One of the many contributions to the debate on the proposed resource rent tax (RRT) over the past week came from Federal Treasury. Given the focus on tax rates paid by industry, the Treasurer brought forward the publication of a paper entitled Disparities in average rates of company tax across industries.
The paper was to have been released on June 24, but the belief was that it would be of value in the current debate. Strangely the study was based on data for the decade to 2004/05 when 2007/08 data has been available for around two months.
Some of the protagonists on the RRT also sought to use the paper to focus on tax rates paid across industry. However the aim of the paper was somewhat different: “the objective of the paper is to investigate whether the corporate tax system impacts differently across industries, rather than focussing on the actual levels of average corporate tax rates”. And to the aim, the paper met its objectives.
Quite simply, industries are indeed very different. And while this is no surprise, it does raise questions about whether there should be tinkering with elements like depreciation provisions. Further, capital: labour ratios clearly differ across industries and the question is whether the way the company tax system is structured favours one type of industry over another.
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Clearly those questions can’t be answered by reference by a simple study. The economic cycle affects industries differently. Some industries may be heavily investing and thus have greater recourse to depreciation provisions. And other industries like agriculture can be affected by seasonal events like drought. And of course factors change.
The paper states that construction is capital intensive and overly reliance on debt finance whereas the latest data shows that isn’t the case. And debt levels in mining were only marginally above the industry average contrary to the assertions in the paper. The latest data also shows a sharp lift in tax paid by the mining sector in the three years after the Treasury paper was completed.
In the interests of ensuring that all industries are paying their way it is appropriate that the Government look closely at the structure of the company tax system rather than just the rate. And of course this is important in doing comparisons across countries. But also other judgements need to be applied. Should investment be encouraged together with research and development, even if some sectors will make greater use of these provisions, such as mining and utilities? The issues are clearly multi-faceted.
The week ahead
The winter whirlwind is upon us. Over the coming week no fewer than a dozen key economic indicators will be released with a Reserve Bank Board meeting thrown in for good measure.
Let’s deal with the Reserve Bank meeting first (held Tuesday). It’s now clear that the Bank should have left rates on hold in May, and arguably it should have done the same in April. And it is not just the volatility on global markets that leads us to that view but our regular discussions with business owners across Australia. The one common element across businesses is the reluctance to spend. And it’s not just businesses – their customers are also tending to keep their dollars in their pockets with discretionary spending the main casualty.
In terms of the week’s economic data, there is basically something released every day. On Monday, RP Data releases latest home price figures, the monthly inflation gauge and the Performance of Manufacturing index are issued, while the Reserve Bank releases private sector credit (lending) and the Bureau of Statistics releases business indicators and the balance of payments. The most important data is home prices.
On Tuesday retail trade, building approvals and government finance data are released. On Wednesday the March quarter economic growth estimates are issued. On Thursday, trade figures and the Performance of Services index are produced while tourism data and the 2009/10 Year Book are slated for release on Friday.
Overall we wouldn’t be expecting any stellar results. Retail trade may have inched 0.3% higher while building approvals may have gone backwards by around 4%. Lending is slowly recovering, perhaps up 0.4% in April. The tourism deficit probably hit fresh annual lows, crunched by the high dollar. And overall economic growth in the first three months of the year would largely have come from the public sector. Consumer spending was flat and investment rose modestly. The economy probably lifted by 0.9% with the annual growth pace largely steady at 2.8%.
In the US, there is not the same Melbourne Cup field of economic data, but certainly some very influential statistics. The main interest is in the non-farm payrolls data on Friday. Current forecasts are centred on half a million jobs being created in May. Yes, that’s right – half a million. Certainly increased hiring of temporary census workers would have boosted the result. But a result of that magnitude may change investor focus from fear to fundamentals. The jobless rate is expected to ease from 9.9% to 9.8%.
Earlier in the week, on Tuesday data on construction spending is released together with the ISM manufacturing index. On Wednesday, latest car sales results are issued together with pending home sales. The ISM services index is produced on Thursday together with factory orders and the ADP private sector employment index.
Gains are expected for pending home sales (1.5%), auto sales (4 million annual rate), factory orders (1%) and the ISM services index (55.6 expected). But softer results are tipped for the ISM manufacturing index (58.9 expected) while construction spending was probably unchanged in April.
We have adjusted our sharemarket forecasts – that is, as best as we can do in the current environment. Markets that trade almost wholly on fear and that can rise 2% one day and fall 2% the next are clearly not rational. However, we believe that once investors focus again on fundamentals they will see a very encouraging picture. By year-end we expect the All Ordinaries to lift to 5,100 points. From current levels that appears a fair stretch – up almost 18% – but for 2010 as a whole it would translate to growth of just below 5%.
Over a period of 30 years the price-earnings ratio for the All Ordinaries index has averaged 15. Clearly there have been significant departures over time; with the PE ratio ranging from 7.8 to 22.8, but 15 has acted like a magnet.
In April the PE ratio lifted to 17.3 – a level that couldn’t be maintained given doubts about full year earnings results. The current PE ratio of 15.76 should make investors feel a lot more comfortable.
Interest rates, currencies & commodities
The Reserve Bank is tipped to leave rates unchanged on Tuesday but that doesn’t mean that savers should despair. The interest rates on offer from major institutions are clearly enticing – one factor that explains why our sharemarket is lagging those in other parts of the globe. For online savings accounts, investors can earn an introductory rate of 6% for the next two months (on-going rate 4.50%). When you consider the cash rate stands at 4.50%, the returns are remarkable. And for term deposits it gets even better. If you squirrel away your funds for five years, and have $10,000 to invest, yields of around 7.25% can be achieved.
Our currency strategists have tweaked their forecasts for the Aussie dollar. That is – and as we noted for the sharemarket forecasts – as best that can be done in the current volatile times. The Aussie dollar is tipped to claw back some of the lost ground once the fear-driven environment ends. The Aussie dollar is tipped to lift to US85 cents in June and US87 cents by September before easing to US82 cents by end year. Generally over the next 18 months the strategists see the Aussie between US81-87 cents.
But while the strategists expect some stability against the US dollar, they expect the Aussie to lift against a weakening Euro over the next year. Late this year the Aussie is tipped to lift to just over €71 cents and rise further to €74 cents at the end of 2011.
Craig James is chief economist at CommSec.