The productivity commissions in New Zealand and Australia recently completed a joint study to mark the thirtieth anniversary of Closer Economic Relations (CER) and examine ways to further strengthen economic ties between the two countries.

This was a welcome development, as there is a feeling that CER has stalled over the past couple of decades, particularly in capital flows and mutual recognition of franking and imputationcredits.

A franking or imputation credit is a way of providing credit against tax on dividends received by domestic shareholders for tax paid at the company level.

By not recognising these franking credits (in Australia) and imputation credits (in New Zealand), shareholders are paying tax twice: once on company tax in the destination country and once via personal income tax in the investor country. This means effective tax rates of 60% and 53 % respectively.

An excellent new report, The costs & benefits of mutual recognition of imputation & franking credits by the New Zealand Institute for Economic Research and the Centre of International Economics (with guidance from the ANZ Leadership Forum Project Steering Group) on this issue is therefore timely.

The report conducts a cost-benefit analysis and case studies, and argues that ‘the existing regime can be seen as a form of tariff on trans-Tasman investment flows.’ It notes that government is resisting changes to the current regime, mainly because of fears about loss of tax revenue, and that little attention has been paid to the potential economic benefits of a mutual recognition arrangement.

Mutual recognition, it is argued, would help the trans-Tasman economy grow by NZ$5.3 billion (net present value) by 2030. Household consumption welfare would increase by NZ$7 billion. Any dynamic productivity benefits would be in addition to these conservative figures and the whole scheme ‘would stimulate business and deliver a significant net benefit to the trans-Tasman economy.

Such a move would result in a short-term drop in tax revenues but a big increase in medium-term benefits. The question is this: do prime ministers Key and Gillard (or perhaps more accurately, Australian treasurer Wayne Swan) have the bottle to sacrifice government balance sheets in the short term to improve both nations' economic performance in the long run?