House of Representatives

Second Reading Speech

By the Minister for Primary Industries and Energy the Hon John Kerin MP

I move that this Bill be now read a second time.

The purpose of this Bill is to give effect to major changes to the operation of the Income Equalisation Deposits (IED) scheme.

The IED scheme provides a mechanism whereby farmers can reduce fluctuations in their income by putting money aside in good years for the bad years that are likely to follow. The scheme has operated, in various forms, since 1976.

In the May 1988 Economic Statement the Government announced that it would introduce a tax-linked IED scheme for primary producers from 1 July 1989. The new scheme, it was announced, would be designed to overcome the drawbacks associated with the tax-linked scheme which operated until 1983.

Income stability has long been a major issue confronting the rural sector. Unstable incomes in the rural sector are due to cyclical movements in the prices of commodities and the variations in weather, which can be experienced in their most extreme form in floods or droughts. The timing and magnitude of variations in prices and the weather are impossible to predict.

As a result the incomes of farmers will be highly variable and subject to sharp and sometimes prolonged upturns and downturns. For example, the wool industry is presently enjoying relatively high prices while the wheat industry is only now showing signs of emerging from a significant downturn.

There are a number of adverse implications of rural income instability, particularly for farm production, investment and farm welfare.

On the production side, resources are often misdirected as a result of price and production instability. After the event, it is often clear that farmers have over-produced or under-produced; resources have been employed producing the wrong things in the wrong places in the wrong quantities.

Large swings in the level of activity in farming industries result in large swings in demand for associated services, such as wheat storage and transport facilities, abbatoirs and factories and businesses providing farm inputs and services. This results in considerable inefficiencies for all concerned and the costs are borne directly or partly by the primary industries. Farmers, of course, seek to protect themselves from instability and its consequences. Common farm responses are maintaining higher liquidity than otherwise, following more flexible operating patterns and diversifying production into a range of products. However, all these strategies result in some profitable on-farm investments not being made and can increase the asset base necessary for farming.

Similarly, risk and uncertainty tends to result in farmers being willing to borrow less and lenders being willing to lend less than would have been the case with stability. However, the service sector now provides facilities to farmers which act to reduce the risk associated with production and borrowing. Finance is now rationed according to price rather than quantity. Loans are increasingly being structured to reflect the characteristics and requirements of individual producers.

Greater stability in farm incomes, however, is likely to result in more farm confidence and borrowing power and, as a consequence, encourage farmers to adopt more efficient production methods over the long run.

There are also considerable 'welfare' costs associated with instability. Widely fluctuating incomes have to be reconciled with regular debt repayment obligations and the rational planning of family living expenses, including health and education. This is particularly serious for lower-income farmers, who face the prospect not only of painful disruption to their family life but also the possible loss of the farm. The problem also extends to many non-farm rural families whose welfare depend on the prosperity of surrounding farmers. While these welfare costs are difficult to determine, they could be very large.

The implications of unstable rural incomes clearly are not restricted to the agricultural sector, but flow throughout our economy, influencing the level and nature of economic activity. You will recall the depressing effect upon the economy of the drought of 1982-83, when the net value of rural production fell by eighty per cent. Conversely, strong prices for a number of commodities increased the net value of rural production by sixty- eight per cent in 1987-88 making a significant contribution to exports and national income.

Because of the diversity of commodities produced and the wide range of climatic conditions in Australia, the variability of incomes for individual farmers is likely to be proportionately much greater than the variability in the net value of rural production.

In view of the significance of farm income fluctuations and their wider implications the Government accepts that some incentive is justified to encourage farmers to provide for them. This view was supported by the 1974 Green Paper - "Rural Policy in Australia", the Industries Assistance Commission in its 1975 report - "Rural Income Fluctuations - Certain Taxation Measures" as well as its 1978 report - "Rural Income Fluctuations" and Professor Lloyd in his Victorian "Rural Economics Study" of 1986. A device which operates directly on income to allow farmers to take action to reduce income instability would reduce the pressure on Government to support a variety of alternative stabilisation measures. Many alternative measures act directly on prices or the quantity of production, with adverse implications for generally efficient industry operations. As well, we would wish to avoid measures which conflict with our general goal of an open international trading environment.

For example, primary industries frequently seek to take common action through arrangements such as commodity price stabilisation schemes, although these rely on Government backing to operate effectively. The Government is supporting a number of price underwriting schemes but as a general policy believes that they should deal only with extraordinary downwards price movements and that industry should assume increasing responsibility for meeting their costs.

That is, the Government, while acting to alleviate the pressures created through fluctuating incomes, believes that the price mechanism, which is transparent and rapidly transmits prevailing conditions, forms the most important base for decision making by producers.

The original IED scheme, established in 1976, was tax-linked, providing tax deductibility on deposit and tax liability on withdrawal and a non-commercial interest rate on the full deposit. However, the operation of both IEDs and tax averaging was distorted by the operation of "in-out" averaging (introduced in 1977) whereby primary producers were taxed at the lower of the average and standard rates.

The IED scheme was revised in 1983, replacing the tax deductibility incentive with an interest subsidy so that the interest earned on deposits was two percentage points above the short term Government bond rate. At the same time "in-out" averaging was abolished.

However, deposits have fallen away rapidly since the introduction of the new scheme. To some extent this would reflect the greater range of financial instruments available following the deregulation of financial markets in 1984. It May also reflect the significant downturns in the sector, for example, the 1982-83 drought and severe downturns in industries such as wheat, sugar and rice.

The Government has therefore decided to introduce a tax-linked IED scheme which overcomes the drawbacks associated with the tax-linked scheme which operated until 1983.

Because this new scheme is tax-linked amendments are needed to two Acts - the Loan (Income Equalisation Deposits) Act 1976 and the Income Tax Assessment Act 1936. The amendments to the Loan (Income Equalisation Deposits) Act 1976 are necessary to establish how deposits can be made, the determination of interest on deposits, the withdrawal of deposits and the application of a withholding tax to withdrawals. The amendments to the Income Tax Assessment Act 1936 are necessary to provide tax deductibility of eligible deposits and for the taxation of deposits when withdrawn. In the new scheme deposits will be tax deductible in the year of deposit and assessable for income tax purposes in the year of withdrawal. However, a number of changes will be introduced to ensure that unwarranted benefits are not available.

Interest will be paid not on the whole deposit but only on the "investment component". The investment component reflects the value of the deposit when reduced by the notional tax that would have applied in the year in which it was deposited. This will ensure that interest is not paid on that part of the deposit which would otherwise have been paid in tax.

As it is not possible to calculate the investment component for each deposit according to the depositor's individual marginal tax rate in the year of deposit, as the marginal tax rate will not be known then, a standard adjustment will be made to all deposits to determine the investment component. The adjustment rate will reflect the typical marginal tax rate of depositors. The rate will be initially set at 39 per cent, to apply from 1 July 1989. Consequently the value of deposits will be reduced by 39 per cent to determine the investment component which will earn interest. Interest will be paid at the short term Commonwealth bond rate.

A minimum deposit term of one year will apply to deposits. Further, a withholding tax will apply to withdrawals to ensure that there is no undue deferral of tax in the year of withdrawal and that withdrawals aren't manipulated to gain tax advantages.

As the taxpayer's marginal tax rate for the year of withdrawal will not be known when a withdrawal is made the rate of tax to be deducted will be set at a standard rate to apply to all withdrawals. This rate will represent the typical marginal tax rate of withdrawees in that year. For 1989-90 the rate will be 29 per cent.

The withholding tax will have provisions allowing withdrawees to have the rate of withholding tax reduced if they expect their marginal tax, based on their total taxable income, to be significantly lower that year. This will ensure that the withholding tax is not harsh in its treatment of farmers who seek to withdraw IEDs in years of poor income. Variations May be obtained through an application to the Department of Primary Industries and Energy when making a withdrawal.

As the purpose of IEDs is to encourage farmers to provide for income fluctuations the tax deduction will be available only to primary producers. Consistent with this, deposits in any year will be limited to net taxable income from primary production in that year. An upper limit of $250 000 will apply to the amount of tax deductible deposits that can be accumulated. This represents a generous provision to maintain against income instability. For example, $250,000 is equivalent to total farm costs for three years for an average farm. Deposits will be deemed to be withdrawn when a taxpayer ceases to be a primary producer. The scheme will be administered by the Department of Primary Industries and Energy. Deposits must be made by 30 June of the financial year. A minimum sum of $5 000 will apply to deposits and withdrawals. Deposits must be accompanied by a fee of $20 which will cover administrative costs.

In the light of the introduction of the new IED scheme, the Government has developed arrangements to phase out both the present scheme as well as the remaining deposits in the pre- 1983 tax linked scheme.

Deposits will not be accepted in the current IED scheme after 30 June 1989 and deposits in the scheme will be deemed to mature on 30 June 1992, when they will be repaid. This is consistent with the nature of the scheme, under which deposits are essentially financial instruments of the nature of bonds.

A sum of deposits remains in the pre-1983 tax-linked scheme, notwithstanding that interest on these deposits has been phased to zero. These deposits will be automatically transferred to the new scheme and will attract interest and be subject to the conditions on withdrawal which will apply to the new scheme. The will also form part of the $250,000 limit on the total amount of tax deductible deposits which May be held. Such deposits would not, of course, attract a further tax deduction when transferred.

The Government is confident that the new IED scheme will make a significant contribution towards assisting farmers stabilise their incomes.

I commend the Bill to Honourable Members and I present the Explanatory Memorandum to this Bill.