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Australia’s Allowance For Corporate Tax Stupidity

If you think heavy-handed public sector stupidity is confined to Europeans or America, have a read of this article by Peter Martin in yesterday’s Fairfax papers. According to Martin, a nine-person working group set up by Treasurer Wayne Swan after the recent tax summit came up with this corporate tax gem. It…

Is examining a proposal known as Allowance for Corporate Equity, which would apply no tax to the portion of corporate profits necessary to get a reasonable return on equity. Most companies – especially manufacturers – fail to meet that hurdle and would pay no corporate tax. Banks and mining companies make a much greater return on equity and so would be liable for the super tax on the excess portion of their earnings.

Emphasis added there is our own. And if there were a way to emphasise how colossally stupid this idea is, we would. It’s not surprising academics and the public service are for it. They know nothing about free trade and free enterprise. What really surprised us is that the Business Council of Australia seems to be for it too. Anyone in business who supports this idea should be forced to work as a mail clerk in the tax office until the end of time.

What is so stupid about this idea? The assumption behind the idea is that large profits are indicative of some sort of structural flaw in how certain funds are accounted for. Businesses who fund growth with debt can write off the interest payments from their tax. Businesses that fund growth through equity are not allowed to write dividends off from their tax. The measure seeks to rectify this injustice.

But according to Martin’s article, the only businesses that would really pay the tax are the banks and the big miners. They enjoy very high returns on equity (currently) for various reasons we’ll get to in a moment. But what does it tell Australia: that most corporations would pay no tax at all under the proposed change?

We’ll tell you what it tells you! It tells you that most corporations in Australia aren’t competitive enough to generate big profits and high returns on equity. That’s the real problem. You don’t solve that problem by resolving not to tax businesses that can’t turn a profit. You figure out if there are any general rules and regulations that make it really hard for Australian businesses to make a profit.

What is so alarming about the idea is that it’s clear evidence of how utterly stupid policy makers are about economics. The banks and the miners are enjoying cyclically high returns on equity because we’re on the tail end of a huge global credit bubble. The banks benefitted directly, via lower global borrowing costs. The miners benefitted indirectly via the boom in commodity demand generated by credit growth, low interest rates, stimulus spending, and quantitative easing.

Absent a credit bubble, banking and mining are low-growth businesses. They are terrible businesses, in fact, fraught with interest rate risk. Their current super profits are not structural. They’re anomalous. A tax that targets them is designed with full ignorance of how credit and money work, which is about what you’d expect from people who couldn’t turn a profit running a lemonade stand.

There is further stupidity to reveal. The bureaucrats are allowed to determine what is a “reasonable return on equity”. Aside from the arrogance and offensiveness of public servants telling entrepreneurs how much money they’re entitled to make, there is the little factor of what the “reasonable return on equity” is based on.

Naturally, it’s based on the “safe” yield of a government bond. Here we are in the middle of a global bond crisis in which the value of sovereign credits is being written down, and Australian policy makers have decided to tell the private sector that you’re allowed to earn about 5.5% to 6.5% return on equity for shareholders… Because that’s what it would take to get someone to buy shares instead of government bonds.

It really is breathtakingly stupid…and arrogant…and coercive. The only feature to the whole proposal that gives it a faint sheen of credibility is that everyone hates the banks. But the banks are making super profits because of the nature of our unsound money system and the virtual monopoly they’ve been granted…by the government.

With a free market for sound money, the banks wouldn’t enjoy their privileged position and lending money would be a low-margin, low-profit business. The only reason it’s not is that the bankers have hijacked the monetary system and preserved their position through government regulation.

If you want to drive business out of Australia and make it thoroughly uncompetitive globally, you’ll turn this tax into law. There is no surer way to drive capital, jobs, and risk takers off Australian shores. The economy will become even more two-dimensional (mining and banks), and the government will be forced to confiscate more of your income through higher compulsory contributions to super. That would probably suit them just fine. But does it suit you?

Dan Denning,
for The Daily Reckoning Australia

4 Comments

  1. SV says:

    What is so wrong with providing level playing field for businesses financed through debt vs equity? putting academics and bureaucrats deciding normal ROE …

  2. Taxi Lurker says:

    Isn’t this a cushioning device not unlike a floating dollar where a company falls to the point of a P.E. level that it then enjoys a tax-free break until once again it has a super profit status and is still earning good P.E..

  3. Golfman says:

    This is a classic case of government meddling with the market. Whenever government gets involved in the market they distort the market – which is the opposite of how markets work.

    Distorting the market adjusts the ‘true’ price of things and when you do that you’re taking on a more ‘designed intelligence’ approach to the economy than the classic ‘evolution’, survival of the fittest based approach that a free market is. In other words you’re trying to play ‘God’ with the markets.

    Evolution, survival of the fittest has resulted in a diverse, optimally adapted set of creatures on this planet.

    Evolutionary economics or “market based” economics has led us to mass produced cars, a computer in every home (well many computers), smartphones etc.,

    It’s easy to look around the world to see examples where the market forces were completely removed, Communist countries in the 1950-1980 or severely distorted by socialist governments in more recent times: Portugal, Ireland, Greece, Spain.

    Market meddling: Australia should withdraw any existing market meddling and definitely not be legislating for more.

  4. Ted says:

    I know this post is almost 6 months old but it’s the second result if you google for ‘allowance for corporate equity’ so I think it’s worth correcting the record. If you had bothered to read anything other than Peter Martin’s sensationalist and inaccurate article (say for instance, the appendix in the AFTS review which explains how ACE would work: http://www.taxreview.treasury.gov.au/content/ConsultationPaper.aspx?doc=html/publications/Papers/Consultation_Paper/appendix_e.htm), you’d realise that it’s essentially an ADDITIONAL deduction in the existing corporate tax system to ensure that there is a symmetric tax treatment of debt and equity financing, which would eliminate the tax distortion that causes businesses to rely overly rely on debt financing (as its tax treatment is relatively more favourable than equity).

    In other words, if this was implemented it would only have the effect of REDUCING the tax bill for pretty much any company that relies in some way on equity financing. It is not a ‘super profits tax’, it is an additional deduction in the existing corporate tax system. The point that Peter Martin and yourself have gotten confused is that an ACE is designed to ensure the corporate tax system only taxes ‘above normal’ (in the technical economic sense of the word) returns. Currently the corporate tax system taxes both ‘above normal’ and ‘normal’ returns to equity. ACE would simply remove the taxation on the ‘normal’ return portion (which is the risk free rate of return to equity, which is why the long-term Government bond rate is viewed as the appropriate rate).

    Please, for the love of god, try to inform yourself before you decide to go out and ‘inform’ the public. Having a public tantrum on your blog, when you clearly do not understand the issue in the slightest, only serves to damage sensible public debate on economic policy.

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