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Is our love of dividends holding the ASX back?

This article may not be popular. It is well known that we Aussie investors love, love, love our dividends –and the franking credits that come attached. The recent Federal Election proved that without a doubt, as the Labor plan to remove excess franking credits caused something of a firestorm (and likely contributed to Labor’s subsequent defeat). Some of the most beloved ASX stocks are famous as ‘income stocks’ – for example the Commonwealth Bank of Australia (ASX: CBA) or Telstra Corporation Ltd (ASX: TLS).

But we have to ask ourselves whether our current policies surrounding dividends and franking credits are the right path forward for the ASX. After all, we are one of the only countries in the world with such a generous scheme in place.

What makes our scheme so great?

If you don’t know, franking credits are a form of tax refund. Companies are required to pay the company tax rate of 30% (27.5% for smaller companies) on all profits earned before dividends can be paid out. This means that dividends are ‘post-tax income’. When we receive said dividends, we get a ‘franking credit’ for this tax already paid, which we can either use to offset other income, or get paid out in cash if no taxable income is earned.

Most other countries’ tax systems don’t allow this ‘credit’ of paid tax, so dividends are effectively taxed twice (once for company tax, once for income tax).

Why would we change?

There must be a reason why other countries shun dividends and franking credits in their tax systems. Of course, it may just be that governments couldn’t help getting a bigger slice of the action (highly possible). But when the United Kingdom abolished its form of franking credits – part of the Advance Corporation Tax system – in 1999, it was on HM Treasury’s advice that the existing corporate tax system created incentives for corporations to pay out profits as dividends to shareholders, rather than to reinvest them back into future growth. Sound familiar?

This may well be a problem for the future of the ASX. Remember, paying a dividend is detrimental to a business – capital is walking out the door. Over in the United States (US), a company is only expected to start paying dividends when its growth runway has reached its end. Apple Inc., for example, has only just started to pay a dividend in the last few years. Goliaths like Alphabet (Google) and Amazon do not currently pay dividends, despite market caps reaching close to US$1 trillion. On the ASX however, companies are expected to start paying out once they reach mid-cap status at most.

Foolish takeaway

I accept that dividends are an important part of our retirement system and we shareholders do love some passive income. But investing is about opportunity cost and everything has its price. Maybe our over-reliance on dividends will prove counterproductive in time. But maybe it won’t. In my opinion, it’s worth a debate either way.

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Motley Fool contributor Sebastian Bowen owns shares of Telstra Limited. The Motley Fool Australia owns shares of and has recommended Telstra Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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