Written by Bryson Constable.

Australia’s story of economic reform centres around the neoliberal policies enacted under Paul Keating, both as Treasurer and Prime Minister. But real, beneficial tax reform has only ever occurred under conservative-minded politicians. It was William McMahon that conducted the Asprey Review into the taxation system, John Howard who introduced the GST, and Scott Morrison who agreed to a revolutionary global 15% income levy on big businesses.

But tax reform does not have to mean the introduction of new taxes. In fact, it should rarely mean that. Untapped potential in taxation incentives is the key to unlocking Australia’s private investment pool.

Enter John Major.

Australians should immediately dispel the notion that John Major’s tenure as Prime Minister of the United Kingdom was uninspired and ineffective. One of the unsung heroes of his premiership was the introduction of a scheme that has grown to a $41.8 billion cumulative investment into high-potential British small business.

The Enterprise Investment Scheme (henceforth EIS), introduced in 1994, provides private lenders with confidence to invest in high risk businesses displaying high growth potential or innovative capability. It does this through a set of tax incentives.

Australia introduced a similar program in 2016, the Early Stage Innovation Companies investment scheme (ESIC), but it doesn’t go nearly far enough to have a tangible effect on investment patterns. This is partly due to lacklustre incentives, with just a 20% non-refundable carry-forward tax offset and only a capital gains tax exemption to go with it. Compared to the UKs 30% income tax offset, tax-free growth, capital gains deferral, inheritance tax relief, and critically, loss relief on exit, Australia’s biggest incentive program for aspiring businesses is walking instead of running.

The justification for such a program is clear. 70% to 90% of small businesses fail during their first five years of operation, and research by the Bank of Queensland indicates that a significant portion of this failure is due to a lack of funding and a lack of guidance.

Addressing the first concern, funding shortfalls, the EIS generates a number of healthy behaviours from investors. Investment can be made into a single company or an EIS fund. Either form provides benefit. If an investor has significant knowledge of an industry, the scheme provides them with the confidence of pursuing more promising and risky ventures, hence alleviating the second concern, a lack of guidance. If they have no specific industry expertise then the scheme allows them to diversify their investment in a fund, which allows investors to forgo the need to conduct due diligence on the company they’re investing in.

The scheme also allows for long term investments, with financiers needing to hold their positions for 3 years in order to attain all tax benefits. Investments are also highly illiquid as, in contrast to the Australian system, investors have no equity in the company they’re assisting, unlike venture capital schemes. Even more dissimilarly, investment is made through a broker and not the stock market. The business must also negotiate and organise an exit strategy with its investors. These two regulations are essential to the design of the EIS’s framework: the entrepreneur is not strained by ill-informed investors holding voting shares, and is also able to receive sustained, guaranteed financial support, aided by funding rounds subsequent to the initial drive.

So, far more than any other incentive program, the EIS plays to the heart of the liberal notions of freedom and autonomy in the conduct of business.

And don’t be fooled, these disincentives for investors are far outweighed by the aforementioned benefits of the scheme. In 2019, 4165 companies raised over $3.3 billion. The evergreen nature of these investment funds mean that this figure also includes much-needed sustained financial support. But more importantly, the investments were unique. A key finding in the University of Cambridge’s investigation into the EIS found that “between 52% and 87% of finance provided in first time investments through the scheme was additional,” meaning it wouldn’t have been generated had the scheme not existed.

Take Loch Fyne Oysters in western Scotland. The company established a consistent supply chain to restaurants across the country and expanded to include other seafood, funding this expansion through the EIS. The exit strategy materialised in a takeover, where the company returned three times the value of the original investment – and that’s before any tax relief, according to the Investors Chronicle. Speaking on a similar food-based, asset-backed EIS fund, Ben Yearsley at financial advisers Hargreaves Lansdown noted that the ideas are “very niche but… very nice [ideas]… the problem comes with raising enough finance.”

Businesses like these exist in the hundreds in Australia, waiting for the confidence of investors to realise their growth potential, hindered only by a lack of capital and expertise.

An offshoot of this scheme, the Seed Enterprise Investment Scheme (SEIS), exists for startups, and has slowly grown since its introduction in the mid 2010s. Much like ESIC, SEIS targets high-innovation businesses, but specialises in startups that have traded for less than two years and have fewer than 25 employees. Although the new Startup Year program introduced by Anthony Albanese’s Government aims to service a similar demographic, its untargeted nature and lack of industry expertise to guide the entrepreneurs leaves significant room for a SEIS equivalent to be established.

Of course, many improvements can be made to the UK model. Greater assistance can be provided to small businesses to design an exit strategy that is more appealing to investors. Information regarding the sale of companies, listing, refinancing and time-expiration contracts is easy to disseminate and would draw a wider pool of investors, particularly professional financiers, but also mum-and-dad financiers who are weary about the high-risk nature of a given fund’s portfolio and individual businesses. The minimum investment limit of around $17500 could also be lowered for similar purposes. The industry restrictions could also be altered. A great way to alleviate supply chain issues for Australian manufacturing would be to provide specific incentives under the EIS for those businesses, although complicating the program may be counterproductive to its ‘wide net’ approach. Whilst excluding legal services, accounting, property development, nursing homes, cryptocurrency startups and parts of the energy sector is necessary, excluding innovative farming enterprises, manufacturing and even mining ventures restrict opportunities for economic growth.

It is evident in the current political climate that the EIS would provide a much-needed way to boost Australia’s manufacturing and entrepreneurial acumen without engaging in inefficient and bureaucratically-dictated, socialist-esque handouts. EIS companies are energetic, their investors are younger, and their funds are forward thinking. Econometric modelling from Cambridge demonstrated that “use of the schemes had a positive impact on companies’ growth.” For an economy as unproductive as Australia’s, the scheme provides a path to structural betterment.

Investment largely funnels towards highly productive and innovative companies.

But above all, an Australian EIS could have significant social impact. Funding for a startup or small business producing life-saving drugs that are likely to fail, or high-yield crops without any testing, may just have a nation-changing impact. PWB Health, a Glasgow-based company, developed ‘BreastChecker’ which, thanks to the help of EIS funding, was successfully commercialised and has used specific light frequencies to reveal tissue with a higher than normal blood supply to identify cancerous growths.

Not everyone is as passionate about economics as I am. In fact, a quick Google search confirms my worst fears: the two least interesting topics to discuss both on a first date and as small talk are finance and politics. For anyone who knows me, that’s quite instructive and damning.

But a crippling internal assessment aside, tax policy is something we have to discuss, even if it cuts to the very core of boredom for some people. Let’s not waste any time in changing ideas and lives for the better.

Bryson Constable is a member of the University of Sydney Conservative Club. He also is a councillor on the University of Sydney Student’s Representative Council and he sits on the Board of the University of Sydney Union as a Board Director. Bryson also chairs the USU’s Finance Committee.