The proportion of dividend imputation cash leaking out of the budget will grow dramatically as the baby boomers age and move into the retirement phase.
Australia is expected to lift its superannuation assets from about $1.8 trillion at December 2014 to about $6 trillion by 2030, according to the median forecast of super asset growth presented to the recent Financial System Inquiry.
If super assets are $6 trillion it is not unreasonable to assume that at least a third of that or about $2 trillion will be in the retirement phase or have beneficiaries aged over 60 and therefore pay zero tax.
The typical super fund has about 40 per cent of assets in equities paying franked dividends. If you assume dividends paid on those assets of about 4 per cent fully franked the total cash paid to these beneficiaries will be about $9 billion.
The remaining super funds in the accumulation phase, which pay tax of 15 per cent, would get estimated imputation credits of about $25 billion assuming 4 per cent fully franked dividends on average Australian equity portfolios equal to 50 per cent of assets.
Treasury has estimated the super system will grow to $9 trillion in assets by 2040.
The simple solution to the nil-tax paid rort for retirees is to exclude dividends from shareholders' taxable income. This solution was suggested by accounting firm PwC in its submission to the FSI.
It is a simple solution because it assumes the tax paid by the company does not have to be paid by the recipient. No more imputation credits would flow out of Treasury coffers.
There are other distortions created by the dividend imputation system that have been identified by the Treasurer Joe Hockey's tax discussion paper.
The paper notes that the dividend imputation system makes little contribution to attracting foreign investment to Australia other than eliminating dividend withholding tax for franked dividends paid to foreign shareholders.
The FSI highlighted the fact that dividend imputation does not benefit mutuals which are competing with institutions with more traditional company structures. Mutuals cannot distribute franking credits.
Dividend imputation has served Australia well. It made equity capital more attractive than borrowings. It provided the country with a sound basis capital formation.
But 28 years after it was created it is time to review the distortions and peculiar incentives which sit oddly with the need to restore equity to the taxation system.
