Broad-based payroll tax an efficient option

28/05/2009 - 00:00


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A rethink on how payroll tax is applied could have widespread benefits

Broad-based payroll tax an efficient option

IN the state budget handed down this month, Treasurer Troy Buswell announced a temporary reduction in payroll tax. This was immediately welcomed by the business lobby and, indeed, the treasurer was urged by the Chamber of Commerce and Industry WA to abolish payroll tax altogether.

Of course, we all hate taxes. But we love the goods and services provided by government - health, education, roads, public transport and much more. These goods and services can only be provided by government if there is sufficient revenue to pay for them. And that, alas, means taxes.

French king Louis XIV's finance minister, Jean Baptiste Colbert, is alleged to have said: "The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing." To that we add, with the greatest efficiency.

An efficient tax is one that causes the fewest distortions to resource allocation and is garnered at least cost in terms of compliance and administrative costs.

It is also important that the tax base should grow with the economy. A government's expenditure commitments grow as the economy grows, so the tax base must grow too.

The states have very limited taxation options. Since the Income Tax Act and the States Grants (Income Tax Reimbursement) Act of 1942, practically speaking, the states can't utilise income tax. Under section 90 of the Constitution, the states are prohibited from raising revenues through an excise.

The High Court has interpreted this power broadly. It has effectively ruled that any attempt by the states to impose a sales tax is an excise, and thus unconstitutional. In addition, the intergovernmental agreements on the Goods and Services Tax have eaten into the states' taxation capacity as have the Council of Australian Governments' (COAG) agreements on competition policy.

Consequently, the states are left with few taxing options. The major forms of taxation available to the states are payroll taxes, land taxes, stamp duties on property transfers, stamp duties on financial transactions (primarily insurance), taxes on gambling and taxes on motor vehicle licenses and registrations. The table shows how WA is raising its tax revenue this year.

Payroll tax accounts for fully 40 per cent of the WA government's taxation capacity. No other single tax comes close. For this reason alone, the payroll tax could only be abolished if there was a massive increase in some other tax.

However, this is not the main reason why the payroll tax should remain as a key taxation tool in the state treasurers' fiscal toolboxes. The payroll tax has two features, which in the less than ideal world of Australia's fiscal federalism make it a tax that should be increased, albeit with considerable reform, rather than reduced or abolished.

The first is that, if the payroll base were widened to encompass all businesses with employees and the rate lowered so as to keep the total tax take tax constant, the effect would be to minimise the distortion due to the tax. All taxes are distortionary. A tax on anything provides an incentive for buyers to buy less of it.

Traditionally the major argument against the payroll tax is that it is a tax on jobs - employers will buy less labour if there is a payroll tax. However, economic theory shows that the broader the base and the lower the rate, the less is this distortionary effect.

In fact the more universal the tax, the more the tax has the economic effect of an expenditure tax, like the GST. If all labour is taxed, the incidence of the tax will ultimately be paid by everyone through a combination of a rise in prices and a fall in real wages. The payroll tax is ultimately born by individuals and not businesses.

Further, research by the Productivity Commission in 1998 shows that the compliance and administrative costs of the payroll tax, although not trivial, are relatively low. Importantly as the labour force grows and as productivity and thus wages grow, the tax base of the state that comes from payroll tax will grow too.

All of this is well and good as theory, but how is it likely to stack up in practice? There has been some empirical work done by the NSW Treasury in 1999 on the economic effects of a broadening of the payroll tax base and lowering the rate using the best economic model available for this kind of work, the Monash Multi-Regional Forecasting computable general equilibrium model.

The study performed a simulation of the Australian economy where all states remove the tax-free threshold for the payroll tax, so that it applies to all employers but that the revenue effect is neutral; that is, rates are reduced so as to leave the total tax take unchanged. What were the results?

The study found that Gross State Product rose by a small amount (about 0.12 per cent, on average) across all states and territories. Secondly, consumption, a good measure of economic welfare, increased across all states and territories, except for the ACT. Also employment increased (by about 0.17 per cent) across all states and territories, except for South Australia and the ACT. The tax change also increased exports slightly by about 0.3 per cent.

Finally, the effect was not revenue neutral for all government revenue because of these growth effects. These results came about, first, because the broad-based and lower rate tax is less distortionary and thus the economy is more efficient than under the current payroll taxation regimes and, secondly, because the tax changes the industry mix by being less onerous on larger firms, which currently pay the payroll tax.

Because these two effects particularly apply to WA, the results for WA were particularly favourable.

It is not therefore clear that the business lobby is doing the best it can for Australian industry or the Australian public by opposing a more rational and efficient payroll tax.

The payroll tax has the hallmark of an efficient tax, both in theory and in practice.

n Peter Kenyon is a professor of economic policy at Curtin University's Graduate School of Business.


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