Mark Draper

Mark Draper

Written by Rebecca Cassells and Alan Duncan (sourced from The Conversation)

As we move closer to Treasurer Scott Morrison’s third budget, what we do know is this - Australia has a revenue problem. A more global and digital economy; an ageing population with fewer taxpayers and sluggish wage growth make future predictions of revenue even more precarious. There’s never been a better time for tax reform. 

But as governments have tried to reform (and stumbled) over the years the burden has shifted to individual taxpayers and the latest budget is likely to be no different.


Read more: Government spending explained in 10 charts; from Howard to Turnbull


We looked at revenue data over the last 20 years drawing from budget papers, government finance statistics and the Australian Tax Office. To compare revenue over time, we have adjusted for the effect of inflation by using real measures.

Tax revenues have risen 26% in Australia since the global financial crisis, from A$310.3 billion in 2009 to A$389.8 billion by 2016. 

Income tax has contributed most to this growth and some is driven by rising wages and jobs growth. Between 2009-10 and 2016-17, individual income tax revenue grew by 37% - an average of 5% each year.

But bracket creep also comes into play as personal tax thresholds have not kept pace with inflation, causing average tax rates to rise among middle income earners in particular. 

The growth in business tax revenue leading up to the global financial crisis was heroic – averaging 11% each year and well above any budget forecasts. In the ten years to 2007, business tax revenue grew by almost 130% - from A$41.4 billion to almost A$95 billion. 

But what goes up must come down, and business tax fell by 6.3% between 2008 and 2016. However we can see strong growth between the last two periods, with business tax receipts growing by 10.7% from A$72.6 billion to A$80.3 billion. 

Revenues from GST and sales taxes have risen, by 16% since 2009.

The relationship between Australia’s economic output and its tax revenue looks somewhat different. The tax-to-GDP ratio reached nearly 25% prior to the global financial crisis, but dropped to 20.5% in 2010-11. It recovered to around 22% by 2012 and has remained essentially flat since then. 

A history of reform attempts

Successive governments have attempted to create an efficient tax system that’s fair and reliable with few distortions. Prior to the turn of the century the Howard government argued the tax system was out of date, complex and inequitable, heavily reliant on individual and company tax, and prevented Australia competing on a global level. 

The Howard government’s new tax system in 2001 was an answer to this. This new tax system seemed to have all the reform solutions needed - income tax cuts for hard working Australians and at long last the introduction of a goods and services tax, along with some pretty big welfare reforms. 

Everything appeared to be going quite well with the new tax system – revenue from company tax was way, way above any Treasury official’s forecast. 

But fast-forward 10 years and cracks began to show, prompting a new review into the effectiveness of Australia’s tax system. The Henry Review, provided some 138 recommendations for tax reform, yet very few saw the light of day. And just five years later, another review was conductedwith then Treasurer Joe Hockey at the helm, which since seems to have been not so much parked as abandoned. 

Income taxes from individuals have always made up the greatest share of tax revenue in Australia. Prior to the introduction of the Howard government’s tax system, income tax from individuals made up 57.3% of the total tax pool – it now accounts for 51.0% of total tax revenue. 

The Howard reforms included a reduction in personal income tax rates. During the next ten years Australian businesses shouldered a greater share of the tax burden, with their share rising from 17.9% in 2000-01 to 27.4% in 2007-08 at the peak of the resource boom. This has since fallen to 20.6%. 

The contribution of taxes on goods and services has remained fairly steady since moving from sales tax to the GST in 2001. GST revenue is consistently around 16% of all tax revenue. 

The share of tax revenue from customs duties, excises and levies has been falling since 2001, from 14.5% to 9.5%. Other tax revenue has been fairly consistent over time, contributing less than 2% of total tax revenue. However, in 2012-13 this increased to around 4%, with the introduction of the short-lived carbon pricing mechanism. 

The problem with predicting future revenue

Taxation revenues were consistently underestimated prior to the global financial crisis, but have fallen below expectations since its end. The tax-to-GDP ratio has been anchored close to 22% since 2012-13. This is despite eight successive federal budgets since May 2010 projecting future tax revenues in excess of 24% of GDP. 

And where does the greatest divergence lie between forecast revenues and out turns?

Company tax revenues are consistently – and by some margin – the most difficult to predict. Receipts fell short of forecast estimates of around 5% of GDP, by around one percentage point over four years, since the May 2010 budget. 

Estimates of company tax receipts for 2017-18 were revised upwards by A$4.4 billion in the latest MYEFO update in December 2017. Should this eventuate, it will take total company tax revenues for 2017-18 to A$83.8 billion (around 4.6% of GDP). 

The government may well feel that this creates space for a company tax cut and personal income tax cuts in the upcoming budget. 

Revenue from individual income tax has been projected to rise to around 12.5% of GDP over the forward estimates, in each budget, since May 2013. Revenue has risen from 9.5% of GDP in 2009 to 11.4% by 2016 before dropping marginally by 0.2 percentage points in the latest Mid-Year Economic and Fiscal Outlook (MYEFO) forecasts.

But wages have not played the leading role that they have been cast in, in every budget going back to May 2011. Since this time wage growth has been forecast at an elusive 3% mark or thereabouts, yet has fallen well short of this each year and currently stand at 2.1%. 

Tax thresholds remained fixed between the 2012 and 2016 budgets, and the only change since has been to lift the 32.5% tax threshold from $80,000 to $87,000, effective 1 July 2016. Tax revenue growth up to now has certainly been driven by the effects of bracket creep. 

Unless tax thresholds in the future are increased at least in line with inflation, this means that average taxes will continue to rise.

Plans for a 0.5% increase in the Medicare Levy rate from July 2019 have been shelved, which would have raised around A$8.2 billion over the next four years to support the National Disability Insurance Scheme.

Expectations have been raised for tax cuts to businesses as the government advocates for the “trickle-down” benefits to Australian households. 

It’s hard to see how this will lead to anything other than a shift in the tax burden towards individual taxpayers – at least in the short term. This is unless company tax cuts are balanced with substantial, not modest, cuts to personal income taxes as well. 

It seems Scott Morrison will be banking ever more on a strengthening economy to support Australia’s taxation revenues into the future.

 by Shane Oliver (Chief Economist AMP)

 

Will Australian interest rates ever go up?

While the global economy is seeing its fastest growth in years and the US Federal Reserve has increased rates five times since December 2015 and is on track for more hikes this year, the Reserve Bank of Australia (RBA) has now left interest rates on hold for a record 21 months in a row. The Australian economy is in a very different position to the US. While the RBA continues to expect that the next move in rates is most likely to be up, and we tend to agree, we now don’t see a hike until sometime in 2020. And the next move being a cut cannot be ruled out. This note looks at the reasons and what it means for mortgage rates, the $A and investors.

Four reasons why rates will be on hold into 2020

We have been looking for a rate hike in early 2019, but have now pushed that out to 2020 for the following reasons:

First, growth is likely to remain below RBA expectations. A bunch of factors will help keep the economy growing: the drag on growth from falling mining investment is largely over; non-mining investment is rising; infrastructure investment is booming; and net exports should add to growth helped by strong global conditions. However, against this housing construction is slowing and consumer spending is constrained with downside risks around slow wages growth, high debt levels and falling house prices in Sydney and Melbourne. Personal tax cuts likely to be tabled in the Budget will help keep the consumer going but are unlikely to offset all the drags. So while growth will likely improve from the 2.4% pace seen last year, it is likely to be to between 2.5% and 3%, below RBA expectations for a pick up to 3.25%.

Second, wages growth and inflation are likely to remain low as growth is unlikely to be strong enough to eat into significant spare capacity in the Australian economy. Some say Australian rates just follow those in the US but there has been a big divergence in recent years. In 2009 while the Fed left rates near zero the RBA started raising rates only to start cutting them from 2011. And while the Fed started hiking rates in 2015 we continued cutting them in 2016. 


Source: Bloomberg, AMP Capital

There is good reason for the RBA to lag the Fed. Labour market underutilisation (see next chart) at 8% in the US is about as low as it ever gets whereas in Australia its around 14%. If wages growth is only just starting to pick up in the US despite a much tighter labour market it’s no surprise that it will take much longer in Australia.


Source: Bloomberg, AMP Capital

Continuing weak wages growth along with excess capacity and high levels of competition in goods markets will keep underlying inflation around the low end of the RBA’s 2-3% target for a lengthy period yet.

Third, bank lending standards are going through yet another round of tightening as the household debt boom comes to an end, doing the RBA’s work for it. Now it relates to policies and practices around borrowers’ income, expenses and total debt levels. This has been driven by APRA which is shifting away from blunter constraints on lending to certain categories of borrowers (such as the 10% speed limit on credit growth to property investors) and is receiving added impetus now. This will particularly hit lower income borrowers and high home price to income markets like Sydney and Melbourne. Tougher checking of income and expenses and constraints in terms of the amount of loans going to high total debt to income borrowers will likely lead to a slowing in credit growth in the months ahead. While a credit crunch is unlikely its hard to reliably predict the impact of tighter lending standards.

Finally, house prices are slowing led by falling prices in Sydney and Melbournewith more weakness likely. APRA measures to constrain investor and interest only borrowers have worked. These measures, combined with poor affordability, rising unit supply, falling expectations for price growth and the end of FOMO (fear of missing out) are pushing prices down. The latest round of tighter lending standards will add to this, as will any move to lower immigration levels (and curtail negative gearing and the capital gains tax discount were there to be change in government). 


Source: Domain, AMP Capital

Capital cities other than Sydney and Melbourne face a much better outlook as they did not see the same boom in recent years. However, we see prices in Sydney and Melbourne falling another 5% this year, another 5% next year and with further slight falls in 2020. We are running around levels for price growth and auction clearance rates that in the past have been associated with the start of interest rate cutting cycles (in September 2008 and November 2011 – see the previous chart), not rate hikes! The risks of a sharper fall in prices if investors lose faith, homeowners decide to reduce high debt levels and if the shift from interest only to principle and interest for many borrowers over the next few years creates problems needs to be allowed for. Raising rates when prices are falling will accentuate these risks.

As a result of these considerations, we have pushed our timing regarding the start of interest rate increases into 2020. Of course, the risk here is that by 2020 the US economy may be weakening making it hard for the RBA to then start considering rate hikes. And of course, if the declines in home prices turn out to be deeper the next move could end up being a cut.

Won’t mortgage rates rise anyway?

Since the time of the GFC “out of cycle” changes in bank mortgage rates have been common. However, the main driver of significant changes in mortgage rates remains what the RBA does with the cash rate – see the next chart. It cut from 2008 and mortgage rates fell. It hiked from October 2009 and mortgage rates rose. It cut from November 2011 and so mortgage rates fell. This makes sense as the banks get around 65% of their funding from bank deposits the main driver of which is the cash rate. However, the remaining 35% can cause some variation as will regulatory changes which saw higher rates for investors and interest only borrowers recently.


Source: RBA, AMP Capital

There are two main pressures at present. The first is a rise in money market funding costs in the US and Australia of around 0.3 to 0.4%. Given that only 10-15% of bank funding comes from this source its unlikely to have much impact. And the banks are unlikely to pass on the extra costs to owner occupiers on traditional loans given the Royal Commission, but banks could raise rates for investors and interest only borrowers. Higher US bond yields could also place some pressure on bank funding costs but again this is likely to be modest, and probably unlikely to result in higher rates for owner occupiers on traditional loans. The main thing for traditional borrowers to watch is the cash rate. If we are right, such borrowers will see pretty stable mortgage rates out to 2020.

What about the $A?

With the RBA likely on hold and the Fed set to keep hiking the interest rate gap between Australia and the US will go further into negative territory. Historically, this means a fall in the value of the Australian dollar. The $A appears to be starting to break below the rising trend channel that’s been in place since 2015 and we see more downside to around $US0.70. A fall to below $US0.50 as we saw in 2001 is unlikely as commodity prices are likely to remain much stronger than they were then.


Source: Bloomberg, AMP Capital

Implications for investors

First, bank deposits are likely to continue providing poor returns for investors for a while yet.

Second, as a result assets that are well diversified and provide decent income flow remain worthy of consideration. This includes unlisted commercial property and infrastructure along with Australian shares which continue to offer much higher income yields compared to bank deposits.

Third, Australian bonds are likely to outperform global bonds which are dominated by the US as US bond yields rise (on the back of Fed tightening) relative to Australian yields (which will be constrained by on hold RBA cash rates).

Finally, with the $A likely to fall further there is reason to keep a decent exposure to global assets on an unhedged basis.

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

Why investors should take notice of rising bond rates

Are the Bond market ghosts of 1994 coming back to haunt, or is this as high as long term interest rates rise?  That’s unknowable at this stage, but investors should ensure their portfolio’s can weather rising interest rates.

Investment strategies that worked well while interest rates fell, are unlikely to be rewarded when rates rise.  

Long term interest rates, particularly the 10 Year US bond rate (also known as the risk free rate of return) is important to investors as an anchor point against which asset prices such as property and shares, are measured.  Generally speaking a higher long term interest rate results in lower asset prices, in the absence of earnings growth.

Future inflation expectations are filtering into long term interest rates following stronger than expected US wage growth in the first few months of 2018.  This has resulted in the total returns for Investment Grade (IG) bonds having their worst start to a year in 20 years.

Chart provided courtesy of Intelligent Investor

US 10 Year Rates have doubled since July 2016 from under 1.5% to currently around 3%.  This has seen long term bond prices fall (price of bonds fall as rates rise). Assets considered bond proxies including infrastructure and property have also come under pressure during this time.

Long term bonds, which feature in many investors portfolio’s under the labels of “Fixed Interest”, “Bond” or “Conservative” funds/ETF’s are vulnerable to rising interest rates, particularly those with longer duration.  While rising interest rates increase the income from bonds, rising rates can be devasting to the capital value of a bond portfolio owned in managed funds, ETF’s and super funds.  The chart below shows the capital destruction of US Bonds and Australian 10 Year bonds in the event of rates rising by 2% and 4% respectively from current levels.  Not exactly a defensive investment in a rising interest rate environment!

Source: Bloomberg

 

Bond proxies such as infrastructure and property are generally considered to be negatively impacted by rising long term rates, but caution is required before dismissing these assets during periods of rising rates.

Assets such as toll roads can offer some protection from rising inflation and increasing interest rates as toll revenue is usually linked to inflation.  Therefore rising inflation (which generally feeds higher interest rates) can result in material earnings growth for toll roads.  Citylink tolls as an example are linked to inflation.

Infrastructure businesses can see an increase in the cost of debt funding as rates rise, and these businesses generally carry high levels of debt.  While higher interest rates obviously increase the cost of debt servicing, good infrastructure businesses have used the extended period of low interest rates to secure long term debt at low rates which means that the impact of rising interest rates may not be seen for many years.   During 2017, Zurich Airport, raised debt for a 12 year term at 0.6214% interest. 

Property investors where rents are linked to CPI can offer some protection against rising inflation and rising rates, but there are some property sectors where rents are under pressure, such as retail property.

While clearly there are potential losers from rising interest rates, there are also potential winners.  Companies that hold large fixed interest portfolios of short duration, such as insurance companies stand to earn materially higher levels of investment income.  Computershare is another listed company in Australia whose earnings stand to benefit from rising rates from client funds it holds.

For other parts of the share market, rising company profits are the best defence against the negative valuation effects of rising rates.  Earnings growth for the ASX200 is forecast to remain at high single digits for financial years 2018 and 2019 (source Ausbil Roadshow) and Asian company earnings are forecast to grow at double digits this year.  This should cushion share prices against the valuation impact of rising rates.

With the unwinding of Quantitative Easing (money printing) in the US, and with the Euro region likely to follow suit soon, it seems that the interest rate environment has changed.  Investors should check their investment strategy is positioned for a rising interest rate environment.

Why investors should take notice of rising bond rates

Are the Bond market ghosts of 1994 coming back to haunt, or is this as high as long term interest rates rise?  That’s unknowable at this stage, but investors should ensure their portfolio’s can weather rising interest rates.

Investment strategies that worked well while interest rates fell, are unlikely to be rewarded when rates rise.  

Long term interest rates, particularly the 10 Year US bond rate (also known as the risk free rate of return) is important to investors as an anchor point against which asset prices such as property and shares, are measured.  Generally speaking a higher long term interest rate results in lower asset prices, in the absence of earnings growth.

Future inflation expectations are filtering into long term interest rates following stronger than expected US wage growth in the first few months of 2018.  This has resulted in the total returns for Investment Grade (IG) bonds having their worst start to a year in 20 years.

Chart provided courtesy of Intelligent Investor

US 10 Year Rates have doubled since July 2016 from under 1.5% to currently around 3%.  This has seen long term bond prices fall (price of bonds fall as rates rise). Assets considered bond proxies including infrastructure and property have also come under pressure during this time.

Long term bonds, which feature in many investors portfolio’s under the labels of “Fixed Interest”, “Bond” or “Conservative” funds/ETF’s are vulnerable to rising interest rates, particularly those with longer duration.  While rising interest rates increase the income from bonds, rising rates can be devasting to the capital value of a bond portfolio owned in managed funds, ETF’s and super funds.  The chart below shows the capital destruction of US Bonds and Australian 10 Year bonds in the event of rates rising by 2% and 4% respectively from current levels.  Not exactly a defensive investment in a rising interest rate environment!

Source: Bloomberg

 

Bond proxies such as infrastructure and property are generally considered to be negatively impacted by rising long term rates, but caution is required before dismissing these assets during periods of rising rates.

Assets such as toll roads can offer some protection from rising inflation and increasing interest rates as toll revenue is usually linked to inflation.  Therefore rising inflation (which generally feeds higher interest rates) can result in material earnings growth for toll roads.  Citylink tolls as an example are linked to inflation.

Infrastructure businesses can see an increase in the cost of debt funding as rates rise, and these businesses generally carry high levels of debt.  While higher interest rates obviously increase the cost of debt servicing, good infrastructure businesses have used the extended period of low interest rates to secure long term debt at low rates which means that the impact of rising interest rates may not be seen for many years.   During 2017, Zurich Airport, raised debt for a 12 year term at 0.6214% interest. 

Property investors where rents are linked to CPI can offer some protection against rising inflation and rising rates, but there are some property sectors where rents are under pressure, such as retail property.

While clearly there are potential losers from rising interest rates, there are also potential winners.  Companies that hold large fixed interest portfolios of short duration, such as insurance companies stand to earn materially higher levels of investment income.  Computershare is another listed company in Australia whose earnings stand to benefit from rising rates from client funds it holds.

For other parts of the share market, rising company profits are the best defence against the negative valuation effects of rising rates.  Earnings growth for the ASX200 is forecast to remain at high single digits for financial years 2018 and 2019 (source Ausbil Roadshow) and Asian company earnings are forecast to grow at double digits this year.  This should cushion share prices against the valuation impact of rising rates.

With the unwinding of Quantitative Easing (money printing) in the US, and with the Euro region likely to follow suit soon, it seems that the interest rate environment has changed.  Investors should check their investment strategy is positioned for a rising interest rate environment.

Tuesday, 03 April 2018 15:58

Trump and Trade War Risks

Written by Shane Oliver - Chief Economist AMP

 

Introduction

After the calm of 2017, 2018 is proving to be anything but with shares falling in February on worries about US inflation, only to rebound and then fall again with markets back to or below their February low, notwithstanding a nice US bounce overnight. From their highs in January to their lows in the last few days, US and Eurozone shares have fallen 10%, Japanese shares are down 15% (not helped by a rise in the Yen), Chinese shares have fallen 12% and Australian shares have fallen 6%. So what’s driving the weakness and what should investors do?

What’s driving the weakness in shares?

The weakness in shares reflects ongoing worries about the Fed raising interest rates and higher bond yields, worries that President Trump’s tariff hikes will kick off a global trade war of retaliation and counter retaliation which will depress economic growth and profits, worries around President Trump’s team and the Mueller inquiry, rising short-term bank funding costs in the US and a hit to Facebook in relation to privacy issues weighing on tech stocks. The hit to Facebook is arguably stock specific so I will focus on the other bigger picture issues.

Should we be worried about the Fed?

Yes, but not yet. The risks to US inflation have moved to the upside as spare capacity continues to be used up and the lower $US adds to import prices. We continue to see the Fed raising rates four times this year and this will cause periodic scares in financial markets. However, the Fed looks to be tolerant of a small overshoot of the 2% inflation target on the upside and the process is likely to remain gradual and US monetary policy is a long way from being tight and posing a risk to US growth.

What’s the risk of a global trade war hitting growth?

In a nutshell, risk has gone up but is still low. This issue was kicked off by Trump’s tariffs on steel imports and aluminium and then went hyper when he proposed tariffs on imports from China and restrictions on Chinese investment into the US and China threatened to hit back. It looks scary and is generating a lot of noise, but an all-out trade war will likely be avoided.

First, the tariff hikes are small. The steel and aluminium tariffs relate to less than 1% of US imports once exemptions are allowed for and the tariffs on Chinese imports appear to relate to just 1.5% of total US imports. And a 25% tariff on $US50bn of imports from China implies an average tariff increase of 2.5% across all imports from China and just 0.375% across all US imports. This is nothing compared to the 20% Smoot Hawley tariff hike of 1930 and Nixon’s 10% tariff of 1971 that hit most imports. The US tariff hike on China would have a very minor economic impact – eg, maybe a 0.04% boost to US inflation and a less than 0.1% detraction from US and Chinese growth.

Second, President Trump is aiming for negotiation with China. So far the US tariffs on China are just a proposal. The goods affected are yet to be worked out and there will a period of public comment, so it could be 45 days before implementation. So, there is plenty of scope for US industry to challenge them and for a deal with China. Trump’s aim is negotiation with China and things are heading in this direction. Consistent with The Art of the Deal he is going hard up front with the aim of extracting something acceptable. Like we saw with his steel and aluminium tariffs, the initial announcement has since been softened to exempt numerous countries with the top four steel exporters to the US now excluded!

Third, just as the US tariffs on China are small so too is China’s retaliation of tariffs on just $US3bn of imports from the US, and it looks open to negotiation with Chinese Premier Li agreeing that China’s trade surplus is unsustainable, talking of tariff cuts and pledging to respect US intellectual property. While the Chinese Ambassador to the US has said “We are looking at all options”, raising fears China will reduce its purchases of US bonds, Premier Li actually played this down and doing so would only push the $US down/Renminbi up. It’s in China’s interest to do little on the retaliation front and to play the good guy.

Finally, a full-blown trade war is not in Trump’s interest as it will mean higher prices in Walmart and hits to US goods like Harleys, cotton, pork and fruit that will not go down well with his base and he likes to see a higher, not lower, share market.

As a result, a negotiated solution with China looks is the more likely outcome. That said, trade is likely to be an ongoing issue causing share market volatility in the run up to the US mid-term elections with Trump again referring to more tariffs and markets at times fearing the worst. So, while a growth threatening trade war is unlikely, we won’t see trade peace either.

Australia is vulnerable to a trade war between the US & China because 33% of our exports go to China with some turned into goods that go to US. The proposed US tariffs are unlikely to cause much impact on Australia as they only cover 2% of total Chinese exports. The impact would only be significant if there was an escalation into a trade war.

Should we worry about Trump generally?

Three things are worrying here. First, it’s a US election year and Trump is back in campaign mode and so back to populism. Second, Gary Cohn, Rex Tillerson and HR McMaster leaving his team and being replaced by Larry Kudlow, Mike Pompeo and John Bolton risk resulting in less market friendly economic and foreign policies (eg the resumption of Iran sanctions). Finally, the Mueller inquiry is closing in and the departure of John Dowd as Trump’s lead lawyer in relation to it suggests increasing tension. The flipside of course is that Trump won’t want to do anything that sees the economy weakening at the time of the mid-term elections. But it’s worth watching.

What about rising US short term money market rates?

During the global financial crisis, stress in money and credit markets showed up in a blowout in the spread between interbank lending rates (as measured by 3-month Libor rates) and the expected Fed Funds rate (as measured by the Overnight Indexed Swap) as banks grew reluctant to lend to each other with this ultimately driving a credit crunch. Since late last year the same spread has widened again from 10 basis points to around 58 points now. So far the rise in the US Libor/OIS spread is trivial compared to what happened in the GFC and it does not reflect credit stresses. Rather the drivers have been increased US Treasury borrowing following the lifting of the debt ceiling early this year, US companies repatriating funds to the US in response to tax reform and money market participants trying to protect against a faster Fed. So, it’s not a GFC re-run and funding costs should settle back down.



Source; Bloomberg, AMP Capital  

Is the US economy headed for recession?

This is the critical question. The historical experience tells us that slumps in shares tend to be shallower and/or shorter when there is no US recession and deeper and longer when there is. The next table shows US share market falls of 10% or greater. The first column shows the period of the fall, the second shows the decline in months, the third shows the percentage decline from top to bottom, the fourth shows whether the decline was associated with a recession or not, the fifth shows the gains in the share market one year after the low and the final column shows the decline in the calendar year associated with the share market fall. Falls associated with recessions are highlighted in red. Averages are shown for the whole period and for falls associated with recession at the bottom of the table. Share market falls associated with recession tend to last longer with an average fall lasting 16 months as opposed to 9 months for all 10% plus falls and be deeper with an average decline of 36% compared to an average of 17% for all 10% plus falls.

Our assessment remains that a US recession is not imminent:
 

  • The post-GFC hangover has only just faded with high levels of confidence driving investment and consumer spending.
  • US monetary conditions are still easy. The Fed Funds rates of 1.5 - 1.75% is still well below nominal growth of just over 4%. The yield curve is still positive, whereas recessions are normally preceded by negative yield curves.
  • Tax cuts and increased public spending are likely to boost US growth at least for the next 12 months.
  • We have not seen the excesses – debt, overinvestment, capacity constraints or inflation – that precede recessions.


We have not seen the excesses – debt, overinvestment, capacity constraints or inflation – that precede recessions.


Falls associated with recessions are in red. Source: Bloomberg, AMP Capital.

What should investors do?

Sharp market falls are stressful for investors as no one likes to see the value of their wealth decline. But I don’t have a perfect crystal ball so from the point of sensible long-term investing:

First, periodic sharp setbacks in share markets are healthy and normal. Shares literally climb a wall of worry over many years with numerous periodic setbacks, but with the long-term trend providing higher returns than other more stable assets.

Second, selling shares or switching to a more conservative investment strategy or superannuation option after a major fall just locks in a loss. The best way to guard against selling on the basis of emotion after a sharp fall is to adopt a well thought out, long-term investment strategy and stick to it.

Third, when shares and growth assets fall they are cheaper and offer higher long-term return prospects. So the key is to look for opportunities that pullbacks provide.

Fourth, while shares may have fallen in value the dividends from the market haven’t. So the income flow you are receiving from a well-diversified portfolio of shares remains attractive.

Fifth, shares often bottom at the point of maximum bearishness. And investor confidence does appear to be getting very negative which is a good sign from a contrarian perspective.

Finally, turn down the noise. In periods of market turmoil, the flow of negative news reaches fever pitch. Which makes it very hard to stick to your well-considered long-term strategy let alone see the opportunities. So best to turn down the noise.

Tuesday, 27 March 2018 16:47

ALP's Shameful Imputation Proposal

Roger Montgomery talks

Wednesday, 21 March 2018 21:54

Robbing Granny in the name of Paul

Written by Dr Don Hamson (CEO Plato Asset Management)

 

When I was first asked to comment about the ALP’s proposed scrapping of franking credit refunds my response was I was “flabbergasted”. “Flabbergasted” that the party whose Treasurer Paul Keating created franking credits would cut those benefits accruing to retired workers, “flabbergasted” that the Leader of ALP Opposition who earns over $375,000 a year would begrudge retirees receiving around $5000 a year on average, “flabbergasted” that the ALP would be offering tax relief to low- and middle-income Australians whilst pulling benefits from the lowest earning individuals who don’t even earn enough to pay tax, and finally “flabbergasted” that it is claimed that “this change only affects a very small number of shareholders”.

Having had time to reflect on this change, read through the fine print and discuss it with a number of people within the industry – and I thank those clients for their thoughts – my views have changed somewhat, but not necessarily in a positive sense.

“ Firstly, this change only affects a very small number of shareholders who currently have no tax liability and use their imputation credits to receive a cash refund.”

“1.17 million individuals, and superannuation funds”

Bill Shorten speech to Chifley Research Centre as quoted by SMH “Labor to target rich retirees in budget fix” 13 March 2018.

Discriminatory policy

We think this is a very discriminatory policy. Whilst we are happy that charities and not-for-profits are exempted from the changes, we are not so happy that the likely worst affected are the very lowest income earners with small holdings of Australian shares.

It is also discriminatory between different types of superannuation funds. Members of mature superannuation funds are discriminated against versus members of less mature funds. The most mature of funds are Self-Managed Superannuation Funds (SMSFs) whose members are all retired, and they would receive no franking credit refunds. The least mature or growing funds are funds largely dominated by younger accumulation phase members with a relatively small proportion number of pension members. These growing funds will be paying significant net tax to the government since the vast bulk of their fund members are in accumulation phase, paying 15% tax on fund earnings together with contributions tax. It is our understanding that pension phase investors in these least mature funds would still be receiving the full value of franking credit refunds under this proposal. The growing fund won’t be getting a refund of tax from the government, but within the fund pension members effectively get a full refund via offsetting (reducing) some of the net tax payable at the overall fund level. A $1m pension phase member of a growing fund would receive full value for franking credits, but the same $1m pension phase investor would not if they were to establish an SMSF. This proposal is clearly discriminatory, and if implemented would favour growing funds such as many industry funds, over SMSFs.

But we don’t believe this discrimination is restricted to SMSFs. Any superannuation fund dominated by pension phase investors will likely stand to lose the value of some or all of franking credits. Mature and often closed defined benefit funds would fit into this category. Some of these funds may be fine in financial years with good investment earnings, but may lose some franking credits in years with low or negative investment earnings where tax payable on accumulation phase earnings and contributions are less than the value of franking credits. We know of a few funds that are government or industry based which may likely be immediately impacted should these changes be implemented.

Industry ticking time bomb

We believe this change may ultimately impact a much greater number of Australians at some stage in their life than the current 1.17 million individuals targeted by this change. Whilst the proposed changes will primarily currently impact mature pension phase SMSFs and low income investors, we believe as the superannuation industry matures as a whole, as more and more members of pooled superannuation funds migrate to pension status, the loss of franking will likely start to impact a growing number of government, retail and industry funds. And these changes would then impact the returns and fund balances of pension phase members of those funds be they rich or poor.

Approximate $5000 a year impact

We estimate that denying the refund of franking credits will reduce the returns for pension phase SMSF by approximately 0.5% pa, meaning a retired couple with a $1m superannuation balance would be $5000 worse off each year, or a retired couple or individual with a $500,000 superannuation balance would lose $2,500. Now this might not sound a lot, but $50-$100 per week makes quite a difference for a retiree. It might mean being able to eat out once a week, take an annual domestic holiday, afford the expensive running costs of air conditioning or cover the cost of a cataract operation.

“$50-$100 per week makes quite a difference for a retiree.”

Our estimate of the impact of scrapping imputation credits is based on our submission to the Tax Discussion Paper entitled “Foreigners set to gain at the expense of Australian retirees?” (April 2015). We based our estimate of the impact of imputation assuming an average SMSF exposure to Australian shares, and the franking credit yield of the S&P/ASX200 Index. Investors with higher allocations to Australian shares, or allocations to higher yielding Australian shares could earn even higher levels of franking credits and would thus stand to lose more.

Impacts the lowest earning individuals who don’t even earn enough to pay tax 

Treasury’s analysis of ATO data indicates that 610,000 Australians in the lowest tax bracket (earning less than $18,200) would be impacted by this proposal, with a further 360,000 individuals impacted in the $18,201 to $37,000 tax bracket. Given this, I should not have been surprised that someone like my mother, who recently passed away, would have been significantly negatively impacted by this change. My parents worked hard all their working life, judiciously investing savings into the share market, managing to save enough to largely self-fund their retirement. They retired prior to the implementation of compulsory superannuation, so their share investments were held outside superannuation. My mother lived off the earnings from those shares, but she rarely earned enough to actually pay income tax, but I can assure you that she dearly valued the franking credit refunds which boosted her modest retirement income. When she was well they enabled her to take the odd holiday, and when she wasn’t so well, they helped pay the medical expenses.

Closing the gate after half the horse has bolted?

In introducing the proposals, Bill Shorten used an example of an extreme franking credit refund of $2.5m to a single SMSF in the 2014-15 financial year. This example is now well out of date and passed it’s used by date. The current government has introduced a $1.6m per person cap on pension phase superannuation which we estimate halves the problem. Perhaps a better way to eliminate the few extremely large franking credit refunds would be to either limit the total amount people can invest into super (not just the amount in pension phase) or limit the maximum franking credit refund per person. Let’s not make just about everyone’s retirement tougher because a few individuals have managed to take full advantage of the system.

Other Impacts

There are other impacts likely to arise from this change should it ever come to pass. Whilst members of defined benefit superannuation funds may not be directly impacted, the organizations’ that underwrite those benefits may need to increase their funding if the expected pension phase investment return assumptions are reduced. Banks and insurance companies may need to reconsider their capital positions in light of the potential impact of these changes on income securities.

Pension fund trustees may need to alter asset allocations. Some might argue that reducing exposure to the very concentrated Australian share market might be a good thing, but it will very much depend on where the money goes to. As well as Australian shares, SMSFs have a strong preference for Australian property, and we are not so sure allocating more money to a fairly expensive domestic property market is necessarily a good thing. Increasing exposure to global shares makes more sense, particularly since SMSF seem under-allocated to global shares compared with industry and retail fund allocations.

We also believe that any changes will likely impact the financial advice that investors receive, particularly investors in mature SMSFs.

Value of financial advice

Tax changes provide financial advisors and tax professionals the opportunity to add value for their clients. Pension phase SMSFs might likely restructure in a number of ways. They could move their pension assets into growing industry or retail funds to continue to receive the effective value of franking. Or they could look to “grow” their own SMSF, by adding say their children who are in accumulation phase as members, but there are constraints to this within the current SMSF rules.

Sadly, the 610,000 lowest income earners who would be affected by this change are probably least able to seek advice and least able to restructure their assets.

Don’t act too soon

We also discourage people from acting too soon on this proposal. It is the policy of the opposition. Not only do they have to win the next election, they would need to win over sufficient cross bench senators to make this change to the law. And even were it likely to happen, companies may act to flush out franking credits prior to any change coming into effect – buybacks and special dividends may come with a flurry in that case.

Conclusion

Overall, we don’t see this as good policy. It’s discriminatory. Whilst positioned as a “taking from the rich to give to the poor” policy, it’s actually 610,000 of the lowest earning individuals who will likely feel the most relative pain. It also discriminates between different types of superannuation funds, impacting the returns and fund balances of pension phase members of SMSFs, but not the returns and fund balances of pension phase members of growing funds such as many industry super funds. We also think that as the superannuation industry matures, and many more members of funds retire, these changes will likely impact members of many of the more mature government, industry, and retail super funds, not just SMSF members. If passed, this policy may become a ticking time bomb for many, many Australians.

Franking credits provide a very valuable increment to the income of all defined contribution retirees be they rich or less well off, as well as to very low income investors outside the super system, and surely we all hope to retire comfortably one day.

 

Mark Draper recently met with Andrew Clifford (Platinum Asset Management) to talk about the change in CEO at Platinum Asset Management and what it means for investors in Platinum funds.

Below is a podcast of the discussion and also a transcript.

 

 

 

 

Speakers:  Mark Draper (GEM Capital) and Andrew Clifford (Platinum Asset Management)

Mark:  Here with Andrew Clifford, Chief Investment Officer, or currently Chief Investment Officer of Platinum Asset Management, soon to be Chief Executive Officer of Platinum Asset Management.

Andrew, thanks for joining us.

Andrew:  Good morning. It’s good to be here.

Mark:  Shooting this in Adelaide, too, by the way. So, welcome to Adelaide, Andrew.

It was announced to the market recently that the joint founder of the business, alongside of you, Kerr Neilson, who is the current CEO of Platinum Asset Management is going to step down as CEO, still stay within the business.

I just want to talk about that this morning for our Platinum international investors.

Are you able to give us an overview? What does this actually mean for the business?

Andrew:  I think what people should understand is that we’ve built over the last 24 years, a very deep and experienced investment team. I think also it would be good for people to understand just exactly how the process works internally to understand the role, how Kerr’s changing role affects us.

Across that team, one of the things that we think if very important in coming up with investment ideas is that there’s a very thorough and constructive debate about investment ideas. If you put someone in the corner of a room and leave them to their own devices for four weeks to look at a company, on average through time, they’re not going to come up with good ideas, they’re going to miss things.

Part of our process is that the ideas, even from the very beginning, should we even be looking at this company or this industry, is something that is thoroughly debated all the way along.

We have five sector teams and also our Asia team. These are teams of sort of three to five people and they’re working away, coming up with ideas, debating them internally before they’d even presented to the portfolio managers for a potential purchase.

Then what happens is we have a meeting around that and you get all the portfolio managers for whom that is relevant and the idea is further debated and one of the things to understand about the process is we’re not trying to all come to some lovely agreement about whether this company is a good idea. We’re trying to work out what’s wrong with it.

Then ultimately, what happens after all of that, invariably there’s more questions to follow up and work to be done, but what happens is then each of the portfolio managers make their own independent decision on whether to buy that company or not.

The important role of the portfolio manager, as I see it, is everyone always thinks of them as these gurus who are making a decision about buying this stock or investing in this idea, and certainly they have that final responsibility. But I actually think their most important role is leading that discussion and debate.

Indeed, what happens in the places, that you can see that if an idea comes through to buy a certain company, if I buy it and Clay Smolinski doesn’t or Joe Lai doesn’t, when it’s an Asian stock, or Kerr does, but he buys 3% in the fund and I buy half a percent, there’s some kind of difference of opinion there that needs to be further debated and discussed. We have particular meetings where we do that.

I give this all as a background to say that there’s a very—

Mark:  It’s a bigger process.

Andrew:  —deep and proper process there.

Mark:  It’s not one person pulling the strings.

Andrew:  That’s right, absolutely. When it comes to Kerr and his role, Kerr will continue to be part of the investment team, he will continue to work away on investment ideas, which is his love. When you do this job, you’re never going to stop doing that.

He’ll still be there working away on this idea or that, as pleases him. Also, he will be looking at the ideas other people are putting forward because that’s what excites him.

He will still be part of our global portfolio manager’s meeting, which is the meeting of the most senior PMs, where we actually debate those ideas, where those differences of opinion are occurring amongst the PMs.

He’s still there going to be doing that and as Kerr would say, the demands of being a—of running a global portfolio, are not inconsequential in terms of the time and effort. What he is hoping to be doing is then being able to take that time where he doesn’t have to think about absolutely everything we’re doing to focus on what he believes are the really good ideas.

It is a change, but it may not be as significant as it sounds to people.

Mark:  I think the interesting thing from my perspective is that it’s not like Kerr is resigning from the company, selling all his shareholdings and just walking away. This is very much—sounds like a planned event. He is still going to be in the business, he’s just moving out of the CEO role so he can focus on the investment side and still remain contributing to the company. Is that…

Andrew:  Yeah, I mean, absolutely. Because I think it’s one of these things is that you, as I said, you can’t really retire from investing. You’re going to be doing it one way or the other. This is a great way for him to continue to do what he loves doing and it’s great for the rest of the organization to still have that input from him. It’s something that the younger members of the team will value because he will, as he does today, he’ll walk across the floor to talk to someone about what they’re working on and be quizzing them on that idea.

Because along with that idea, all those sort of more formal processes of how an idea comes to life, there’s also the discussions in the kitchen when you’re making a cup of tea and what have you.

He’s going to remain there as a full-time employee and part of the investment team.

Mark:  What’s he likely to do with his shareholding? Because he does own a significant amount of Platinum Asset Management. I think he said publicly in the press that he’s just retaining them. Is that—

Andrew:  Yes, so it’s hard for me to talk for him, so I can really only repeat what he has said, which is that I think at the moment there’s no intention to sell any of the stock at this stage.

Mark:  Going back to the funds for a second, what are the changes to the management of the funds and with a particular focus on the Platinum International Fund, which is the flagship fund, and also Platinum Asia. Probably the easiest one to start with is Platinum Asia.

Andrew:  Really, for Platinum Asia, there’s no changes in the management of that. Joe Lai has been running that in its entirety for a number of years now.

What you would expect with what we’ve done with Asia previously, with myself and Joe, when I used to run that, he started at 15% of the fund and progressively moved up to half and then the whole fund. That’s something—this is all part of both the development of individual members of the team and also building in that succession planning across the firm.

While there’s no intention to change that today, at some point in the future, you would expect that we will bring in another portfolio manager to run a small part of that fund and then build that up through time.

Mark:  I think that’s really interesting because Joe started out having a smaller amount of that fund, got built up, and then is now running all of it. The Platinum International Fund is not too dissimilar to that, in that Clay Smolinski, who has been with Platinum for quite some considerable time and is a very high quality investor, he’s currently managing 10% of the Platinum International Fund.

Andrew:  Yes.

Mark:  What’s going to change in that respect?

Andrew:  Clay’s also been running the un-hedged fund for a number of years now.

Mark:  Which has performed really, really well.

Andrew:  It’s performed very well, as the European Fund did, or continued to, even after Clay left, but is also—he did a very good job running that.

What’s going to happen is Clay will take 30% of that fund and what you again might expect at some point in the future, that is a third portfolio manager will be brought in there. One of the reasons for not doing that—a lot of people ask us why we’re not doing that today and it’s simply that these types of changes now, five years ago, didn’t attract a lot of attention, these days, the research houses are very focused on these changes. We’ve already given them quite a bit to think about in the last month. So, rather than make yet another change at that point, we want to leave that for a point in the future.

But people might be interested, across the range of our funds, that besides moving to that 30%, we will essentially bring—

Mark:  And then you manage 70%?

Andrew:  I manage 70%.

Mark:  You’re currently managing around half?

Andrew:  40.

Mark:  40, so you got a lot and so does Clay.

Andrew:  But some of our other funds that are similar mandates, this is not so much relevant for Australian investors, but our offshore uses product will also be 70/30. I will take over the management of Platinum Capital, whereas Clay will take over the management of—

Mark:  Platinum Capital being the listed investment company?

Andrew:  Listed investment company, yes.

Mark:  We have some invested in it.

Andrew:  But then also there are funds, the Platinum Global, which is the in fund, that its mandate is much more similar to the un-hedge fund, so Clay will take over that.

Mark:  Right.

Andrew:  They’ll be changes in other funds as well.

Mark:  Yeah. You touched on research houses. One of the things—and this is probably more relevant for Platinum Asset Management investors, rather than investors of the funds, but it strikes me that one of the key things is what the research houses say about you in their capacity as acting as a gatekeeper between you and financial advisors, like us.

What’s been the reaction of the research houses, Morningstar, Lonsec, etc.? What’s their reaction been to this, Andrew?

Andrew:  As you can imagine, we were on the phone to them, in for a meeting within 24 hours.

Mark:  You’re very much on the front foot, I must say, with that.

Andrew:  Yes. Both Morningstar and Zenith have reaffirmed the writings across our fund, so there’s been no change there. I don’t really want to speak for them either. They’re very independent in their views and their positions can be read. But essentially, I think, this was not unexpected in their minds and they’ve reaffirmed those writings, but as always, they’re watching carefully to see how we go.

Mark:  As always.

Andrew:  As it stands today, while we’ve had feedback from Lonsec, we don’t know what their final decision is at this stage.

Mark:  I do know Morningstar were out in the press last week, I think, saying they think that the management of Platinum Funds just continues as is. They were actually quite supportive in the press.

Andrew:  Yes. And I think that came on the back of the one that had that we won the Morningstar, not just the fund manager, the International Fund of the Year, but we also got the Fund Manager of the Year Award, which means that’s won against the entire, you know, all comers who are doing product across the range. And they assured me that was decided before any of the decisions anyway, but it was actually very nice timing to win that at that point for the organization and the investment team because it really recognizes what has been a period of very strong performance.

Mark:  Yes.

Andrew:  After a period where actually we didn’t think our performance was that poor, but in a relative sense, we had lagged the market for a while, by a very small margin, but I think that it was very nice to win that aware at that point.

Mark:  Absolutely.

Andrew:  We stuck to doing things the way we’re doing and the end result has been good. As I say, I’m not one to normally get too excited about awards, but it was a lovely time to get it and at this point in time as well.

Mark:  Congratulations, by the way for that. The track record, so Clay and yourself are running the flagship fund. There’s no changes to Platinum Asia. The track record of Clay and you has been really good over a long, long period of time. Are you able to provide any context around that? I know that’s actually a hard question.

Andrew:  This is the thing, I go back to where we started and talk about the process that is there, and I don’t want to take away from Clay’s excellent record, but here’s the thing, over our 24 years of history, we’ve had 14 different portfolio managers running money. Every one of them, their long-term record was one of out performance. That’s quite extraordinary. I don’t think you find that many easily, in any market.

Now, of those 14, 10 are still with us. 2 of them were other founders who have stepped aside. But I look at this say, this is the system. If I have a flippant response to people when they worry so much about the role of the portfolio manager because if I’m sitting here, I have 30 people in the office bringing me great ideas. If they only bring me great ideas, because they’re well thought through and well argued out,  then all I need to do is buy every one of them or flip a coin and buy every second one, whatever it is.

Now, there’s more to it than that. But the job of running money becomes easy when you’re supported by a strong team.

Mark:  The main message really here is that. This is very much a team business and it’s a big team. You’re probably one of the deepest teams in the country, in international equities.

Andrew:  I think in the country, very easily and across probably all investment teams in terms of depth of experience and what have you, I mean, there will be other people globally who have similar histories.

But, you know, I think the thing that we see when we talk to clients overseas, is that the things that differentiate us very strongly, not any one of these things, but a collection of all of them, is that we’ve been going for a while, 24 years. We’re managing a substantial sum of money with 27-odd billion Australian dollars. Very defined investment approach and extraordinarily deep team, and a long-term record of out performance. You’ll find that people who have got four of the five or three of the five, but there aren’t many.

What I should say, I think one of the things that stands out with overseas clients is when we say we construct our portfolios independently of the MSCI Index, is that we genuinely do. There are many other people who say they do.

Mark:  Say they do and they don’t. [Laughs]

Andrew:  But they still end up with—and some of those who’ve got great records, but they still end up with 45% in the U.S., even though they say they’re not doing that, which interests us. We genuinely are—

Mark:  You’re true to label though, aren’t you? You’re very much true to label. What you say you’re going to do, you do.

Andrew:  We do. I think that maybe sometimes in Australia that’s not valued quite as much as it could be because we’ve been around a long time and people know us. But I think it is—there’s no one else we know of that can show all those attributes.

Mark:  Our position, Andrew, is that we know the depth of your management team at Platinum Asset Management, and you individually have been managing that team for the last five years officially, I believe, in any case.

Andrew:  Officially, yes. Unofficially, for longer than that. [Laughs]

Mark:  Yeah, that’s right. [Laughs] From our perspective, nothing has really changed other than it’s a change of role for Kerr, but he’s still in the business. We’re still positive on Platinum Funds, clearly.

Have you got any last thing that you would like to say for our Platinum investors or PTM shareholders?

Andrew:  I think the other thing that people ask about is, I’m taking on this additional role of CEO and what are the—how much of a workload, how does that—I guess the fair concern is how does that detract from the investing side of things?

Again, I think that not everyone will be aware of just how strongly our organization, that investment team is supported by the other functions. Liz Norman, who was there on day one and I think most clients and financial planners in this country know her. I make the joke, I walked into the Morningstar Awards and everyone is saying, “Hi, Liz. Who are you?”

Mark:  [Laughs]

Andrew:  But you know, he’s run all of that part of the business for 24 years, does an extraordinary job. On the other parts of the business, the accounting, legal, compliance, tax, we had a great founding CFO, Malcolm Halstead. He left the business a few years ago, but he built an extraordinary team of people. There’s all these boring things people wouldn’t know about, portfolio accounting and registry, but these are very important functions because when they go wrong, they can create havoc and they can cost—well, they never cost the clients money but they’ll cost—

Mark:  They cost the business and it’s a management distraction.

Andrew:  It costs the business money and a lot of distraction and we have an incredibly strong team there, now led very well by Andrew Stannard, our current CFO.

When it comes to the role of CEO, the reality is that Liz and Andrew and their teams, they run the business. We want an investment person as CEO because ultimately the CEO makes the final, critical decision on important things and we want those decisions taken from a perspective of is this going to impact the investment process? You can have all these great ideas, we should have this product, we should do this, we should open an office in New York, we can have all the great ideas in the world, but ultimately, they need to be run through the filter of how does this impact the way the investment team functions.

All of those things, those sort of decisions, can impact and hurt that and that’s why I’ve taken on that role. In reality, yeah, there will be times where there’s more to do, but in fact, the way it’s worked, is Kerr and I have already long divided those responsibilities. So, most of the accounting and compliance-type discussions where it’s come through to the management committee, which is Andrew Stannard, Liz, Kerr, and myself, they’ve tended to be my area and Kerr is focused more on the client side of the business. I’ve been part of those discussions for 24 years, so it’s not like I have to all of a sudden get on top of, or how does this work or how does that work? I’ve been there the whole time.

There will be some time into that, but I don’t believe that it will be substantial.

Mark:  Good answer. Andrew, all the best for the new role as CEO and I know you’ve been there forever [laughs], so all the best for the transition. Thanks very much for making the time to talk to us about it.

Andrew:  Thank you.

[End of Audio]

Transcription by Fiverr.com bethfys

Thursday, 15 March 2018 05:48

Shorten's tax grab from retirees

The ALP has proposed that if it wins Government at the next election it will scrap cash refunds that are currently paid to investors with surplus imputation credits they receive from shares that they own which pay franked dividends.

Bill Shorten claims that only the wealthy will pay the tax, clearly continuing his class warfare with ‘the big end of town’.

He also said “a small number of people will no longer receive a cash refund but they will not be paying any additional tax”.

With all due respect to a potential future Prime Minister, this is rubbish! 

The Australian reports today that Treasury analysis of official tax data shows the largest group of people to be hit by Labor’s $59bn tax grab will be those receiving annual incomes of less than $18,200, the majority who receive the Age Pension.

In fact the likely number of people hit by this proposal is estimated at well over 1 million, bringing into question the ALP’s definition of small.

The current effective tax free threshold for a retiree couple over age 65 is around $29,000 each, courtesy of the Seniors Australian Tax Offset and of course the $18,200 tax free threshold that applies to everyone.

Therefore any retiree who’s taxable income is less than that, is currently not paying tax and at risk of having their surplus imputation credits retained by the ATO.

The whole point of dividend franking – introduced by a Labor treasurer Paul Keating of course was to stop the double taxation of dividends. 

Dividends have to be paid by companies out of profits which have already paid company tax.  In the old pre-Keating world those dividends would then be taxed a second time as personal income.

Under the Keating change you would get a ‘credit’ for the company tax paid on the dividend, you would then still be taxed at your full marginal tax rate on the underlying income out of which the dividend was paid.

Critically, if your marginal tax rate was lower than the 30% company tax rate, you still paid “too much” tax.  That is why Peter Costello legislated the cash return of that overpayment in 2000.

If the ALP proposal becomes law, this would result in high income earners gaining the full benefit of dividend imputation but retirees and low income earners being discriminated against and unable to use the tax credits.  In other words retirees would become one of the few groups in the country to pay double taxation on their dividends.  The very people the ALP are alleging to protect are those most likely to lose from this proposal.

So how much do retirees (including those with Self Managed Super Funds in pension phase) stand to lose from this proposal?.  The table below sets out different levels of investment in fully franked dividend paying investments and the corresponding potential loss of income for retirees.(assuming retirees are below effective tax free threshold)

Investment Level

Dividend Rate (fully franked)

Franked Income

Imputation Credit

Cut to Retiree income under ALP proposal

$100,000

5%

$5,000

$2,142

$2,142

$200,000

5%

$10,000

$4,285

$4,285

$300,000

5%

$15,000

$6,428

$6,428

$400,000

5%

$20,000

$8,571

$8,571

$500,000

5%

$25,000

$10,714

$10,714

$600,000

5%

$30,000

$12,857

$12,857

GEM Capital is not opposed to tax reform, but we are opposed to leaders using the tax system as a political wedge for political gain that disadvantages the retiree sector.

We are deeply concerned that a potential future Government can propose in an incredibly short time frame, in a retrospective manner, such a drastic reduction for retirees’ income.  Retirees have limited capacity to increase their earnings through employment which makes them a very vulnerable segment of the community to sudden changes in Government policy.

GEM Capital will be contributing to media articles in the coming weeks on this issue and will also be talking with politicians of both sides of politics with a view of broadening their perspective on the issue and at the same time represent the interests of retirees.

Feel free to share this article with anyone you believe may be impacted by this proposal.

Thursday, 15 March 2018 05:42

Shorten's tax grab from retirees

The ALP has proposed that if it wins Government at the next election it will scrap cash refunds that are currently paid to investors with surplus imputation credits they receive from shares that they own which pay franked dividends.

Bill Shorten claims that only the wealthy will pay the tax, clearly continuing his class warfare with ‘the big end of town’.

He also said “a small number of people will no longer receive a cash refund but they will not be paying any additional tax”.

With all due respect to a potential future Prime Minister, this is rubbish! 

The Australian reports today that Treasury analysis of official tax data shows the largest group of people to be hit by Labor’s $59bn tax grab will be those receiving annual incomes of less than $18,200, the majority who receive the Age Pension.

In fact the likely number of people hit by this proposal is estimated at well over 1 million, bringing into question the ALP’s definition of small.

The current effective tax free threshold for a retiree couple over age 65 is around $29,000 each, courtesy of the Seniors Australian Tax Offset and of course the $18,200 tax free threshold that applies to everyone.

Therefore any retiree who’s taxable income is less than that, is currently not paying tax and at risk of having their surplus imputation credits retained by the ATO.

The whole point of dividend franking – introduced by a Labor treasurer Paul Keating of course was to stop the double taxation of dividends. 

Dividends have to be paid by companies out of profits which have already paid company tax.  In the old pre-Keating world those dividends would then be taxed a second time as personal income.

Under the Keating change you would get a ‘credit’ for the company tax paid on the dividend, you would then still be taxed at your full marginal tax rate on the underlying income out of which the dividend was paid.

Critically, if your marginal tax rate was lower than the 30% company tax rate, you still paid “too much” tax.  That is why Peter Costello legislated the cash return of that overpayment in 2000.

If the ALP proposal becomes law, this would result in high income earners gaining the full benefit of dividend imputation but retirees and low income earners being discriminated against and unable to use the tax credits.  In other words retirees would become one of the few groups in the country to pay double taxation on their dividends.  The very people the ALP are alleging to protect are those most likely to lose from this proposal.

So how much do retirees (including those with Self Managed Super Funds in pension phase) stand to lose from this proposal?.  The table below sets out different levels of investment in fully franked dividend paying investments and the corresponding potential loss of income for retirees.(assuming retirees are below effective tax free threshold)

Investment Level

Dividend Rate (fully franked)

Franked Income

Imputation Credit

Cut to Retiree income under ALP proposal

$100,000

5%

$5,000

$2,142

$2,142

$200,000

5%

$10,000

$4,285

$4,285

$300,000

5%

$15,000

$6,428

$6,428

$400,000

5%

$20,000

$8,571

$8,571

$500,000

5%

$25,000

$10,714

$10,714

$600,000

5%

$30,000

$12,857

$12,857

GEM Capital is not opposed to tax reform, but we are opposed to leaders using the tax system as a political wedge for political gain that disadvantages the retiree sector.

We are deeply concerned that a potential future Government can propose in an incredibly short time frame, in a retrospective manner, such a drastic reduction for retirees’ income.  Retirees have limited capacity to increase their earnings through employment which makes them a very vulnerable segment of the community to sudden changes in Government policy.

GEM Capital will be contributing to media articles in the coming weeks on this issue and will also be talking with politicians of both sides of politics with a view of broadening their perspective on the issue and at the same time represent the interests of retirees.

Feel free to share this article with anyone you believe may be impacted by this proposal.

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