Labor's menacing tax memo to the world

The decision to raise Australia's withholding tax on foreign investment brings it into line with other countries but creates a terrible dilemma for institutional investors.

Perhaps the most maddening thing about Treasurer Wayne Swan’s backdown on a budget surplus for 2012-13 is it forces us to ask whether some of the damage that’s been inflicted on Australia’s reputation among international investors in pursuit of that goal was ever necessary.

Much has been made about how little the minerals resource rent tax will raise for government coffers and thus help deliver a surplus that's no longer coming. Indeed many column inches have been devoted to how commodity price fluctuations ensured that a reliance on this tax device to deliver in this financial year, or any year, in any meaningful sense was clearly idiotic the day it was suggested.

It was this tax device that, when announced in its original form as the resource super profits tax, raised serious questions about Australia’s sovereign risk, particularly in the world’s financial capital, New York. These questions can best be addressed with a change of government, even if it’s a government that will be led by one of the most unlikeable and uninspiring leaders in Australian political history.

But in a strange way, the MRRT of 2010 is less of a problem for Australia’s international reputation as an investment destination than the lesser known changes to the withholding tax made as part of the May budget.

The government announced its intention to raise the withholding tax on foreign investors in managed funds to 15 per cent from 7.5 per cent.

The argument is that these rates tend to apply to wealthy investors who can afford it, plus it would bring Australia’s rates into line with international competitors. Both these points are correct and it should be noted that this rate used to sit at a much higher 30 per cent.

So sure, the tax would be doubled, but it’s still half what it used to be. What’s the problem?

There are actually two problems here and neither can be easily addressed, no matter what Swan has conceded about the budget’s bottom line.

Firstly, it was terribly communicated to international financials – just like the RSPT, or was that the MRRT? Sources in New York’s banking industry indicate that big institutions are still somewhere between puzzled and infuriated with this meddling without consultation.

Secondly, it’s a complete about-face on what Labor was telling us in 2008. It was the then Rudd government that cut the withholding tax from 30 per cent, to 15 per cent and then 7.5 per cent, all the while making a big deal about how it was sending a message to the world that Australia is a place for investment – a terrific message, particularly when the investment world is in such a mess.

The MRRT was a bigger tax policy blunder for the country, no question. But global financials were concerned about it on behalf of their mining clients, almost all of which were always going to be able to meet their obligations, mining tax or not. Besides, the swift amendments made by the freshly installed Prime Minister Julia Gillard via closed talks with BHP Billiton, Rio Tinto and Xstrata ensured that the thing wouldn't raise much more than dime.

By contrast, the withholding tax changes mean that these financial firms have to go to clients across their organisation and tell them, "Hey, remember when we said you should invest your cash in Australian infrastructure and construction because they’ve got their head screwed on straight? We were wrong and your return is seriously compromised. Oh, and if you're still keen at 15 per cent, the Australian dollar is in a terrible mess."

It’s embarrassing for them. The spectre of the RSPT just reinforces the questions in their minds about Australia’s reliability.

Granted, international financials have rightly been brought down a few rungs after the global financial crisis. They can no longer expect to get everything they want from governments around the world or demand to have a direct line to relevant ministers on minute policy details before they’re made public.

But the unconvincing performance of Australia’s economy, the primary reason for our budget deficit, illustrates how desperately we need international investment.

For that we need the confidence of major multinational financial institutions and a proper discussion about how to fix the budget’s structural problems, rather than random tinkering with tax rates and a shuffling of spending forwards and backwards.

Between the MRRT and withholding tax changes, the first has been significantly weakened. Between the ALP and the Coalition, the judgement is yet to come – but the withholding tax decision is unlikely to do Labor any favours.

Alexander Liddington-Cox is Business Spectator's North America Correspondent.