Labor’s super tax will smash entrepreneurship, growth and productivity
And risks making Australian uninvestable
Startups are a vital part of Australia’s economy. They drive innovation and commercialize essential research into medical devices and pharmaceuticals. They also enhance productivity and improve our health and welfare through medical breakthroughs.
Unfortunately, Labor’s plan to tax unrealized capital gains will take a sledgehammer to a sector that is vital to Australia’s productivity and growth. This is unfortunate: Growing the economy – and the tax base – is precisely how the government can afford to pay for nice things.
Initially, Labor’s tax on unrealized gains would apply ‘only’ to 0.5% of superannuants as it ‘only’ applies to people with balances above AUD 3 million. Leaving aside the moral repugnance of targeting someone merely because they are wealthy, the number of people impacted will expand. This is because the aforementioned $3 million threshold is not indexed and Labor’s budget is banking on bracket creep. The intention is to not raise the threshold so as to capture more people.
This will harm startup investment.
Superannuation funds heavily back startups. To put this in perspective, Australia Super purports to invest 5% of its portfolio in private equity, and had previously aimed to increase that allocation to 8%. This amounts to at least $15 billion in unlisted investments. Aware Super claims to have invested $9 billion in private equity, with at least 25% being in growth or venture-style investments. Thus, many superannuants are exposed to unlisted assets, and startups, without even realizing it.
Self managed super funds (SMSFs) also invest in startups, often directly in companies. SMSFs also often have more concentrated portfolios than do standard super funds. At least 20% of startup funding comes via SMSFs; some reports estimate that the figure could be as high as 60% of all startup funding.
Superannuation is a nigh essential model for startup funding. This is because the risks of investing in startups are extremely high. Thus, for the after tax payoff to be sufficient to take that risk, the tax rate can be no higher than the superannuation rate. If the tax rate more than doubles – as would be the case outside of superannuation – then many startups would simply not offer a high enough potential return to attract investment.
The tax on unrealized capital gains, in addition to the tax hike to 30%, would undermine superannuation funds’ investments in startups. Let’s not forget that the long term capital gains tax rate is below 30%. That alone would be bad enough. But, taxing unrealized gains takes it to another level.
The tax on unrealized capital gains creates significant risks for superannuation funds. This is because if an unlisted company hypothetically increases in value, then superannuants will be liable for the tax on such gains. But, since the assets are unlisted, they cannot be sold to pay the tax. This creates a liquidity risk.
The money to pay the tax must come from other assets, presumably forcing an asset sale elsewhere within the fund. This creates major issues for asset allocation: how do you plan long term investments when you do not know what you might need to liquidate to pay an unknowable tax? Presumably, the portfolio would become increasingly concentrated in unlisted assets, as the listed ones must be sold to pay the tax. But, this just amplifies the risk of future imposts.
The tax on unrealized gains can thus create a death spiral where the only assets left in the portfolio are unlisted as all listed ones have been sold to pay tax. It is difficult-to-impossible to sell shares in unlisted companies. This begs the question of what then happens when there are no liquid assets left to sell?
The problems are amplified when we consider that startups can soar in value only to fall into bankruptcy. In this case, the individual must pay taxes on the unrealized gains. But, when the investment falls, they only receive a tax credit to offset against future losses. They do not receive a refund.
This problem with only receiving a credit for future gains is obvious. A dollar today is worth more than a dollar tomorrow. Thus, due to inflation, the value of that tax credit diminishes over time. But, the person must pay the tax on unrealized gains immediately. Furthermore, it is quite foreseeable that if the superannuation fund invested in a ‘paper unicorn’, which subsequently failed, the fund might never make enough money to use that tax credit.
These concerns do not merely apply to superannuants with balances above $3 million. This is for the very obvious reason that the $3 million is not indexed with broader market returns. At an average return of 10% pa, $3 million is equivalent to $450k in 20 years time and $66k in 40 years time. It is myopic in the extreme to focus on the $3 million threshold and to naively hope that it is appropriately raised when the government has signaled ever intention to not do so.
The net result: superannuation funds, especially SMSFs, will not invest in startups. The corollary is that the innovation Australia sorely needs to improve productivity will suffer even more capital rationing. This is not to mention the terrible precedent the tax sets: investors will rightly fear that the tax will expand. Once that fear sets in, Australia will be uninvestable.
If the government is serious about innovation and productivity, it will dump the tax on unrealized gains.