In looking at the health of the Australian economy and its ability to recover from Coronavirus shutdowns it is easy to focus on the big end of town. The insolvency of Virgin Australia, the threats of large retail chains to stop paying rent and the rush of capital raisings on the ASX dominate the business headlines. Yet amongst these big news stories, one jarring statistic stood out in an article I read this week; that the ATO approved over 800,000 payment plans with small businesses in the last financial year. Given the economic damage of the last month, it is likely that this will exceed one million small businesses in the near term. This a dire warning of the pain ahead for large swathes of the economy.

What those who don’t run businesses may not understand is that a payment plan is akin to a small business using the ATO as a form of overdraft. In normal circumstances, no small business should have a problem paying the ATO on time as the money owed almost always relates to taxes already collected by the business. For my own small business, GST is collected over the quarter and then paid to the ATO at the beginning of the next quarter. PAYG is held back from employee wages each month and submitted to the ATO in the next month. For a business not to have the money to pay the ATO when they have already collected it signifies substantial financial mismanagement.

For those businesses that have been forced to close by government edict and that already had payment problems this is likely to be the end of the road. Unlike large businesses that can look to obtain fresh capital from share raisings and/or bank debt, small businesses typically have few options. If the business owner is willing to mortgage their home they may obtain finance, but for those without property to offer or who already have substantial debt against their hard assets all doors might be closed. Government support programs can cover a portion of the rent and wages accruing, but they are not nor should they be a complete bailout for poorly managed and poorly capitalised businesses.

Before looking at what should be done it is helpful to consider how we got here. A run of nearly 30 years without a recession all but guarantees that many businesses will have increased their risk tolerances beyond what is prudent. This could be by expanding too quickly, borrowing more and/or keeping less cash in reserve. Well-meaning government actions have distorted market forces and encouraged greater risk taking. Central bank rate cuts and admonishments for businesses to borrow, relaxations of insolvency protections and a light touch approach by the ATO to collecting debts have all allowed the amount of economic deadwood to accumulate. If the Coronavirus hadn’t been the spark for this inferno, something else inevitably would have come along to deliver the same outcome.

There are two general approaches to dealing with zombie businesses; extend and pretend or take the medicine. As an old school lender I’ve seen many times over that “your first loss is your best loss”. Searches for miracle solutions almost never succeed at anything other than increasing the eventual loss. We can see this play out with countries; compare the ongoing funks in Greece and Japan, who have failed to take reformative action, with the strong recoveries of South Korea (Asian Financial Crisis) and Iceland (Global Financial Crisis) that took their medicine early. The rejection of requests for government assistance by Qantas in 2014 proved to be the catalyst for that business to address its financial issues.

There will inevitably be calls for more assistance and cries that everything must be done so that jobs are saved. This is wronghead logic that denies basic economic principles. Bailing out poorly managed and poorly capitalised businesses, whether by government handouts or forgiveness of ATO debts, is a deliberate choice to “back losers”. The funds for these bailouts come from higher taxes on successful businesses and individuals, the very people we should be encouraging and incentivising not punishing. The lost jobs argument is another fallacy; the staff from failed zombie businesses frequently become employees of the replacement businesses that fill the gap.

As the economy starts to re-open the Federal Government will be required to make tough decisions on which stimulus measures end and when. Saddling future generations with a near trillion dollar debt load to forestall inevitable economic change is neither wise or moral. Tax reform measures such as eliminating payroll tax and reducing company tax, as part of a broad tax reform agenda that shifts taxes away from work (income tax) to spending (GST) and wealth (land tax) should be top priorities. These changes would be a guaranteed way to “back winners” as only successful businesses pay company tax.

The insolvency changes of the last two years need to be rolled back. Protecting employees, suppliers and taxpayers from businesses that don’t pay their debts isn’t draconian, rather encouraging businesses to steal from other participants in the economy is draconian. The 30-day payment terms being adopted by governments should be legislated for all businesses. Whilst these changes will initially trigger an increase in weak businesses failing, in the long term they will greatly reduce business failures. Well capitalised businesses are far better prepared for future economic downturns than the zombie companies they will replace.

Ray Falzon

Hi Jonathan, Another good article, but I have a different perspective on the ATO approving 800,000 payment plans with small businesses over the past year. From my experience, having until recently run a graphic design studio for over 25 years, the real problem facing small businesses is the increasingly longer payment terms that small businesses are being forced to accept. In our case, many clients pushed out payments to more than 60 days, in some cases over 120 days! This situation was not through any mismanagement on our behalf, but rather the corporations we worked for renegotiating our contracts to accept 90 day payment terms on a take-it or leave-it basis. GST is paid on the basis of the invoices a business sends out, not their eventual payment, so GST is often collected by the ATO BEFORE the invoices are paid and the cash is received in the bank. In the meantime the small business still has to pay its staff, rent, leases and all the other running costs of doing business. This is a big issue for small business and one where the ATO should look at reforms. So yes, whilst there are some businesses that might be using the ATO as a form of overdraft, there are many others that are being made to pay tax based on a book entry that hasn’t yet materialized into cash in the bank.. In regards to the problem of cash flow for small business, the ATO seems to have a tin ear. Regards, Ray

Jerome Lander

It is not just businesses that have "increased their risk tolerances beyond what is prudent". How many investors - including large institutional funds and super funds - have done the same... How many of them think that by simply investing in properties or shares you can expect a high return? How many of them anticipated our economies would be run so poorly? In other words, how many of them need to rethink their assumptions and portfolios..

Mark Cardell

Jonathan you make some good points on tax reform, and I agree that an increase in GST and a decrease in payroll and company taxes would be efficient. On the other hand I just don't get this recent enthusiasm that so many people seem to have for land tax. Surely that is just another ongoing tax that governments can easily increase at any point. Stamp duty on property is more efficient and closer in design to GST - a one off hit at the time of purchase. Please, let's not give govt more opportunities to regularly dip into our wallets.

Jonathan Rochford

All true Jerome, excessive risk chasing applies across governments, businesses, consumers and investors. What if governments and central banks can't or won't bailout everyone?

Andrew Gemmell

As you point out Jonathan it is just encouraging mediocracy. It's akin to a "social wage" for business. Which is counter intuitive when encouraging people to run a business successfully, considering risk and rewards. Come the end of Jobkeeper and lease & loan deferrals we will see reality step in.

Ignace Louis

Hi Jonathan, thanks for the article. Certainly very insightful views on what could be coming our way in the business environment. Do you think other parts of the economy, such as the banks will be pretty badly affected? I’m thinking increased levels of loan defaults etc

Jonathan Rochford

Ho Ray, thanks for your comments re timing of payments. I'm running my accounts on a cash basis so I'm not hit with the same timing issue. Your points on this are fair, but I do note that many small businesses (and some large ones) are running with very little equity and reserves, which worsens this issue. I think the best solution for the country is to move to 30 day payment terms. Every business must pay every supplier within 30 days. If you can't do that call in the administrators. As the small business ombudsman and I have repeatedly argued this is the only way to stop larger businesses abusing their power. See their recent media statement on this.

Jonathan Rochford

Thanks Ignace - the numbers I've seen are that 5-10% of home loans are now in hardship, though one large bank reported more than this. I'm hoping that a majority of these will normalise over the next 12 months but no doubt a decent number will under selling the property under duress.

Jonathan Rochford

Thanks Mark - I'm also a supporter of lower taxes. The argument for land tax to replace stamp duty is one of efficiency, land tax has a far lower negative impact on the economy. We also need a wealth tax as the population ages and there are fewer workers. Land tax works because you can't move the land, other forms of wealth can (and already are) moved to lower tax jurisdictions. For my experience in property lending, there are more loopholes for stamp duty than land tax.

Jerram Robinson

Hi Jonathan, Great article, I can't really disagree with you on your major points. I wish there was a mechanism available to get rid of all the zombie publicly-listed companies on the ASX as well. But that's another discussion in itself.

Jack Upton

I can only agree 100% Johnathon. Fortunately, in 24 years of business I totalled 3 bad debts to the tune of a few ten thousands and they occurred in the first five years. Looking at them afterwards I saw that they were running on near empty most of the time. It was a case of "what doesn't kill you will make you stronger" and I was better for it. There are quite of number of businesses out there who always look very marginal and it's been my opinion for the last couple of months that this CV19 event will sweep away the non-performers probably in the owners' best interests. It's just a case of wearing the pain to get through to the other side. Apart from which, there are some people who should never go into business for their own "safety".

Jonathan Rochford

Thanks Jack - fully agree that there are people who are best suited as employees and are not good at managing the risks that come with running a small business. So many things can go wrong and you are the last to be paid. You are spot on that many marginal businesses won't survive.

Heng Lai

This is an excellent explanation of the big picture problem. Well done. Unfortunately, what we have now is a short term political solution, NOT a long term big picture social economic one.

Greg Wallace

Interesting commentary, your observations are factually correct, i feel though you haven't dug deep enough. Zombie businesses -"you should have got out years ago" etc do not get to the heart of the issues..Business fail due to a lack of demand for the product, - the fall in demand arises for a number of reasons, three of the key reasons that have hurt many Australian businesses have been in the falling price of competitive product, labour substitution and product replacement...Each of these has undermined profitable businesses in a race to the bottom. The paths for this were set many years ago. A realisation must dawn that a country needs many capabiities if it is to grow and encourage a population from within it simply cant blindly subscribe to the free trade mantra - which sees a countries capabilities wiped out in the pursuit of an ideology - that's what we are now seeing... . The reality has been for the imeedaite past we as a Country have been exporting Accomodation whilst dismantling our broader capabilities..Its time for a rethink on many fronts

Julie Myers

I agree with increasing the spending tax and decreasing the working tax. Less opportunities for tax avoidance. Company tax is a disincentive to creating/doing business in Australia and encourages complicated creative accounting as they look for loop holes and moving of profits offshore. Payroll tax is a disincentive to hiring - it results in companies making their people work longer hours (for no additional pay), it puts stress on the workers and their families, it inhibits growth of a business and exposes those companies to major impact when someone leaves as they have no redundancy in their systems. Yes, I have seen small businesses make the decision to keep numbers below the threshold to avoid paying payroll tax. I agree with Ray Falzon's comments below about the timing issues with paying GST. Your focus is on retail collection of GST but there are many other situations eg. manufacturing, professional services. When companies you have supplied pay their invoices 60-120days later (most do - its considered ACCEPTABLE practice) and GST is owed to the government 30days after an invoice, cash flow can be a significant problem especially when you are still required to pay wages, other suppliers etc.. You may end up paying your suppliers late and it has a roll on effect. Basically you require a very large cash reserve or overdraft and that is not always possible. I believe this is a substantial factor in the tax department giving small businesses the "loan" as you put it. All this is largely caused by the top feeders not paying on time. Lets get it legislated that invoices must be paid within 30 days if the contract conditions are met and have a cheap, quick legal process that allows people to retrieve their money from poor payers. We also need appropriate fines for companies that are regular offenders. They are doing it to improve their bottom line through getting a free loan from you, so if it costs them more in fines they will stop. I have worked for big business most of my life and seen how my companies put small business through impossible hoops financially creating incredible stress levels in small businesses (eg. paying 60 to 120 days out, withholding payments over technicalities even though projects were completed to the specified criteria, making them invest in new equipment only to pull the contract 3 months later because they could get it cheaper elsewhere or the worst yet, asking for a reimbursement of money paid because they realised that a company they took over was paying more than they were - backdated 3 months before the takeover). It is not just the large companies failing to pay invoices on time, it is wealthy individuals. They learnt from their top feeding employers and do the same to businesses they employ (builders, electricians, plumbers, engineers, architects) - knowing most will not take them to court because of the cost in time/lost business/lawyers. Part of the problem is that many small business owners have not been trained in contract negotiation and get a poor deal in the fine print. When I hire a plumber, I want one who can install a pipe reliably not an expert at contracts and legal processes. They need a better deal in the legal system and there should be free training or assistance in contracts for small business! Through loss of the honest, good workers to other fields because of this behaviour, we are left with less choice, loss of skill, higher prices, and businesses using strategies for getting the price back up (eg. variations, stop-work ransoms, etc). We already have a shortage of trades people. The awareness of stress and not getting paid is out there, making trade professions an unpopular career choice for our young people. It will continue to get worse. Something needs to be done.

John Goulter

Hi Jonathon, I look at this situation from the perspective of a long-term (42 years) business owner in the construction industry, and in the construction services industry, who has had to compete against these fly-by-night "businesses" that had no intention of paying their taxes or their suppliers from day 1. Various governments have forced this situation on this industry by making it too easy, and almost essential, to corporatize to avoid the high personal tax rates that have applied vs the much less stressful company tax rates. It was also essential, for some, to avoid the imposts being forced on the subcontractor system by a Union controlled industrial relations system. Those of us who survived and paid our dues have been trying to get the various governments and industry bodies to address this situation. We new when a contractor or sub-contractor changed their business model from personal to corporate that it was to avoid their financial responsibilities. Their lawyers and accountants made a motza out of setting these structures up, almost always involving a Trust, for "financial protection". There was, and is, no training or guidance required to set up a company and obtain the necessary registrations with the ATO & ASIC, or the industry groups. Without training, most of the operators of these 'companies of convenience' proceed to spend their cashflow on cars, houses, holidays, boys' toys, gambling, and wonder why they have no money left to pay their wages, taxes, etc. That is where a great proportion of the ATO's 800,000 delinquent taxpayer accounts come from. The covid-19 business collapse just provides an opportune time for these grubs to exit.

Paul Donovan

Hi Jonathon, Your understanding of how small business operates sounds straight out of a business 101 lecture. The reality is that most small business do not start out life well capitilised, conservatively geared with strong reserves. Many go into business because they are prepared to to take a risk. In operating a small business, there are so many things outside of the control of the managers, so many very well managed businesses are not always in a strong financial position. They may have recently started, they may have recently bought out the family or a partner, a farmer may have suffered drought or suffered any number of a myriad of other factors such as technology change, government regulations or new competition. The good managers will eventually surmount these challenges but to think that a business moves on a steadily upward trajectory, always strengthening its financial position is pure fantasy. My point is that at any one point of time, many well managed businesses are vulnerable when you get a massive black swan event out of the blue. The question becomes, "is society the better for the Jonathan Rochford neo- liberal textbook approach" versus government support to ensure most current businesses in badly afflicted industries survive? Is there any evidence that destroying many businesses by with holding support, results in their replacement by superior businesses? There is enormous cost in closing businesses, putting people on the dole ques and all you have done is replace one lot of entrepeneurs with another lot. Some evidence that the new result leaves society in a better place would be a great help. Helping businesses during massive black swan events does not eliminate the normal ebb and flow of businesses during normal times. Poorly managed operations will still go out of business. It is just that a number of fine businesses will not go with them. Fortunately the government, to their credit, have thrown ideology out the window and implemented sensible practical policies which will leave society much better off. One last comment. The additional cost cost to date of government measures are approx $300 billion, I understand. The interest on that per year over 10 years is less than $3 billion/year. That is less than 1 % of the Fed Government budget, almost a rounding error. Paying interest only on the additional debt for 10 years reduces the debt to GDP ratio by between 30 to 50% on that debt over 10 years. Surely it is reasonable and sensible to increase debt during these extraordinary times?

Jonathan Rochford

Thanks Julie and John - I'm in strong agreement with the need to speed up payments and penalise companies that don't pay on time. If everybody is paying on time it becomes obvious who the poorly managed and poorly capitalised businesses are very quickly. I've also long argued for action on phoenixing, which ASIC and the Federal Government have done little about. Liquidators write thousands of reports that find insolvent trading each year yet ASIC prosecutes at best a handful.

Jonathan Rochford

Thanks for your comments Paul. I've been running my own business for 8 years. When the money wasn't there I didn't get paid but I made sure everyone else was paid, so I'm well aware of the difficulties and risks that come with running a business. I made sure I had plenty of capital behind me and have grown carefully to avoid bad clients and bad situations. The best evidence of what bailouts bring is what has happened over the last 20 years. The bailouts of last crisis, combined with low interests and QE (a form of welfare for the rich and big businesses) have set us up for another crisis. Moral hazard plays out right in front of our eyes. A focus on short term stimulus/sugar hits creates the environment that means a subsequent crash and round of sugar hits is called for. The assumption that interest rates will remain low forever is a very dangerous one. Keeping rates low disincentives savings, we need a lot more savings now in our overly indebted economies.

maurice smith

An excellent article. Jonathon has nailed it precisely. Good logic and well written

David James

Great points raised Jonathan. A lack of creative destruction has crept in thanks to our record-breaking economic run and ridiculously low interest rates. Add to your list our obsession with property prices and desperation to get on the ladder is why many small businesses are under-capitalised. Why would you invest in your small business when a house can lazily rise by 10%pa (with the added benefit of leverage which is not generally available to small business). We have a bad incentive setting for SMEs to thrive.

Ron P

The article that just keeps giving! Rare to get such an insightful editorial followed by equally compelling contributions from readers. Everything you write is worth the effort Jonathan. Thanks mate. And everyone else.