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Economics References Committee
24/04/2018
Commitment to the Senate issued by the Business Council of Australia

SWAN, Professor Peter, Private capacity

Committee met at 10:30

CHAIR ( Senator Ketter ): I declare open this hearing of the Senate Economics References Committee for its inquiry into the commitment to the Senate issued by the Business Council of Australia. The Senate referred this inquiry to the committee on 26 March 2018 for report by 7 May 2018. The committee has received 15 submissions so far, which are available on the committee's website. This is a public hearing, and a Hansard transcript of the proceedings is being made, although the committee may determine or agree to a request to have evidence heard in camera. I remind all witnesses that in giving evidence to the committee they are protected by parliamentary privilege. It is unlawful for anyone to threaten or disadvantage a witness on account of evidence given to a committee, and such action may be treated by the Senate as a contempt. It is also a contempt to give false or misleading evidence to a committee. If a witness objects to answering a question, the witness should state the ground upon which the objection is taken, and the committee will determine whether it will insist on an answer. If the committee determines to insist on an answer, a witness may request that the answer be given in camera. Such a request may also be made at any other time.

Welcome and thank you for appearing before the committee. I invite you to make a brief opening statement, should you wish to do so.

Prof. Swan : Thank you very much for inviting me to be here today. My presentation evidence came out of research I've been doing for a number of years on the effect of imputation credits on investment in Australia and the pricing or otherwise of these credits. I don't have a great deal to say about the requirements that may be imposed upon BCA companies, because I don't think this is a very effective way of getting any credible commitments from them; in fact I don't think the sorts of promises and commitments they are making are credible in any way, shape or form. In my evidence I want to show why it's very unlikely that there would be any increase in investment or higher wages paid to Australian workers; in fact, if that were the case, it would be a very indirect way of giving benefits to Australians.

The substance of my case is that I have shown that there is a difference in return between franked dividends and unfranked dividends. Unfranked dividends generally relate to Australian companies investing offshore, and my research shows they have a higher cost of capital than Australian companies investing here and paying out franked dividend credits. There is a substantial difference, largely represented by the grossed-up 30 per cent headline rate of taxation, because of the benefits Australians receive via credits for the taxes paid on their behalf by Australian companies.

The substance of my evidence is that Australians don't pay company tax as such, but their personal incomes are credited with both the income from companies and the tax paid on their behalf. Any reduction in the corporate tax rate simply weakens our existing system of imputation credits. I played a role in the introduction of that scheme some years ago. I think it works very well, encourages a large payout, low debt, low risk, and less incentive for Australian companies to push profits offshore to tax havens, and so protects the integrity of Australia's tax base.

That's what I am here to say today—that we need to protect the integrity of our tax base, given that in the last 10 years Australian governments have been running huge deficits which show no sign of declining: the third-highest country increase in indebtedness in the world. If we went ahead with these tax cuts, it would further weaken the position of the Australian government and its ability to provide services to the Australian public, perhaps in the order of between eight and $13 billion a year once these tax cuts are fully implemented, so I'm very strongly opposed to these tax cuts, because I can't see their yielding any benefit to Australia.

My research indicates we are already receiving the benefit of imputation credits in the low cost of capital to Australian companies, because the harvesting of these invitation credits by foreign investors—that is, the sale of Australian shares to get a capital gain leading up to stock going ex dividend—transfers a tax benefit to the foreign investor, so foreign investors are already getting a very large tax benefit. This has increased investment in Australian industry to a likely maximum possible extent, so a further reduction in the corporate tax rate is not likely to yield any additional benefits to the Australian economy. I'm happy to elaborate on any of these points or arguments as a result of your questioning.

CHAIR: You are fairly unequivocal in your view on this proposal. Do you agree that the change proposed to the company tax rate provides a windfall gain for existing investments rather than incentivising new investment?

Prof. Swan : It provides a windfall gain to existing foreign investors. There is no windfall gain to Australian shareholders in these companies, but there is a very substantial windfall gain to foreign investors, which I estimate to be around $2,500 for every man, woman and child in the country. This is based on the government's own estimates of the tax gift to foreigners over the next decade. There could be some very marginal improvement in the ability of foreign direct investors, not portfolio investors. Their returns in Australia are already depressed by competition—the passing on these of these tax benefits to portfolio investors in Australia—but there are still some direct investors who don't get the benefit of these imputation credits, and they may very marginally increase their investment. We are picking up that very substantial rents are earned particularly in the resources and the banking sectors, and there is no particular reason to pass on these rents to foreigners, because passing on rents doesn't yield any higher level of investment; in fact it may even worsen our balance of payments and other effects. Why? If it encourages investment, it'll be largely in the mineral sector and will lower the price of iron ore and other goods that we export. Since we have some monopoly position in those goods, it'll simply worsen our terms of trade.

CHAIR: You cite Chris Murphy's research, particularly tables 8 and 9, which indicates that wages increase only slightly and employment goes down when the company tax cuts are funded by bracket creep.

Prof. Swan : That's correct. I'm simply reporting what he says.

CHAIR: What in your opinion would be the impact in the medium term if the alternative fiscal approach to pay for this tax cut were to run higher deficits?

Prof. Swan : I think it's taking Australia further down the Whitlam-like path we already went down in the early seventies. At some point all of this will lead to higher inflation and higher levels of debt. At the moment Australia benefits from very low interest rates on global debt, but this is changing; the US is starting to raise its interest rates. We're already incurring billions of dollars in interest over very short intervals of time. Funding further outlays through increased deficits is a very destabilising and short-run strategy which will ultimately lead to a major disaster. If you want to fund things by raising deficits, why would you go down this path? There are many better ways to spend our taxpayer dollar than giving it to people who will give us nothing in return.

CHAIR: Your research picks up the issue of foreign investors who benefit from our dividend imputation system, which is something others tend not to focus on. Can you very briefly talk about that for us.

Prof. Swan : I originally interpreted my research to show that the cost of capital to Australian investors was lower than to Australians investing offshore and therefore, apparently, to foreign investors, but that didn't make much sense to me or anyone else, because if the cost of capital in Australia is lower than the rest of the world, why aren't we massive exporters of capital for the rest of the world? Conversations I had with senior public servants suggested that this as the most likely explanation for my findings: in 1997 the Treasury put forward and passed a law which prevented Australians from receiving imputation benefits if they were very large investors and had held the shares for only 45 days. This forced foreign investors to sell their shares about 47 days prior to the stock going ex dividend, but that still leaves about three quarters of the tax benefit residing with the foreigner. I'm pretty sure Treasury are concerned about this weakness in our current tax arrangements, which arose because they, in their wisdom, didn't fully implement my scheme and the scheme put forward by the Campbell inquiry for complete integration of the corporate and personal systems. They went to more than a halfway house; they did a great job, but they didn't take into account the holding period of the Australian investor. They took account of 45 days, 10 years after they introduced the scheme, but they would probably be currently looking at ways of further tightening these .provisions. In the meantime I think we are the beneficiaries of these provisions, because they give us a very low cost of capital and a much higher level of investment than we would otherwise have.

CHAIR: Would I be right in drawing from that the conclusion that the cost of capital in Australia is already very low, and that arguments that Australia is not competitive in that regard may not hold water?

Prof. Swan : According to my estimation, Australia already has one of the lowest, if not the lowest, costs of capital in the world. Moreover, when one looks at the effective tax rates that foreign investors—particularly US investors—investing in Australia actually pay, they don't pay the headline rate of 30 per cent. A couple of years ago the US budget office part of congress carried out an analysis of the tax returns of US corporate investors in every country in the world, and they concluded that Australia had one of the lowest, if not the lowest, effective rates of tax, at around 10 per cent.

This was based on data from 2012. I don't think there's any reason to think that the situation has gotten any better since then. What they've done is look at the actual tax returns of all of these US investors in Australia and every other country in the world to show that the effective rate of tax is already the lowest. Already we have the lowest or one of the lowest costs of capital. We see why that is. It's because our imputation system is giving us a much lower cost of capital than the US even after the Trump tax cuts. In the US they're still paying 21 per cent corporate tax on top of high rates of personal tax, whereas Australia is probably the only remaining country in the world where we are completely exempt from paying double tax on corporate income.

CHAIR: Finally from me, I'm interested in your views on the BCA's commitment to the Senate, promising to increase investment. What do you say about that?

Prof. Swan : Actually, I just think it's a pile of rubbish. There's no way they can credibly commit to increase the level of investment. Even if they did, who is to say whether they wouldn't have done it anyway? Australia has many, many advantages for foreign investors: a highly educated workforce, the English language, the common law system, a very stable form of government relative to most other countries, huge natural resources and so on and so forth. There are very, very good reasons for foreigners to continue to invest here and to increase their level of investment. I think there are other things we need to do to free up our electricity markets to make ourselves more competitive so that foreigners will want to invest more here, but that's probably outside of your terms of reference today.

CHAIR: So it's not worth the paper it's written on?

Prof. Swan : That's right.

CHAIR: Thank you.

Senator HUME: Just before we begin I want to thank you very much for your submission. I'm very glad it came in the form of an op-ed first and then a submission and then your paper, because your paper is extremely dense. Not you personally being dense; I meant the contents of the paper, obviously.

Prof. Swan : There was an op-ed today as well.

Senator HUME: I suppose what your submission and, particularly, the paper prove is that the concept of dividend imputation, while deceptively simple, is in fact quite intricate and has quite far-reaching implications. Do you think that the vast majority of Australians understand the implications of dividend imputation or the operation of it?

Prof. Swan : No. I'm sorry to say that even most journalists and most highly educated people wouldn't.

Senator HUME: Do you think politicians understand dividend imputation?

Prof. Swan : Without wanting to be at all derogatory of politicians, I would think not. If they understood it they would not accept such a proposition of policy not to benefit one cent to Australians but to actually impose additional taxes on them. I don't think, if they really understood the imputation system and how it works, they would support these proposals for a minute.

Senator HUME: I might just ask you a question about one of your claims—this claim of warehousing, for want of a better expression. Your claims rely on the theory that foreign investors who aren't eligible for franking credits can completely avoid paying Australian company tax by selling or warehousing their shares.

Prof. Swan : Or harvesting.

Senator HUME: Harvesting is probably a better word. Harvesting them with those that are eligible for franking credits.

Prof. Swan : They can't completely claim the benefits of imputation, but, for every $30 of tax paid by Australian companies, they can reap about $22 out of that $30.

Senator HUME: They have to buy them back, though, once the dividends have been paid. Is that correct?

Prof. Swan : They would buy them back typically—

Senator HUME: So it's quite complicated.

Prof. Swan : as soon as they go ex-dividend.

Senator HUME: The theory asks us to accept that foreign investors sell very large volumes of shares to Australians immediately before dividends are paid and then those transactions are completely reversed 47 days later and that none of that has any effect on the share price whatsoever. Is that right?

Prof. Swan : No, not at all.

Senator HUME: All right. You'd better explain it to me, because that was the part of your submission that I didn't understand.

Prof. Swan : The Treasury was well aware that there was a lot of trading in Australian shares around the time they go ex-dividend. That's why they brought in this 45-day rule. What I'm suggesting is that what's happened is that there's still a lot of trading, but it takes place at an earlier date, around 47 days prior to the ex-dividend date. But it won't occur on any particular day; there will still be some random element to the timing of it.

Senator HUME: And it's only foreign direct investors as opposed to foreign portfolio investors? Is that correct?

Prof. Swan : No. Direct investors can't gain from this until such time as they list in Australia and start paying taxes in Australia. It affects only portfolio investment.

Senator HUME: Right. So foreign direct investors are unlikely to escape company tax by selling dividends that way. Is that correct?

Prof. Swan : Yes, because if you take Google—

Senator HUME: Yes, because they're unwilling to give up control over their—

Prof. Swan : Australians don't own these foreign companies. Google, Apple, Microsoft, Facebook—they're not going to set up an Australian branch of the company here and float shares here. They potentially might be affected by the tax rate; but very little, because most of their income gets transferred to Ireland and other tax havens with very low rates of tax.

Senator HUME: I feel like we're getting into the weeds, but unfortunately that seems to be where the action's at here. My understanding is that the ABS data suggested that nearly $600 billion of stock is the stock of foreign direct equity investment in Australia at the moment, and that accounts for most of the foreign equity investment in Australia. So, theoretically, wouldn't that mean that most foreign equity investors wouldn't do this warehousing or harvesting of imputation credits in the way you describe?

Prof. Swan : No. I think, unfortunately, the ability of ABS or anyone else to get a firm handle on the composition of foreign investors is very difficult. I've tried to do this with live data from the stock exchange, but they use nominee companies—they use all sorts of devices—to make it very difficult to be able to identify foreign investors.

Senator HUME: So you're suggesting that the Australian Bureau of Statistics is wrong, as opposed to—

Prof. Swan : No. I'm just saying, for example, that the Reserve Bank, based on ABS data, found a few years ago that something like 80 per cent of the mining and resource sector was funded by foreigners. I don't know that that was broken up into portfolio investment vis-a-vis direct investment. But I'm agreeing with you that direct investment is not subject to this—

Senator HUME: The warehousing or the harvesting.

Prof. Swan : harvesting. But it has an indirect effect, because it reduces the return to the post-tax levels. That's the mechanism by which it operates.

Senator HUME: So if the majority of foreign investment in Australia can't harvest or warehouse imputation credits, doesn't that undermine your argument?

Prof. Swan : No, not at all, because foreigners have a choice. They can invest through portfolio investments. We know, for example, that foreigners—

Senator HUME: But do they? According to the ABS data—which I know you dispute, but it tends to be where the vast majority of people draw their data from—

Prof. Swan : You just have to look at the shareholdings of BHP and all our major companies. A very large proportion of them are foreign investors. My point is that, regardless of the proportion that direct investment as a percentage of the total foreign investment makes up, markets are equilibrating—that is, the returns are driven down to the relevant after-tax return. So direct investors are influenced by the return on portfolio investment and vice versa. At the margin they have to be indifferent to making either a relatively tax-free investment through portfolio investment or a direct investment. They're going to use the direct investment where they have particular skills and abilities to develop our resources.

Senator HUME: I'm hugely conscious of the time—and I know that there are a lot of senators here who have questions—but I want to ask you one more thing. You said in your opening statement that you didn't think that this inquiry was going to be an effective way of getting any commitments from the BCA companies. Do you think it's the role of a Senate inquiry or, indeed, the role of government generally to extract commitments from the private sector?

Prof. Swan : No.

CHAIR: Nobody has extracted; it has been volunteered.

Prof. Swan : I think that, even if they did give commitments, I don't think they're going to be meaningful in terms of achieving what the Senate, you or I would like to know, which is whether their investments and payments in salary would be much higher if the tax cuts go ahead.

Senator HUME: I think their commitment was that they would further invest in their own companies, which is not an unlikely scenario. But do you think that it's the government's role to demand that that's the case?

Prof. Swan : No, it's not. I don't think so at all.

Senator HUME: Thank you.

Senator RHIANNON: Thank you very much for your evidence today and your written work in this area. You just now described the BCA commitment as a pile of rubbish. I will put my questions together because of the time factor. Who will benefit most from the corporate tax cut if it goes through? Considering that the government's justification for the tax cuts has been the assertion that it will lead to wages growth, could you outline a successful way to encourage wages growth? I'm particularly interested for you to comment on the often suggested solution—that one way to drive private sector wage increases is to increase public sector wages.

Prof. Swan : The plan to reduce corporate taxes and therefore indirectly through capital deepening investment leading to higher demand for labour and higher wages is an extremely roundabout process and in my view is unlikely to happen to any great extent in this instance. I know that the public sector has been the leader in raising wages in Australia—paid for by taxpayers—but that's not the way to make a successful private enterprise economy. The way to raise wages is to get rid of the obstacles to higher wages, and the main obstacle I see is the doubling or tripling of power prices. Just yesterday I received a bill for a tiny little apartment with a couple of rooms that we own. It was a $1,000 power bill. It's just gotten out of control. With escalating power prices real wages are going to have to fall quite dramatically in this country, and that's why they're so static at the moment in my view.

Senator RHIANNON: Thank you.

Senator STOKER: Thank you for your evidence. If I have understood properly the warehousing idea and the harvesting idea, there's a sale by foreign investors of shares at the time or immediately before there is a dividend issued and then a repurchase thereafter—is that it, in short?

Prof. Swan : This is what happened prior to 1997, but after that it's delayed. They have to do it at least 47 days prior to going ex-dividend. But still, that's the general idea, yes.

Senator STOKER: And you say this practice is quite prolific?

Prof. Swan : Well, I'm doing research at the moment just to see how extensive it is, but I don't have the evidence before me right at this moment. In fact, the idea for this came from the most senior public servants in the country who specialise in this area, and I don't see any other rational explanation for my findings.

Senator STOKER: I'll put it this way: where a shareholder has five per cent of a listed company, they're required to notify the ASX about it. That's right, isn't it?

Prof. Swan : Yes, I believe so.

Senator STOKER: And if there are changes of one per cent or more, they similarly have to be notified?

Prof. Swan : One per cent or more—

Senator STOKER: Do you accept the proposition that there's a requirement to notify?

Prof. Swan : I accept that there are reporting requirements on trades, yes.

Senator STOKER: If there were changes of substance at that above-five-per-cent mark, they would be the subject of publicly available notifications to the market that would demonstrate the accuracy of this warehousing theory with its 47-day gap?

Prof. Swan : The sort of information on shares traded is often not about who owns those shares or where the beneficial ownership resides, but I agree that there would be information for large shareholders who change their position. But I don't think these are necessarily very large shareholders. Five per cent of a $100 billion company is a very large shareholder.

CHAIR: Senator Stoker, in view of the time, I might hand the call to Senator Storer; he has indicated he does have one further question.

Senator STOKER: Can I just conclude this line?

CHAIR: Yes.

Senator STOKER: Thank you. Doesn't the very fact that there are not ASX disclosures at this point in time demonstrate that your theory is either incorrect or it occurs nowhere near as prolifically as you say it occurs?

Prof. Swan : No, I think it's the subject of ongoing research, and, as I said, I've tried to use the very confidential data supplied by the ASX to identify foreign investors and their trades, but, because of the nature of the weak ownership data, it's very hard to do, and it's not going to be substantial shareholders making these changes; it's going to be hundreds and hundreds of smaller entities.

Senator STORER: Professor Swan, I wanted to focus on page 5 of your submission—your analysis of the modelling by Chris Murphy. I noted that you had referenced bracket creep as the means by which the tax is funded. You noted the lower consumer welfare gain, from 4.9 to 3.8, but, in your notes, you had that the budget gain as stated by Murphy's modelling is minus 0.2, but you have noted it to be the 4.7 from the lump sum/no change column. So I just wanted to understand why you brought 4.7 across to the 3.8 versus the—

Prof. Swan : It's possible I made a mistake or was just talking about one column rather than another, but the point I wanted to make about the column I took from table 10 is this. He says that there's still a very substantial consumer gain, even when it's funded by bracket creep, and I was trying to understand that, and I showed that the after-tax wages gain gave a consumer benefit of around $2.8 billion—way short of the 4.7 or whatever gain he was claiming. He's assuming that if you make very small reductions in the tax rate, Australian consumers will save billions because these foreign companies, like Apple and so on, will do less shifting of profits to tax havens. I don't think that's valid. I've never seen any real evidence to support that.

Senator STORER: That's certainly a point to follow up on, so thank you.

CHAIR: Thank you, Professor Swan, for being before us today.