Reforming State Taxes: Rationale and Options

John FreebairnThe University of Melbourne

3 September 2014

Outline

• Arguments for reform of state taxes• Description and critique of current taxes• Some reform options and packages

• Builds on:– Henry Review (2010)– State tax reviews, including Harvey (2001), IPART (2008),

ACT tax Review (2012)– Extensive academic & professional literature

State taxes, 2012-13(fund about 33% of state expenditure)

Tax Category $billion

PayrollLandStamp duty: conveyances insurance motor vehiclesOther motor vehicleGambling

Total

20.86.2

12.84.22.56.15.5

63.5

Plus royalties of $10.6 billion

Arguments for State Tax Reform

• Improve productivity and efficiency– Remove most inefficient state taxes– Broaden bases of potentially efficient land and payroll

taxes– Rationalise special taxes on motor vehicles and gambling

• Provide a “hard budget” constraint for the states• Leave most of redistribution and macroeconomic

management tasks to the commonwealth

Current Taxes and Critique

• Describe each in terms of:– Tax base or taxable sum, especially exemptions– Tax rates

• Assess effects and critique in terms of:– Distortions to decisions and efficiency costs– Long run economic incidence and distribution– Simplicity and operating costs– Potential use as part of “hard budget constraint”

Current Land Taxes

• Narrow tax base– Exempts owner occupied housing and primary

production– Use asset value (rather than rental income)

• Progressive tax rate schedule• Results:– Distorts the efficient allocation of land across different

uses– Some of the tax burden passed forward as higher costs

for consumers of higher land tax uses

Proposed Land Tax Reform• Design:

– Comprehensive base of unimproved land value with minimal exemptions

– A single flat rate. But, right for states to vary rate for “hard budget constraint”

– Simple to use existing local government baseA revenue neutral package, including replace current land tax and conveyance duty, would require a doubling of local government rate• Effects:

– Remove distortions to best use of land– All burden on landholders, and any change a one-off windfall

change in asset value

Current Payroll Tax

• Narrow base– Small businesses exempt, and about 50 % of employees– Other special exemptions

• Rate– Flat marginal rate

• Effects:– Exemptions distort choice of business structure and

organisation– In the long run, most of the tax is born by employees of both

taxed and non-taxed businesses as lower wages

Payroll Tax Reform• Design

– Comprehensive labour remuneration for all– Flat rate. But, right to vary rate for “hard budget constraint”– Use workers compensation or commonwealth PAYG base– Either:

• Lower rate for same revenue– Less business structure distortions– Minimum changes in wage rates

• Increase revenue to fund replacement of relatively less efficient state taxes• Effects

– Efficiency gains from removal of business structure distortions– Minimal distortions to investment and saving decisions

Current Conveyance Duties• Base

– Transfer of property, including value of land, improvements and buildings

• Rate– Progressive

• Effects– Among the most inefficient of all taxes– An additional indirect tax on a specific product, buildings– Important incidence on a specific business input– Distorts reallocation of property from less valuable to more valuable

uses with changing circumstances– Inequitable to frequent property transferees– Most volatile revenue of all state taxes

Replace Conveyance DutiesA replacement broader base and higher rate land tax, e.g. double local government rates• Significant efficiency gains• Long run equity effects

– Small net increase in burden on landholders– Small fall in burden on the building industry

• Short run, political noisy, losers– Infrequent property sellers– Asset rich and income poor

May require a long transition process, such as ACT strategy

Stamp Duties on Insurance• Current– An extra indirect tax on a specific product– Leads to non- and under-insurance, and more so among

the less well off• High priority to remove for efficiency and equity

reasons• Possible replacement options– Larger land tax (as for the fire levy)– Larger payroll tax– Larger GST– Access to commonwealth income tax

Rationalise Taxes on Motor Vehicles

• Current. Historical revenue raisers– Federal fuel excise– State stamp duties, registration fees, parking fees, licence fees– Together, they collect a bit more than expenditure on road

construction and maintenance• Henry Review and PC propose explicit user pay fees for

– Use of roads and damage caused– Congestion by road and by time– Pollution to internalise external cost

(first two could be reformed state charges)

Rethink Taxes on Gambling

• Current– Very different effective rates on different types of gambling– Logic is to internalise external cost of problem gambling

• Henry review assessment– Unclear that current taxes are effective in deterring problem

gambling, and distort leisure spending choices– A logical case to tax the economic rent earned on government

restricted supply casinos and machines• If, as many argue, demand is not price responsive, an

efficient tax. Equity and simplicity says a flat rate for all.

State Tax Reform Package • Land tax: broader base and flat rate• Payroll tax: broader base and flat rate• Stamp duties: replace• Motor vehicles: rationalise as user charges• Gambling taxes: focus on economic rent

• Meaningful reform will require federal and state cooperation. Include revised federal-state financial relations. Maybe promised White Papers!