Effects of mutual recognition of imputation credits

In both Australia and New Zealand, when tax is paid on corporate income at the company level, dividend recipients can credit this tax against their personal (or institutional) income tax liability. This is referred to as an imputation (or franking) credit. Although both Australian and New Zealand grant imputation credits for tax paid domestically, they do not recognise the imputation credits granted by their trans-Tasman partner. It has been argued that the absence of imputation credit recognition creates a distortion in favour of local investment, to the detriment of both countries. This is particularly an issue for New Zealand, where a large share of foreign investment is sourced from Australia. Both governments have considered the mutual recognition of imputation credits (MRIC). Conceptual analysis alone cannot determine the net impacts of implementing MRIC on each country. This is because the net impacts depend on relative magnitudes of investment and investors’ behavioural responses, and these responses can have positive or negative impacts on each country depending on a range of assumptions. This paper uses a small, custom-built, international CGE model to analyse the potential impacts of implementing MRIC. The model includes the minimum detail necessary to examine the policy — for example, it includes detailed domestic and international capital and income tax treatments for Australia and New Zealand, and only includes Australia, New Zealand and the Rest of the World as regions. The small size of the model enabled comprehensive sensitivity testing of one million different combinations of 8 behavioural parameters and data items to produce distributions of results for each country. Sensitivity testing is particularly important for the imputation credit policies given uncertainty in the data about capital stocks (Australian and New Zealand statistical agencies report very different amounts) and uncertainty about behavioural responses.