Henry Review: Improving Australia's Investment Incentives

by Mary Swire, Tax-News.com, Hong Kong

20 August 2009

In a speech to the Australian Industry Group, the Australian Treasury Secretary and head of the ongoing tax review, Ken Henry, commented on possible changes to the structure of business taxes in the country to improve incentives for productive investment.

He said that, as the economy emerges from the recession and economic growth returns, it will be important to embrace “policies that allow structural change to occur and facilitate the efficient allocation of resources.” In that respect, he pointed out, there is a role for tax reform in improving “the way in which Australia emerges from the downturn and, more obviously, for long-term participation and productivity growth.”

“Two matters among many that the review is considering,” Henry said, “are how Australia’s tax system can be reformed to improve incentives to invest in Australia and to ensure that capital is invested in the most productive way.” He demonstrated how the present tax system produces “very different effective tax rates for different types of investments financed in different ways.”

He indicated that the tax review was looking at future corporate tax changes to make equity investment more competitive with debt financing. He said that the effective tax rates for investments financed by debt are much lower than those financed by equity, reflecting the full deduction against taxes for interest expenses, while equity dividends are taxed. Importantly, he added, “foreign sourced debt remains tax favored relative to foreign sourced equity.”

This raises the prospect, Henry continued, of “a sub-optimal allocation of resources. One consequence of the overall bias in favor of debt is that it encourages some firms to increase leverage, an outcome that may increase their risk exposure. For an individual firm, debt financing can exacerbate vulnerability in the profit and loss statement when revenue falls, since – unlike dividend payments – the debt servicing costs are essentially unavoidable, short of default.”

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