States Ponder Own-Tax Reform OptionsPost-Forum

Neil Warren1

Australian States raise through taxes less than half what they spend. Inresponse to States’ calls for access to income and consumption taxes, the Com-monwealth at the recent Tax Forum responded with a demand that States firstmake maximum use of their available tax bases. In response, New South Walesand Queensland agreed at the Forum to work with the other States to develop aState tax reform plan by the end of 2012. This article examines the own-taxreform options available to States and which of these options are likely to beincluded in any plan brought by States to COAG.

Keywords: taxation, tax mix, efficient, land, payroll.

1. Reforming Inefficient State TaxesCalls for the reform of State taxes are not new nor are attempts to reform them. States themselvesfreely acknowledge the need to reform their taxes2 but have been unable (or unwilling) eitherindividually or collectively to undertake major changes without Commonwealth financial support.It was not surprising then that in the Final Report of Australia’s Future Tax System (AFTS, 2010),nearly 20 of its 138 recommendations focused on State taxes. However, this was a Commonwealthreview and carried no weight with the States. At the October 2011 Tax Forum3 State taxes againdrew attention with a whole session given over to discussion of their reform.

What was different in this discussion was the strong statement prior to the Forum that the Com-monwealth would not be funding any reform to State taxes. It was against this background thatNew South Wales and Queensland Treasurers have agreed to work through the Council of Austra-lian Federation (CAF involves all Premiers and Territory Chief Ministers) to develop a tax reformplan for all States. The first iteration of this tax plan is due to be discussed with the Common-wealth at Treasurer level by the end of 2012 with the agreed plan then taken to the Council ofAustralian Governments (COAG involves the Premiers, Territory Chief Ministers and the PrimeMinister) for agreement and implementation.

Clearly, the Commonwealth and States are serious about State tax reform but since the Com-monwealth has indicated it will not fund State tax reform through increased grants and States areunlikely to cut their expenditure, any major reform must be funded through a change in a State’sown-tax mix or through new taxes.

1Australian School of Business, University of New South Wales, Sydney, NSW, Australia2For example, see discussion in Victorian Treasury(2001) and Independent Pricing and Regulatory Tribunal

of New South Wales (IPART) (2008).3See http://www.futuretax.gov.au/content/Content.aspx?doc=TaxForum.htm.

JEL classifications: H21, H22, H27, H71, H77Correspondence: Neil Warren, School of Taxation and Business Law, Australian School of Business, University

of New South Wales, Sydney, NSW 2052, Australia. Email: n.warren@unsw.edu.au

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2. State Tax MixThe challenge for States is that, on their own admission, their taxes are inefficient and inequita-ble,4 and in submissions to the Forum many organisations lent support to this long-held senti-ment.5 In its submission to the Forum, CPA Australia updated the excess burden estimatesprepared by KPMG Econtech6 for the Final Report of Commonwealth of Australia (2010).7 Table 1shows that if additional revenue was sought to fund increased government expenditure, then landtax is clearly preferred over all other taxes, having a marginal excess burden (MEB) only 26% ofthat of a comparable small increase in payroll tax and 10.6% of that of the residential transferduty.

Given the low MEB for the GST and Personal Income Tax, it is also not surprising that States havesought access to the personal income tax base and business has proposed an increase in the GST. Ifneither funding option is available to States (as indicated by the Commonwealth Treasurer), theissue for States (and Treasurers Baird and Fraser) is which of their own-taxes should they increaseand decrease (or abolish) in any tax reform plan to be brought back by CAF to COAG.

Table 1 also indicates that, by revenue, the three most important State own-tax bases are pay-roll, land and property transactions. Of these, only two have worthy attributes – payroll and land.Abhorred are property conveyancing duties (23% of State tax revenue in 2009–2010) and insur-ance taxes (8%).8 However, while the payroll tax is important to States (31%), because of its high

Table 1. Excess Burden Estimates of Selected Australian Taxes

MEB AEB Land tax asbenchmark

Payroll tax asbenchmark

Per cent ofstate taxrevenue

(Cents perdollar ofrevenue)

MEB AEB MEB AEB

Land tax 9 6 1.00 1.00 0.26 0.30 10.6%GST 12 10 1.33 1.67 0.34 0.50Personal income tax 24 15 2.67 2.50 0.69 0.75Payroll tax 35 20 3.89 3.33 1.00 1.00 30.8%Company tax 37 20 4.11 3.33 1.06 1.00Motor vehicle registration 31 25 3.44 4.17 0.89 1.25 3.9%Insurance duty 31 29 3.44 4.83 0.89 1.45 5.7%Motor vehicle stamp duty 33 31 3.67 5.17 0.94 1.55 8.9%Fire insurance levy 65 59 7.22 9.83 1.86 2.95 2.0%Residential transfer duty 85 60 9.44 10.00 2.43 3.00 22.5%Commercial transfer duty 74 70 8.22 11.67 2.11 3.50

Notes: AEB, average excess burden or excess burden relative to tax revenue (or the economic harm of introducing a wholetax); demonstrates the benefit from abolishing the tax. MEB, marginal excess burden or change in excess burden with a smallincrease in the tax (or more simply, the economic harm from a small increase in tax revenue); demonstrates the cost ofincreasing the tax.Source: KPMG Economic Analysis of the Impacts of Using GST to Reform Taxes, Report prepared for CPA Australia, September2011, page 5. ABS Cat No 5506, Taxation Revenue 2009–2010.

4See footnote 2.5See the submission by CPA Australia, Property Council, Business Coalition for Tax Reform and Insurance

Council of Australia amongst others at http://www.futuretax.gov.au/content/Content.aspx?doc=TaxForum/Submissions.htm.

6See http://www.futuretax.gov.au/content/taxforum/statements/business/CPA_Australia_att_1.pdf.7See KPMG, Econtech CGE Analysis of the Current Australian Tax System, Final Report, 26 March 2010, Table 5.1

(p. 44) and Table 5.14 (p. 63), http://www.taxreview.treasury.gov.au/content/html/commissioned_work/downloads/KPMG_Econtech_Efficiency%20of%20Taxes_Final_Report.pdf.

8See submissions referred to in footnote 5.

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threshold it collects only 57% of what it could with no threshold or exemptions.9 Equally, landtax (11%) is only applied to investment properties and then has a relatively high threshold beforeany tax is paid, resulting in a small proportion of all properties being taxed.

3. State Reform through Changing the MixIn the State taxes session at the Tax Forum, most attention was given to how changes to payrolland land taxes could fund State tax reform with ‘payroll’ mentioned some 48 times and ‘land’ 61and the offending ‘stamp duties’ mentioned 32 times and ‘insurance’ taxes 16.

3.1 Payroll Tax OptionsThe State payroll tax was ceded to the States by the federal government in 1971 as a growth tax,having been introduced in 1941 to finance a national scheme of child endowment. The tax wasinitially applied at 2.5 per cent on almost all private sector businesses but by 1974, just three yearsafter its transfer to States, the rate had increased to 5 per cent. Today, less than 10% of businessesare included in the base (due to a high threshold) and each State imposes a different rate10 andvarying base definitions (although in recent years progress has been made in harmonising the defi-nition of the base across States).

The Forum discussion on the payroll tax typified the ongoing debate about how to reform this tax.Two disparate views were expressed: one arguing for the abolition of the tax and replacing it with anew tax or an expansion of other taxes; and the other wanting to broaden the base of the tax. Underly-ing these differing positions are different interpretations of the incidence of the tax. While businessesdo bear its legal incidence – as they are responsible for its collection – this is often confused with its eco-nomic incidence – or who ultimately bears the burden of the tax. This view is reinforced by business’sperception that if the tax was removed, their profitability would improve. While this view could betrue in the short run, it is not the case in the long run where it is generally accepted that the tax has itseconomic incidence primarily on labour, even where there is a threshold (AFTS, 2010, Box D3-2).

What is broadly accepted though, is that the ‘Existing payroll taxes are more complex and lessefficient than they could be because of tax-free thresholds and other exemptions’ (AFTS, 2010,Part 2, p. 293). What is less clear is the policy response. In Recommendation 57, the Common-wealth of Australia (2010) proposed that ‘State payroll taxes should eventually be replaced withrevenue from more efficient broad-based taxes that capture the value-add of labour’. To this endthe Review considered a PAYG tax imposed at a flat-rate on all employee compensation butrejected this option because of concerns about equity (in particular its regressivity), economicinefficiency (arising from employers converting labour income (wages) into capital income (divi-dends)) and sustainability (with an ageing population).

In Recommendation 55 AFTS (2010, Part 2, p. 276) made its preference clear when it stated that:‘Over time, a broad-based cash flow tax (CFT) – applied on a destination basis – could be used tofinance the abolition of other taxes, including payroll tax and inefficient State consumption taxes …’.Here the Review proposed States introduce a new CFT designed to tax all value added. This optionhas received little serious attention – including at the Forum – being rightly seen as an option raisedby the Review primarily because an expanded GST was excluded from consideration through itsrestrictive terms of reference. This also explains the 50 direct references to ‘GST’ in the State taxes ses-sion of the Forum and numerous submissions proposing funding the reform of the payroll tax throughan increased GST rate (and broadened base),11 with only two references to ‘cashflow’.

9See Table 3-11 in Commonwealth Grants Commission, Report on GST Revenue Sharing Relativities – 2010Review, Volume 2 — Assessments of State Fiscal Capacities, http://www.cgc.gov.au/__data/assets/pdf_file/0008/18386/2010_REVIEW_FINAL_REPORT_VOLUME_2.pdf.

10For a detailing of the various rates, threshold and rates imposed by the different States, see InterstateComparison of Taxes 2011–12 at http://www.treasury.nsw.gov.au/__data/assets/pdf_file/0005/20984/TRP11-01_dnd.pdf.

11See the submissions to the Tax Forum by CPA Australia, the Business Coalition for Tax reform and theInsurance Council of Australia discussed in footnote 5.

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Post-Forum, the only realistic short-term payroll tax option for State Treasurers Baird and Fraserto consider will be changes to the threshold, and to industry and employee exemptions. In the caseof NSW, removing current concessions to those above the threshold would increase current reve-nue by 18%12 while removing all concessions including the threshold would broaden the payrolltax base some 75 per cent (AFTS, 2010, Part 2 p. 298). Politically, the downside of broadening thepayroll tax base is the significantly increased number of taxpayers – in the case of NSW, a 13-foldincrease – and with this, a real political risk for any government implementing such a proposalindependently of others.

3.2 Land Tax OptionsThe second major State tax issue discussed at the Tax Forum was the repeal of property conveyanc-ing duty and its replacement by increased land tax. Considerable literature already exists on thevirtues of such reform13 and how it would improve labour mobility and the efficient functioningof the property market. However, it is the transition to a greater role for land taxes that is themajor impediment to this reform. In NSW for example, while there are 2.4 million properties, in2009–2010 only 189,588 were sold, just 7.8%14 of properties, implying the average property trans-acts every 14 years. But in practice, home units are sold more frequently than houses, while someproperties do not transact for decades which, in the case of retirees, can mean these home ownersare often asset rich and income poor.

A transition arrangement which exempts current property owners from the new land tax andtaxes only new home owners (who no longer pay the conveyancing duty) would itself create alock-in effect and see ‘old’ properties not transacted – only ‘new’ (post-implementation date) prop-erties sold. Alternatively, a fixed date for transferring all properties into the new land tax basecould be imposed with any resulting financial hardship being addressed through the current landtax provisions allowing for the deferment with interest, of any land tax liabilities.15

The other important issue is how to design the new much broader based land tax. At present,conveyancing duty is imposed on the market value of property while land tax is on unimprovedvalue in most States.16 Although land is generally accepted as the preferred base of a broad basedtax on property,17 less clear is how to measure this base. AFTS (2010, chapter C2) proposed a har-monised definition of the base, defined as land value per square metre. Rates and thresholds wouldthen be set by States designed to exclude most agricultural land.

4. State Reform through New Taxes and Shared BasesAt the Forum, Personal Income Tax revenue and base sharing between the Commonwealth andStates was excluded outright by the Commonwealth Treasurer – even though both options havebeen available to States at times in the past.18 There is every reason to expect that it could be anoption if States demonstrated by their actions a willingness to reform their own-taxes in ways

12See NSW Budget 2011–12, Budget Paper No 2, Chapter 5, Section 5.9, http://www.budget.nsw.gov.au/budget_papers_2011-12/bp2/2011-12_budget_paper_2.

13See various submissions to the Forum (footnote 5) and the discussion in Independent Pricing andRegulatory Tribunal of New South Wales (IPART) (2008) and Commonwealth of Australia (2010).

14For dutiable land transactions, see http://www.osr.nsw.gov.au/lib/doc/stats/table_transferduty_land.xls. Forland titles, see http://www.lpi.nsw.gov.au/about_lpi/publications/annual_reports.

15See, for example, the lifetime deferment option in Queensland http://www.legislation.qld.gov.au/LEGISLTN/REPEALED/L/LandTaxA15_02A_.pdf.

16Land tax is imposed on Land Value (NSW, Tasmania), Site Value (Queensland, Victoria and Tasmania), andunimproved value (Western Australia and ACT). Northern Territory has no land tax.

17See the discussion in Commonwealth of Australia (2010) and Independent Pricing and Regulatory Tribunalof New South Wales (IPART) (2008) on why unimproved value is an efficient land tax base, being independentof the decision on how to improve land.

18Between 1976 and 1989, the Commonwealth did permit States to impose their own personal income taxsurcharge (effective base sharing) and at various times, general grants have been set as a share of personalincome tax revenue.

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which exploited their current full potential. What is not an option is funding State tax reformthrough a GST increase – despite numerous requests at the Forum for such an option to beexplored. Just as unlikely is States reintroducing the death and gift duties they repealed between1977 and 1980.19 More feasible are State environmental levies, congestion charges and road usercharges (all raised in Commonwealth of Australia (2010)).

An option attracting some attention at the Forum was that in Recommendation 55 of AFTS(2010, Pt 2, p. 279) which proposed States impose a simple CFT designed to tax private consump-tion as broadly as possible. The attraction of a CFT is its base, taxing all household consumptionrather than only around 57% as with the current GST (AFTS, 2010, Part 2, p. 273). Being a newtax and with a large number of new taxpayers administered alongside the GST on a similar base,the CFT did not receive serious consideration at the Forum, unlike the GST where base broadeningand rate increases attracted considerable attention.

5. Progressing State Tax ReformIf States want to reform their tax systems then funding the repeal of inefficient taxes by broaden-ing the base of land and payroll taxes is an obvious choice. These were options recommended byCommonwealth of Australia (2010) and no doubt will be a consideration by CAF prior to it report-ing on State tax reform options to COAG at the end of 2012. If history is any guide, moving fromidea to actuality on tax reform by States is difficult and has been hampered by inter-State competi-tion. However, there is every reason to think the future might be different.

Three recent developments are key: the first is that there is far less scope today for tax cuts andtherefore for tax competition. Not surprisingly, reference to harmonisation was mentioned 41times in the State taxes session at the Forum and ‘competition’ only nine times and ‘competitive’seven. Second, the Commonwealth Treasurer has demanded that States first get their own Statetaxes in order before asking the Commonwealth for financial assistance or for access to broad taxbases such as personal income. Reference to the Commonwealth and how it can assist Statesreform their taxes was extensive, receiving some 42 mentions. And third, that Commonwealthgrants – a source of nearly half of total State revenue – are under review by the Commonwealthwhich has acknowledged that the methods used to allocate them to States can discourage individ-ual States from reforming their taxes.20

There can be little doubt that on State taxation the Tax Forum was a success – the only issue nowis whether States can work together to develop a tax reform plan which, as the CommonwealthTreasurer insisted, is feasible, practical and genuine. Success here might see the Commonwealthprepared to facilitate (financially) such reforms and maybe ultimately allow States to impose theirown taxes on personal income or an increase in the GST in return for further State tax reforms.

REFERENCESCommonwealth of Australia (2010), Australia’s Future Tax System: Report to the Treasurer [referred here as AFTS,

2010], December 2009. Available at: http://taxreview.treasury.gov.au/content/Content.aspx?doc=html/pubs_reports.htm.

Independent Pricing and Regulatory Tribunal of New South Wales (IPART) (2008), Review of State Taxation: Reportto the NSW Treasurer, Other Industries – Final Report. Available at: http://www.ipart.nsw.gov.au/investigation_contentasp?industry=5&sector=current&inquiry=142.

Victorian Treasury (2001), Review of State Business Taxes. Available at: http://www.dtf.vic.gov.au/CA25713E0002EF43/WebObj/FullReport/$File/FullReport.pdf.

Warren, N.A. (2010), ‘Intergovernmental fiscal arrangements as a constraint on State tax reform under Henry’,in Evans, C., Krever, R. and Mellor, P. (eds), Australia’s Future Tax System: The Prospects After Henry. Thomson-Reuters, Sydney; 305–364.

19See http://www.aph.gov.au/library/intguide/law/taxlaw.htm.20See Warren (2010) and the submissions to the GST Distribution Review at http://www.gstdistributionreview.

com.au on the disincentive effects of the current grant distribution framework.

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