concessional or non-concessional contributions to be made up to the age of 75.

The non-concessional cap is being completely restructured. Under the rules that were in place prior to budget night a person could contribute up to $180,000 a year, or $540,000 every three years under the bring-forward rule.

With effect from Tuesday 3 May, the cap has been converted to a lifetime cap of $500,000. This will include all non-concessional contributions made since 1 July 2007, although if the cap has already been reached there will be no penalty imposed. However in future if a person breaches this cap it will be required to be withdrawn or subject to penalty tax.

Other measures to reduce the tax benefits to high income earners are the lowering of the income threshold where contributions are subjected to the higher 30% tax rate to $250,000. However there is a new proposal to limit the tax exemption of superannuation in retirement phase when the member has a balance of more than $1.6m in assets. If a member balance is more than $1.6m, the surplus needs to be left in accumulation phase where it is subject to 15% tax, or penalties will apply. Assets that are used to support transition to retirement income streams are also to be taxed at 15% in the superannuation fund.

In addition to the rollover of concessional contributions, a spouse can receive a tax offset of up to $540 for contributions made on behalf of a spouse who earns less than $37,000 – increased from $10,800. The low income threshold resulted in the existing concession being underutilised. However there is no superannuation guarantee requirement on paid parental leave.

Overall, the package is progressive. The government has estimated that the net increase to the revenue is $2.9bn after redistributing over $3bn to low income earners and in removing some anomalies.

There is evidence that high income earners will continue to save in other environments. The test will be how much of the savings is switched to productive income, and how much goes to other tax shelters, such as the property market.

How will tax excises change and what will this mean for the cost of alcohol and cigarettes?

Megan Vine, Law Lecturer, UNE

The proposed a 12.5% annual increase in tobacco excise over the next four years to 2020, will act as a continuation of the same increase over the previous four years introduced by the Labor government. If previous estimates are correct this means a 25-cigarette pack will cost approximately $40 by 2020. In addition to increases in tobacco tax the government will be decreasing the duty free tobacco allowance in Australia from 50 cigarettes to 25 cigarettes or equivalent.

There will be no changes to excise tax rates for alcohol or fuel and no changes to the way in which wine is taxed. This means inconsistencies in the current tax arrangements for alcohol, where rates of taxation vary considerably for different types of alcoholic beverages will not be addressed by the current budget.

However, as part of its Ten Year Enterprise Tax Plan, the current brewery refund scheme, which provides a refund to independent breweries of 60% of the excise duty paid up to a maximum of $30,000 per financial year, will be extended to domestic distilleries and producers of low strength fermented beverages such as non-traditional cider from 1 July 2017.

Further in response to integrity concerns the government will be reducing the wine equalisation tax (WET) rebate cap from $500,000 to $350,000 on 1 July 2017 and to $290,000 on 1 July 2018 and will be tightening eligibility criteria from 1 July 2019. Hopefully these changes will have some impact on the distorting effects of the rebate discussed in the Senate Committee report into the grape and wine industry. The Government will also be providing $50 million over four years to the Australian Grape and Wine Authority to promote wine tourism within Australia and Australian wine overseas to benefit regional wine producing communities. While changes to eligibility will likely be welcomed by the wine industry the reduction in the cap may impact smaller producers.

Will there be a new Australian Google tax to crack down on tax avoidance?

Antony Ting, Associate Professor, University of Sydney

The government has introduced the Multinational Anti-Avoidance Law (MAAL), commonly known as the Google Tax, effective from 1 January this year. The MAAL is designed to deal with tax avoidance structures of multinational enterprises such as Google and Microsoft.

Early signs suggest that the MAAL has both positive and negative impact on the behaviour of MNEs. On the positive side, many multinationals have proactively initiated discussion with the Australian Taxation Office with the intention to ascertain whether they will be subject to the MAAL, and if so, to explore how they should restructure to comply with the law. An obvious positive result of the MAAL is that Google recently announced that it will restructure its operations and commence to pay more tax in Australia in 2016

On the negative side, the ATO has recently released a tax alert to warn multinationals that it is aware that some have entered into “artificial and contrived arrangements to avoid the application of the MAAL”.

The silver lining of this development is that it suggests that the ATO appears to be on top of the issue and the release of the tax alert is likely to have some deterrent effect to curb the zest for aggressive tax planning by multinationals with respect to the MAAL.

To further strengthen the tax law on this front, the Treasurer announced in the Budget that the government will introduce an even stronger anti-avoidance law, a new Diverted Profits Tax (DPT). The new tax will be effect from 1 July 2017. Its design follows largely the DPT introduced in the UK last year.

The new DPT will have a wider scope than the MAAL. It will apply to large multinationals (with a global revenue of at least $1 billion) if among other things, a multinational has artificially shifted profits from Australia and the foreign tax paid on that profits is less than 80% of the Australian tax otherwise payable.

In other words, if the profits are shifted to a jurisdiction with a corporate tax rate of less than 24%, the DPT may apply. This threshold will cover most of the low tax countries commonly used by multinationals in their tax avoidance structures.

If properly designed, the new DPT is likely to have strong deterrent effect. This is because its tax rate is 40%, which is 10% higher than the standard corporate tax rate in Australia. The experience in the UK with its version of the DPT suggests that this penalty rate will be an important factor for MNEs to consider before entering into aggressive tax avoidance structures.

The new DPT is a welcome move by the government to combat tax avoidance by multinationals.

Do the tax changes represent real reform?

John Freebairn, Professor, Department of Economics, University of Melbourne

The Treasurer has proposed tax reforms which in aggregate are approximately aggregate revenue neutral. The question then is will the reforms reduce distortions to productive decisions to work, invest and spend, and what are the implications for distribution of the tax burden?

The decision to extend special tax concessions to small businesses (a lower rate of 27.5%, immediate write-off for investments less than $20,000, and extend the small business definition from turnover of $2 million to $10 million) while maintaining the current higher taxation of larger businesses might be politically popular, but it involves a revenue loss for no productivity gains. While the Treasurer indicated funds to pay for the current changes, mostly from greater integrity of the taxation of multinational companies. However, no indications were given for funding to extend the 27.5% rate to all businesses by 2023-24.

There is no compelling evidence that small businesses are more or less important or successful than large businesses in creating jobs, developing and implementing new products and production processes. There are many examples of successes and failures across both small and large businesses. The revised $10 million cut-off for the concessions is just as arbitrary as the preceding $2 million number. A more nationally productive reform would have identical and lower tax rates on comprehensive business income tax bases independent of size.

Budget proposal to reduce some of the tax concessions for superannuation for high income earners and use the revenue saved to raise the personal income tax bracket from an annual income of $80,000 to $87,000 for those on upper middle and above incomes represents a very tentative move towards a more equitable and less distorting system of personal income taxation. Of course, part of the change is no more than a return of bracket creep and the associated increase of average tax rates for all.

Those who are making large superannuation contributions will lose more from the reduced concessions than the gain from the lower tax rates. For many with average decisions the gain and loss will roughly cancel. A broad and comprehensive labour income tax base would tax all forms of remuneration, including super and fringe benefits, the same as wages and salary income. The broader base and lower rate approximately revenue neutral package would reduce distortions to decisions to work and encourage participation.

The Treasurer in defending no changes to the lower income tax brackets fell back on the argument that these people received income tax cuts as compensation for the carbon tax introduced in July 2012. Bracket creep is causing larger increases in average tax rates for the two-thirds of taxpayers with incomes below average weekly earnings. When the carbon tax was removed in July 2014, the income tax cuts were retained. This seems a tough equity argument to sell.

Authors: Helen Hodgson, Associate Professor, Curtin Law School and Curtin Business School, Curtin University;
Antony Ting, Associate Professor, University of Sydney; John Freebairn, Professor, Department of Economics , University of Melbourne; Megan Vine, Law Lecturer, University of New England

The way Australia taxes housing is manifestly unfair

From The Conversation.

When politicians talk about tax and fairness, it’s easy for them to point out undeserved loopholes benefiting the wealthy, or multinational companies. But the elephant in the room is the difference between those who own and those who rent (or have recently bought and have huge mortgages) the house they live in.

The tax advantages of housing offend against justice on every count: they place financial stresses on the poor, they are unequal, and the increase in price is not deserved.

Owner-occupied houses are exempt from income and capital gains tax, and from social welfare means tests. Negative gearing gives investment properties a tax advantage, which is exacerbated by discounts on rates of capital gains tax. Rent assistance given to those on social security (currently a maximum of A$130 per week) is not sufficient to compensate for the difference.

The high price of housing is created by tax inequalities and by supply and demand imbalances created by government failure. At the same time, the government has encouraged banks to borrow hundreds of billions offshore to fund greater mortgage debt – pushing prices higher. Foreign depositors are faced with a low 10% withholding tax (reduced from 15%), and have not been subject to adequate money laundering controls.

And there is not much social benefit in higher house prices to counteract the costs to non-homeowners. Higher prices have not led to a significant increase in supply over time; people do not spend the increase, nor use it much to fund their retirement.

Defining ‘justice’

The word justice is used so widely, it needs some definition. While “fairness” is applied more widely, justice can be used to incorporate four sometimes conflicting objectives. Justice seeks, as much as possible to:

  • Contribute to economic equality
  • Give each person their just deserts
  • Meet people’s essential needs
  • Allow for personal liberty by not interfering in people’s lives.

Such a model of justice can be used to evaluate tax systems.

For those concerned that justice comes at a cost to efficiency and economic growth – there is considerable evidence to show that the relationship, where it exists, is positive. Giving people their just deserts provides the material incentives so beloved of economists. Evidence from a broad group of countries shows little overall relationship between income inequality and rates of growth and investment. Fairer taxes lead to greater compliance with tax laws. Research has found a significant increase in Australian tax morale between 1981 and 1995, which was explained by reforms that people saw as making the system more just.

Clouded by politics

Amid the ongoing debate about tax reform during the last year, many had hoped for some meaningful changes in the coming federal budget.

Instead, the current debate on the tax system, and more recently negative gearing, is concerned with perceptions of political acceptability.

This was also typified by the dismissal of any change to the taxation of housing in the Re:think tax discussion paper:

“Given the central importance of the home for Australian families, there is a strong consensus that it would not be appropriate to tax either the imputed rent on owner-occupied housing or capital gains derived from it.”

“Strong consensus”, whatever that means, is not a good reason if it involves injustice. The argument works the other way: given the central importance of the home, and its place in income and assets, it is essential for housing to be included in our tax and welfare systems. Let’s be the land of the fair go, even if we have to give up some personal advantages.

Reform options

Addressing the issue is complicated politically in that around 70% of voters own their houses, and a significant minority have borrowed heavily to get into the market in recent times. If prices drop, they will suffer through no fault of their own, as would the banking industry. With more than two million shareholders, banks are also strong politically.

The Henry tax review did, however, recommend a transition from stamp duties to a land tax, a significant increase in rental assistance and the removal (albeit with a high threshold) of the exemption of owner occupied homes from the means test for pensions.

The greater efficiency, and justice, of land taxes means that they have fairly widespread support from informed commentators. Taxes on property currently raise A$29 billion annually for the states and another A$14 billion for local governments in Australia. If land accounts for 50% of the value of residential housing, the additional revenue would be of the order of A$75 billion. Another A$40 billion might be possible if commercial land was also be included.

Removing capital gains discounts and taxing imputed rents should also be considered. Research released in 1994 found the latter would be both efficient and more equitable in Australia. The advantage of this is that such a system allows for the tax deductibility of mortgage repayments, so would provide compensation for the minority that had recently bought into the housing market. A higher withholding tax on international deposits would also reduce the availability of funds to push up assets, and encourage local businesses by removing some of the artificial support for the currency.

Housing accounts for more than 60% of the value of total assets held by Australians. Translated into imputed rent it amounts to about A$150 billion annually, or 20% of the gross personal income of those who own their homes. If taxed at marginal rates of tax, imputed rents would add about a third to current personal tax of A$190 billion annually.

This article is a summary of a paper “The justice of 2016 Australian tax and redistribution” to appear in the St Mark’s Review.

Author: Anthony Asher, Associate Professor, UNSW Australia

Six things a tax haven expert learned from the Panama Papers

From The Conversation.

The Panama Papers is a treasure trove of information on the activities and clientele of a large, but not atypical law firm operating in an offshore financial centre. In this case, it is a firm called Mossack Fonseca, based in Panama. It follows a series of spectacular leaks by the International Consortium of Investigative Journalists, including the HSBC files and the Luxembourg leaks. Here are six things that stand out from the latest revelations.

1. Same old techniques

Although it is still early days and it will take some time for the 11.5m files that were leaked from the Panama-based law firm Mossack Fonseca to be analysed, I have not come across any information on any new or unfamiliar techniques of tax avoidance. Everything that has been revealed so far: the use of offshore entities, nominee directors, accounting firms, legal firms and the like, is depressingly familiar.

2. Part of modern business

I am least surprised to learn about the profile of the typical Mossack Fonseca client. They are members of the globe-trotting elite: politicians, top echelon lawyers and accountants from a vast number of countries, some businessmen, many more in the business of finance.

In a book written by Richard Murphy, Christian Chavagneux and me on tax havens, we use the sub-title: How Globalization Really Works. We argue that tax havens are now a central component of the way international business is conducted. The Panama Papers leak is just further evidence that tax havens are an integral component of modern business.

3. A lot of it is legal

The law firm Mossack Fonseca is probably not any worse or better than your typical law firm specialising in offshore activities. If we have learnt anything from the various leaks about what takes place in the offshore economy, then it is that the accountancy and legal firms are key players in making them function.

Will this law firm be subject to penalties or taken to court? Very, very unlikely. In response to the leak, Mossack Fonseca have stressed the legality of their activities:

Our firm, like many firms, provides worldwide registered agent services for our professional clients (e.g., lawyers, banks, and trusts) who are intermediaries …

Finally, it is well established that many countries (e.g. UK, USA) have trust laws that permit a person or enterprise to represent a third party in a fiduciary capacity, which is 100% legal and serves an important purpose in global commerce.

It is up to the Panamanian government to take the firm to court to establish whether it broke the laws on compliance, due diligence and money laundering standards. Only then will we know if all their actions were legal, despite what the Panama Papers show.

What is worrying, though, is that when it comes to fighting tax avoidance (and evasion), it is highly likely that governments around the world will turn yet again to these large accounting firms and top law firms. The problem here is that these advisers then have the power to sell their expertise in tax planning to wealthy clients – after all, they know the law best, as they more or less wrote it.

4. Watch out for the whistleblower

The person who is likely to suffer most from the leak is its originator: the whistleblower. Their life – if they are identified – will be hell. Members of our globe-trotting elites will make sure of that. They are as likely to suffer from Putin’s henchman as from the courts of a leading and supposedly fair nation such as Sweden or the UK where they could be sued for the theft of the data.

Edward Snowden. 360b / Shutterstock.com

The whistleblower who exposed wrongdoing at HSBC’s Swiss bank, Hervé Falciani, was sentenced to five years in prison by a Swiss court for industrial espionage, data theft and violation of commercial and banking secrecy. He has managed to escape imprisonment by living in exile in France, but it goes to show that whistleblowers do not necessarily have the law on their side. Edward Snowden who released the Wikileaks files remains in Russia, hiding from US prosecutors.

5. There’s a long way to go

The OECD may claim that there are no longer any unco-operative tax havens in the world; UK prime minister, David Cameron, may say that Britain is taking a lead in the fight against tax abuse. The reality is that there are a number of tax havens facilitating these secretive deals and Britain is connected to a lot of them. More than 100,000 companies in the leak are based in the British Virgin Islands, a British overseas territory.

The Panama Papers, which revealed the activity of only one legal firm operating largely in one of the less glamorous tax havens, Panama, is another reminder that we face a very long fight against tax abuse in the offshore economy, and anyone professing to have conquered that world is either wilfully misleading us or blissfully ignorant.

6. Public outcry is needed

To end on a positive note, the Panama Papers when added to previous leaks will have a cumulative effect on the public that cannot easily be predicted. It may fuel a complete and utter disgust with the establishment, and the further rise of either right-wing populist politicians such as Donald Trump in the US, or a left-wing social democratic response such as that espoused by Bernie Sanders in the US or Jeremy Corbyn in the UK. The perpetrators may get off lightly, as has been the experience so far with the other leaks, but the impact on society may yet be far reaching.

Author: Ronen Palan, Professor of International Politics, City University London

Will house prices ‘collapse’ if negative gearing is changed?

From The Conversation.

There is much confusion about the effects of Labor’s tax proposals with respect to investors in rental housing. They propose to grandfather existing arrangements. But investors in the future can only negatively gear newly constructed housing, while the policy recommends the capital gains discount fall from 50% to 25%.

Claims by Prime Minister Malcolm Turnbull that house prices will collapse appear to be contradicted by his assistant treasurer Kelly O’Dwyer who claims that housing costs will soar. These puzzling assertions arise due to a failure to distinguish between the market in rental housing, where housing is leased, and the market in which investors and owner occupiers buy and sell housing. Critically these two markets are interrelated.

To see why, consider the first round effects of Labor’s proposals when we put the grandfathering arrangements to one side (for the moment). Some existing investors will sell up when leases come up for renewal. There are now more tenants seeking rental housing opportunities than there is supply to meet their demand. Rents will begin to rise.

But the houses which investors quit add to the properties available for sale; there are now more houses available for purchase than there are buyers. House prices will begin to fall.

These market signals trigger a second round of effects. Some tenants will elect to buy rather than rent. After all renting has become more expensive and home ownership has become cheaper. These second round effects help to put a floor under falls in house prices, and help cap rent rises.

By considering the inter-relationships between the two markets we can understand how the government has issued apparently contradictory statements. Rents will rise and so the housing costs of tenants will increase. But there will be falls in house prices (or more likely a slower growth in prices); while existing owners take a hit, first home buyers housing costs are lower and attainment of home ownership becomes more affordable.

The second round effects mean that impacts are likely to be muted. This is made even more likely by a grandfathering proposal that should prevent a stampede by existing investors seeking to relinquish their property investments.

A disappointing aspect of the debate so far has been its neglect of the longer term structural consequences of Labor’s suggested reforms. Our current arrangements encourage high tax bracket investors to take on debt in the “chase” for capital gains. Capital gains are leniently taxed as compared to ordinary sources of income, such as earnings and rents.

Only 50% of capital gains are added to assessable incomes. This is particularly attractive to high tax bracket investors. Moreover, they are taxed on realisation rather than as they accrue. The shrewd investor realises the gains when assessable income from other sources declines; for example, following retirement when the investor’s marginal tax rate commonly falls.

There are not enough high tax bracket investors willing and able to invest in all our private rental housing stock. They tend to cluster in those segments of the market where healthy capital growth is expected, but rental yields are lower. Low tax bracket investors tend to cluster in segments where capital growth is expected to be subdued. Typically these are areas with lower house prices. To ensure adequate returns rental yields have to be higher in these low house price segments.

We therefore get a distorted investment pattern that disadvantages the supply of affordable rental housing.

Labor’s proposals will curb these distortionary effects by reducing the capital gains discount. They will also reduce the tax incentives to leverage investments. Rising indebtedness is a threat to the resilience and stability of our housing market.

Many believe that repayment and investment risks carried by heavily indebted home buyers played a central role in precipitating the global financial crisis. Tax concessions that favour taking on debt exacerbate those risks. If Labor’s proposals succeed in attracting attention to these and other structural problems that plague Australian housing markets, they will have a much wider significance.

Author: Gavin Wood, Professor of Housing, RMIT University

How policy success, not failure, has driven Australia’s housing crisis

From The Conversation.

To see Australia’s shortage of affordable housing as a failure of government is to misunderstand the politics that underpin housing. The vast proportion of government money spent on housing directly benefits the well-off at the expense of private renters and public housing tenants.

Government policy has not, on the whole, failed. It has been a huge success insofar as protecting the opportunities for speculative investment and profit for homeowners and private landlords.

If the government was serious in wanting to end the housing crisis it would need to invest in new social housing and pursue measures that choke off, via tax reform, the opportunities for profiteering currently enjoyed by landlords and homeowners.

The pursuit of these options would be bitterly opposed – not least by many homeowners and property investors, as it would lead to a fall in house prices.

Why this misdiagnosis persists

The government’s current housing response can be viewed as a charade. Ministers have been able to convince many that the government is working hard to put in place measures to fix the problems faced by low-income households.

There are two discernible ways that the government has maintained this charade. The first is by permeating an impression that action will be forthcoming. Social Services Minister Christian Porter recently announced that he would be establishing a working group to explore ways to improve the availability of affordable housing.

Porter’s working party should come as no surprise. Over many years, governments have undertaken many reviewsandenquiries.

Second is the recycling of a set of myths. Among these is that public housing is a failed policy that reinforces welfare dependency and that state and territory planners impose arbitrary rules and regulations that impede new housing development.

Public housing and planning regulation are framed as dysfunctional. We are told that affordable housing would be built quickly if the commercial sector were not impeded by bureaucratic demands.

Should we discard statements from the government that effective reforms are underway and recognise that the prospects for low-income Australians will deteriorate over the coming years? Already there are as many as 105,000 people who are without a home and 160,000 households on public housing waiting lists. The overall stock of public housing had fallen from 331,000 units in 2007-08 to 317,000 in 2013-14.

The Productivity Commission estimated that the proportion of low-income households in housing stress – that is, those that pay more than 30% of their income on housing-related costs – increased from 35% in 2007-08 to 42% in 2013-14.

In its 2012 report, the former National Housing Supply Council highlighted that between 2002 and 2012 rents increased in nominal terms by 76% for houses and 92% for flats. And the median value of a home in Australia is now A$576,100.

Sticking to the script

There are already signs in 2016 that the government intends on sticking to the usual script – one that frames the affordability crisis as stemming from a shortage of land, excessive red tape, and high labour costs within the building industry.

Acting Cities Minister Greg Hunt recently identified:

Three critical elements that require government attention. One – land release. Two – the cost of building – and this is in particular in relation to the inner city apartments where there is an urban infill. The third is bureaucracy.

Hunt’s attribution of the causes of the housing affordability crisis are broadly in line with the pronouncements of finance, developer and real estate lobbyists. All have made similar claims and work tirelessly to safeguard the opportunities for profit-making that exist when housing is in short supply.

It is no coincidence that supply-side interventions, such as sustained investment in public housing, have been eschewed in favour of demand-based subsidies. The latter includes initiatives such as Commonwealth Rental Assistance and inputted tax subsidies that enable landlords to boost their profits, alongside first homeowner grants and the exemption of capital gains tax for owner-occupiers when they sell their home. This amounted to A$54 billion of revenue forgone in 2016.

For those who wish to reap profits from their housing investment, there are good reasons to maintain the status quo; for a shortage of supply to continue and for public housing to remain a stigmatised tenure only available for those without any recourse elsewhere.

Stressing land release as a significant cause of the affordability crisis is misleading but not surprising. This is the claim repeated by developers who wish to increase their profits. It is not uncommon for developers to delay development plans on land they have acquired on the expectation that the opportunity to secure greater profits will accrue when the land value increases at a later stage.

It is disappointing that Hunt offered such a myopic explanation of the housing affordability crisis. A more insightful analysis would attend to the failure to invest in public housing, the subsidies that distort the private rental market such as negative gearing, and the tax privileges that are extended to homeowners.

The housing problems experienced by low-income households are a symptom of entrenched inequality within Australia. Public and private tenants remain disadvantaged and have to endure problematic tenancies that are increasingly insecure. Unless this inequality is addressed, Australia’s housing problems will endure.

Author: Keith Jacobs,  Professor of Sociology and ARC Future Fellow, University of Tasmania

If you want Google to pay more tax, change the law

From The Conversation.

Globalisation – and the global economic crisis – have contributed to the erosion of national tax bases and in recent years some of the biggest multinationals, among them Apple, Vodafone, Amazon, Google, Starbucks and Microsoft, have been scrutinised for their aggressive tax planning practices. Using (among other techniques) transfer pricing, inter-company lending, royalty payments for licensing agreements, cost-sharing agreements and offsetting group losses, multinational groups can achieve very low effective tax rates.

The ability to shift profits into low or no-tax jurisdictions with little corresponding change in business operations has also been criticised. Fuelled by media attention the reporting of these practices has in some countries led to public outcry and politicians seem to have jumped on this bandwagon.

Google’s £130m tax deal with HMRC is the latest instalment in a “UK vs Google” saga. Google’s encounters with the UK’s parliamentary public accounts committee had already been recorded in a report: “Tax Avoidance – Google. At the time, the committee questioned how Google, which generated US$18 billion (£12.6 billion) in revenue from the UK between 2006 and 2011, could only pay the equivalent of just US$16m (£11.2m) of UK corporation taxes in that same period.

The company used the now-defunct “double Irish” structure to achieve these low effective tax rates. Central to Google’s tax planning was the position that sales of advertising space to UK clients took place in Ireland. The public accounts committee found this “deeply unconvincing” back in 2013. But arguments against Google’s position relied on concepts of morality and fairness rather than clear tax rules – and this is the problem.

Google has now agreed to pay £130m in back taxes. To put this into context, consider that Google made more than £3 billion in UK sales in 2013 alone. Some (mainly the chancellor of the exchequer and HMRC) see this as a big success, while others have labelled it as “derisory” and “a sweetheart deal”.

These stories provide fertile ground both for the government and the opposition to raise the stakes: the government is arguing that it is doing more to curb tax avoidance than previous (Labour) governments and the opposition is arguing that this government is not doing enough.

Letter of the law

What underpins the whole anti-Google, anti-Starbucks, anti-Vodafone rhetoric is the idea that multinationals should follow the spirit and not just the letter of the law – and pay taxes accordingly. This is buttressed by an overriding concept of “tax morality” or “tax justice” which trumps the actual legislation.

Facebook is thought likely to strike a similar deal to Google’s. Reuters/Dado Ruvic

By contrast, what underpins the comments of those who defend the tax planning practices of these multinationals is the idea that legality and illegality is determined according to whether or not they complied with the law. If people disapprove of tax planning practices, whether perceived to be aggressive or not, but still legal, then they should press their governments to change the relevant tax laws.

You can understand why words like “morality”, “fairness” and “justice” are attractive in this context, but the reality of the situation is that most of these instances of aggressive tax planning (or stateless income, as coined in the US) are not technically illegal. In other words, current domestic tax laws and the vague non-binding principles of international tax law seem to facilitate such tax planning – some might even say, encourage it.

New initiative

What has clearly emerged in the last few years of “tax crusades” is the inadequacy and unsuitability of existing principles of international tax law to deal with the internationalisation of business. Some argue that existing tax rules on jurisdiction in particular need to be adapted to new business models such as digital. Others argue that existing principles are sufficient but there is discord as to how tax authorities ought to apply them.

The OECD/G20, in the context of its Base Erosion and Profit Shifting (BEPS) project, has tried to find solutions to some of these issues through consensus – something initially thought of as nearly impossible.

The OECD launched its BEPS action plan on multinational tax minimisation in 2015. OECD

However, to the surprise of some, the OECD did meet its deadlines and produced recommendations for the issues raised in an action plan. These recommendations were set out in the final reports it published in October 2015. Whether the BEPS project will make it easier (and more transparent) for tax authorities to tackle aggressive tax planning remains to be seen. However the international tax community, through the OECD/G20, is making an effort to address existing problems and should be at the very least congratulated for its efforts and encouraged to continue.

The European Union has also been at the forefront of these developments. While most associate the European Union with open borders and market liberalisation – with member states’ budgetary concerns of secondary importance – the European Commission has seized on this unique political momentum to further its agenda. The various commission action plans and recommendations evince the inception of a strong EU policy against international tax avoidance. The recent state aid actions, also spearheaded by the commission – which prevent national governments from giving corporations “an unfair competitive advantage” – seem to corroborate this.

Whether or not one agrees with the EU’s – some would say slightly overkill – approach, it should nevertheless remain a priority for those working in tax to address the inadequacy of the existing rules with new or refined rules and principles – not with the injection of vague notions of morality and fairness. The UK has made a valiant attempt to (partially) address the problems with its Diverted Profits Tax also known as “Google Tax”. This legislation broadly allows HMRC (under certain circumstances) to tax the profits of multinationals arising from business activities taking place in the UK when there is no taxable presence, because of contrived arrangements diverting these profits from the UK.

While this unilateral stance has been criticised for going against the spirit of multilateralism in the BEPS project, it is a welcome example of rules – some would say imperfect rules – filling in the gaps of the international tax system. The enemy is not just complacency – it is also uncertainty and vagueness.

Author: Christiana HJI Panayi, Senior Lecturer in Tax Law, Queen Mary University of London

‘Catch up’ super contributions: a tax break for rich (old men)

From The Conversation.

It’s no secret that our superannuation system is unfair. Over half the value of the tax breaks goes to the top 20% of income earners, people who already have enough resources to fund their own retirement.

As shown in our new report for Grattan Institute, Super tax targeting, the system provides overly generous opportunities to contribute to super. These opportunities are usually defended on the grounds that people with broken work histories, especially women returning to work, can “catch up” before retirement. Super lobby groups make a lot of noise about middle-income people scrambling to build a decent nest egg for retirement, and our super system bends over backwards to help them.

But it’s hard to find many middle-income earners in real life who make large voluntary contributions to super. Instead the system mainly creates large tax-planning opportunities for many more people who already have enough resources to fund their own retirement. The plight of catch-up contributors is the tail that wags the super dog.

Author provided

Superannuation tax breaks allow people to pay less tax on their super savings than is paid on other forms of income. Annual caps on super contributions act as a brake on the system’s generosity, and its cost. If set at the right levels, these caps prevent high-income earners from abusing generous super tax breaks to lower their tax bills.

Yet Australia permits larger voluntary contributions to superannuation than many other countries. The flat 15% tax rate is applied to contributions made from pre-tax income – delivering enormous tax breaks to high-income earners on high marginal rates of income tax. Even where superannuation contributions are made from post-tax income, savers then benefit from generous tax breaks on super fund earnings, only taxed at 15%, or zero in retirement.

Catch-up contributors are a myth

All the evidence shows that very few middle-income earners, and even fewer women, make large catch-up contributions to their super funds. Only 12% of taxpayers, or about 1.6 million people, make large pre-tax contributions of more than $10,000 a year, and that includes compulsory super paid by their employer. Just 164,000 women earning less than $77,000 make such large pre-tax contributions. However 935,000 men earning more than $77,000 do so. These high-income savers get a tax break on the way in, and then pay little or no tax on their super earnings.

Author provided

Why do so few middle-income earners make large catch-up contributions? Put simply, they can’t afford to. In 2012-13, the median taxable income in Australia was $41,561. Gross incomes (before any deductions) are not much higher. More saving boosts incomes in retirement, but it reduces living standards today. This fundamental trade-off is rarely discussed in the superannuation debate.

Benefits flow to high-income earners

Not surprisingly it is mainly high-income earners who have the disposable income to put more than $10,000 a year into their super. They get large tax breaks, even though they are likely to retire with enough assets to be ineligible for an Age Pension.

The cap on post-tax contributions is even more generous. It allows people to contribute up to $180,000 per year. People under age 65 can also bring forward an extra two years’ contributions, so they can put in up to $540,000 during a single year, and that’s on top of up to $35,000 in contributions from pre-tax income.

These post-tax contributions total $33 billion a year – about three times the size of voluntary pre-tax contributions. Many post-tax super contributions appear to represent tax-planning rather than any genuine increase in retirement savings. Of all post-tax contributions, around half are made by just 200,000 people who already have at least $500,000 in their superannuation. Only 1.2% of taxpayers have total super account balances of more than $1 million, yet this tiny cohort accounts for 26% of all post-tax contributions. By contrast, the 70% of taxpayers with super balances of less than $100,000 make just 9 per cent of total post-tax contributions.

Author provided

Lifetime caps would likely make things worse, unless set at very low levels. To maximise their superannuation tax breaks, taxpayers who have not used up their lifetime pre-tax cap could sacrifice the entirety of their earnings into super. Such tax planning is likely given how super tax breaks are used already.

Counting the cost

Whatever the benefits of superannuation tax breaks, they must be balanced against the costs. Superannuation tax breaks cost a lot – over $25 billion in foregone revenue, or well over 10% of income tax collections – and the cost is growing fast. Lower-income earners and younger people have to pay more in other taxes – both now and in the future – to pay for the tax-free status of so many retirees.

The way forward

Caps on super contributions need to strike a better balance between allowing those with broken work histories to contribute towards a reasonable superannuation balance, and restricting the opportunities for tax minimisation by those unlikely to qualify for an Age Pension. That means being realistic about the level of catch-up contributions that are likely from those who are genuinely making up for broken work histories.

Grattan Institute’s new report, Super tax targeting, recommends three reforms to better align tax breaks with the goals of superannuation.

One, annual contributions from pre-tax income should be limited to $11,000 a year. This change would improve budget balances by $3.9 billion a year. There would be little increase in future Age Pension payments since the reductions in tax breaks would mainly affect those unlikely to receive an Age Pension anyway.

Two, lifetime contributions from post-tax income should be limited to $250,000. It won’t save the budget much in the short term, but in the longer term it will plug a large hole in the income tax system.

Three, earnings in retirement – currently untaxed – should be taxed at 15%, the same as superannuation earnings before retirement. A 15% tax on all super earnings would improve budget balances by $2.7 billion a year today, and much more in future.

Previous repeated changes to superannuation have been too timid. Decisive reforms must target super tax breaks at those who need them most, and limit the benefits for those who don’t need them. Until then the system will keep chasing its own tail.

Authors: John Daley, Chief Executive Officer , Grattan Institute; Brendan Coate, Senior Associate, Grattan Institute.

 

Three superannuation reforms that would promote fairness and equity

From The Conversation.

The taxation of superannuation has been the cause of much consternation. Much of the difficulty is the result of the slow drift of superannuation from the moorings of its original purpose.

In introducing the superannuation guarantee in 1992, the Keating government was pursuing an ideal firmly centred on the ordinary person of ordinary means. The hope was to extend superannuation to the entire workforce as a means of ensuring working people were not wholly dependent on the state in funding their retirement.

Over time though, this vision has been lost. A succession of reforms have seen superannuation gradually assume the function of a tax shelter for the wealthy. The concessions available under the present framework are overwhelmingly skewed towards those who are perfectly capable of funding their retirements without government assistance of any kind.

These three reforms would promote fairness and equity in the taxation of superannuation.

Progressively tax fund earnings

Treasurer Scott Morrison has indicated he is open to this proposal of reforming the way super is taxed which has been publicly championed by Deloitte Access Economics.

Fund earnings are, in general, taxed at a rate of 15% while the fund is accumulating, and are tax-free once the fund is being used to provide a pension. The benefit of this is relatively modest for those to whom a low marginal income tax rate applies.

But for those who have large funds and to whom the top income tax rate applies, the value of this concession is extraordinary. By concentrating assets within super, wealthy individuals are able to avoid the high tax rates which would apply to those assets’ earnings if they were held in the individuals’ own names.

The burgeoning self-managed-super-fund advisory industry is testament to the zeal with which high-net-worth individuals are pursuing the tax advantages which the present system affords.

Superannuation was never intended to operate as a tax shelter for the earnings of multi-million-dollar equity portfolios. There is a strong case for introducing progressive taxation of fund earnings to prevent this misuse of super.

Lower the cap on concessional contributions

The general concessional contributions cap presently sits at $30,000. This means that individuals can contribute up to $30,000 to their super from their pre-tax income in a financial year (including any employer compulsory contributions) and pay a concessional tax rate (usually 15%).

There is a very strong case – put by the Grattan Institute’s John Daley in April – that this general concessional cap is far too high. The present figure represents a huge proportion of the annual income of the average Australian. Most workers are simply unable to take advantage of the full extent of the tax concessions available.

The lion’s share of the benefits are therefore captured by those with large incomes who can afford to make voluntary super contributions by way of salary sacrifice. While it is sensible to encourage workers to make voluntary contributions to super, it must be recognised that the average Australian is simply unable to spare tens of thousands of dollars a year for this purpose.

Retain the low income super contribution

One of the peculiarities of the current system is that some low-income workers are actually made worse-off by the ‘concessional’ contribution tax rate.

Take, for example, a part-time cleaner who earns $15,000 per annum. This income falls below the tax-free threshold, and therefore attracts no income tax. But the compulsory employer contributions made on this worker’s behalf are still taxed at the standard concessional rate of 15%. The profoundly unfair result is that this worker’s super contributions are subject to a “concessional” rate which is actually higher than the tax rate applied to his or her ordinary earnings.

This is currently remedied by the existence of the Low Income Superannuation Contribution, which operates to reverse this unfair result for those who earn under $37,000 per annum. The motivations which underlie this policy are admirable. But the LISC is due to cease on 30 June 2017, and the government has not yet indicated an intention to extend its life or make it permanent. If the LISC is permitted to cease, the result will be a system which actively disadvantages the least well-off while directing substantial largesse to the wealthy. This would be an extraordinary outcome.

If the government is serious about superannuation reform, it should be looking closely at some of these. The opportunity of raising revenue while taking super back to its original purpose is too good to pass up.

Author: John Eldridge, PhD Candidate, Adelaide Law School, University of Adelaide