Economic surplus

Economic surplus

Closing the company car tax loophole is an obvious budget winner

Expect a “tough love” budget from the federal government in two weeks. And expect lots of (pointless) debate about whether or not a levy is a tax.

If, however, we cast our thoughts back to July last year, we can find an easy and equitable $1.8 billion waiting to be picked up by the government. The money is from reforming the tax treatment of “company cars”. The problem? Well, it was Labor party policy going into the last election and was disavowed by the current government.

The treatment, under the Australian tax laws, of company cars for private use, is a transfer to (upper) middle class employees who get a company car for personal use through their employment. Closing this fringe benefits tax (FBT) loophole will raise $1.8 billion over four years. Not a huge sum, but every bit helps. The changes can protect legitimate business use of a car while getting rid of an inequitable tax perk.

The best evidence that the current rules are a rort came from the reaction to the policy announcement by the then Labor government last July. The price of shares in McMillan Shakespeare, a company that provides salary packaging to take advantage of the FBT loophole, fell by almost two-thirds.

During the 2013 election campaign, the coalition came out against FBT reform. It restated its position in November:

“During the 2013 election the Coalition pledged not to continue with Labor’s $1.8 billion Fringe Benefits Tax change that would make it harder for people to have a company or salary sacrificed vehicle. The Coalition Government today confirms it will not proceed with this measure.”

But the main reason not to proceed with the changes was the effect on local car manufacturers. And since November, all of the local manufacturers have announced that they will be closing domestic manufacturing by the end of 2017. So the main reason to keep the current FBT rort – protecting the local car industry – is no longer relevant.

Closing the fringe benefits tax loophole on cars is good economics. The whole idea of the fringe benefits tax is to remove the incentive for employers to pay their workers through “perks” rather than money. Before FBT was introduced in the 1980s, employee remuneration involved a range of non-monetary benefits used to top up wages. These benefits made sense for the individuals involved, but created a loss for the economy.

For example, say you are in the 30% tax bracket and there is no FBT. If you get tax-free benefits (for example, meals, travel, and/or a car) from your employer that costs your employer $10,000 and gives you a benefit of $8,000 then you are better off than if the employer paid you $10,000 in cash. The cash would attract $3000 in tax. Both the cash and the benefits cost the employer $10,000. But you prefer the $8,000 value from the benefits to the $7,000 after-tax cash.

But the nation is worse off when non-monetary benefits are used to avoid tax. If the employer pays you $10,000 in cash, you get $7,000 and $3,000 goes to the government, for use on schools, hospitals, roads, and so on. But if you get the benefits, your employer spends $10,000, you get $8,000 in value and $2,000 is destroyed. No one gets it. The scheme reduces value and creates what economists call a deadweight loss.

The Fringe Benefit Tax stops this value destruction. A comprehensive FBT would treat all payments – whether income or non-monetary benefits – the same. But our current FBT with the “company car loophole” is not comprehensive. Closing the loophole will improve the tax system.

With domestic car manufacturers packing up and leaving, the main losers from the FBT reform will be employees who currently use the tax loophole and the companies, like McMillan Shakespeare, who have a business helping people to minimise tax. But everyone else – and the economy as a whole – is a winner.

So, over to you Mr Hockey.