Opinion
Since the federal budget, social media has been full of memes casting government as a “silent partner” in small business: entrepreneurs take the risk, do the work, and Canberra – specifically Prime Minister Anthony Albanese in the memes – turns up with a hand out for 47 per cent.
It is a good line. It is also misleading.
I am what people now call a “founder”. I run an economic consultancy company. I used to be a salaried employee paying the top marginal tax rate but 20 years ago, my business partner and I started our own company. We worked harder and earned more, but fundamentally did the same work we did before. Yet I paid much less tax.
Like many small-business people now complaining bitterly about the government’s proposed tax changes I have taken advantage of numerous tax breaks for founders. I had a family trust own my share of the company; distributed income to family members on low tax rates; paid out only what we needed to live on, avoiding the top marginal personal tax rate; retained the rest inside the company, accumulating value over time; and can live off retained earnings in my retirement or sell some or all of the company and potentially access the CGT discount.
When founders say, “I worked hard, didn’t pay myself a salary and poured the profits back into the business”, spare me. Yes, we all did that, not because we were saints, but at least in part because it helped us reduce tax. Most of this is still allowed.
A salaried employee with taxable income of $200,000 pays income tax on the whole amount above the tax-free threshold – about $60,000. (Not to mention the $10,000 in payroll tax paid by their employer, but in reality is borne by the employee.) The employee cannot distribute their salary to a spouse or adult children, park their salary in a company at a 25 per cent rate, realise their salary in retirement, or convert accumulated earnings into a discounted capital gain.
When you hear about tech start-up founders doing it hard, don’t waste your sympathy on them. Imagine a Tech Guy who works hard for a year, builds an app and sells it for $1 million. With the CGT discount, their tax rate is about 20 per cent, including Medicare levy.
Compare that to a top engineer working for Rio Tinto. They work hard too and earn a $1 million salary. They are taxed at an average tax rate of 44 per cent (46 per cent when you include payroll tax). Even a nurse on $100,000 salary pays a 26 per cent average tax rate.
But that is not the end of the story. If Tech Guy created a family trust to own the app they could get the benefit of both the CGT discount and income splitting. If Tech Guy distributes the $1 million equally to themselves and their spouse they only pay 17 per cent tax (assuming no other income). If they split it with two adult children at university they pay only 12 per cent tax.
Why does Tech Guy get to pay less than half, and maybe only one quarter, of the tax rate paid by the engineer? Why do they pay a substantially lower tax rate than a nurse? Do we need apps more than we need engineers or nurses?
Now you might say that the 46 per cent rate is too high and needs to be lowered. I would agree with you. But if we are going to get the 46 per cent down we are going to need a larger contribution from people like the Tech Guy and myself.
Of course, business owners take risks. I did. Businesses fail, clients disappear, employees have to be paid before owners are paid.
But risk is not a magic word that justifies any level of tax concession. The question is not whether the tax system should have concessions for entrepreneurs that salaried employees don’t receive. I happen to think that it should. But does 12 to 20 per cent tax on $1 million strike the right balance?
If you think 30 per cent is closer to the right balance then you should be applauding the government’s budget and its proposed minimum 30 per cent tax rate on trust distributions and capital gains taxes.
When you hear someone say the government is becoming a lazy partner in their business, ask a simple question: compared with whom?
Compared with the nurse or engineer whose income is taxed before it hits their bank account? Compared with their own employees (many of whom will pay more tax than the business owner)?
The truth is that people like me have done very well out of the current system. We have played by the rules. But we should not confuse playing by the rules with the rules being economically sensible – let alone fair.
I haven’t even mentioned that a small business owner can still sell the company and, if the company qualifies as an active asset and has been held for 15 years, access the 15-year CGT exemption. This exemption means zero tax on the sale proceeds. What’s more, the same owner could contribute $1.9 million of the sale price into their super and have the earnings taxed at only 15 per cent. The budget leaves this exemption untouched.
The government is not raiding the small (and often not so small) business sector. It is asking some of us to pay a respectable minimum.
That may be bad news for some tax plans. It is not bad policy.
Dr Tom Hird is an economist and the founder of CEG Asia-Pacific.
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Dr Tom Hird is an economist and the founder of CEG Asia-Pacific.