How to reform state taxes

how to do state taxes

So what’s then required for a hard budget constraint? Well, a) the states have to have control of expenditure, so they should be looking after all of health and education. You don’t want Peter Dutton or some other minister in Canberra telling them how to run hospitals and schools, a) Canberra can’t do it, but b) the way you want to run it in Victoria may be different to the Northern Territory. So that gives them control over expenditure. You’ve then also got to give them control over taxation. So they’ve gotta have some taxes that, “I can push the land tax up or the payroll tax up or down to meet my extra expenditure commitments”. So I want the states to have some decent tax bases. It won’t cover all their expenditure, but I want them to have a hard budget. Now other roles of governments are for redistribution and that’s primarily the Commonwealth’s role. They’ve got a progressive income tax system which includes rental income, includes labour income, includes capital income. They can work out who are the better off. They’ve got a social security system which is the safety net for looking after the unemployed, the disabled, the aged. Let Canberra do that. Let the states then concentrate on efficient taxes and not worry about too much distribution. That then requires a bit of decent cooperation between the states and the Commonwealth to sort out the whole story. Again, in terms of fiscal management, that’s primarily a Commonwealth responsibility.

So those are the criteria that I’m going to focus my story on. So in critiquing each of the states I’m going to talk about the tax base or the taxable sum, the reality is they’ve got enormous exemptions and deductions. I’m going to talk about the tax rates. I’m then going to assess them in terms of their effects on efficiency, how much does it cost to transfer a dollar from the private sector to the public sector? It’s always much more than a dollar and what we know is some taxes cost as much as a $1.80 per dollar transfer. There are other taxes that only cost about a $1.10. Well, you want to move to the $1.10 type taxes and get rid of the $1.60 or $1.80 taxes. Long run economic incidents? We’ve had so much bullshit today from the changes in the superannuation. We had this great story that superannuation is paid by business. Yes they write the cheque to the superannuation fund, but if you were in a full employment economy, and tax reform’s about the long run, superannuation is actually paid by the employee in lower current take home pay.Business is quite happy to accept that when they pay wages and PAY as you go tax is taken out, that’s borne by the employee. That’s exactly the same for payroll tax and for superannuation and Workers’ Compensation. It’s a tough argument to get over, but self-interest, rent-seeking business groups will go on with this bullshit and get away with it. They should not. A good tax system is simple. And finally, in terms of the revenue story, I want it to be part of the hard budget constraint, that’s is states can change the rates so if they want more expenditure they push the rate up, if they want less expenditure they can push the rate down, and they can tell the electorate why they’ve pushed them up or why they’ve pushed them down.

So let’s go to land taxes. Every state except the Northern Territory has land taxes. They’re at a very narrow base, owner-occupied housing and primary production are the big exemptions, so it’s largely falling on commercial use land. And then there are some other special exemptions for other governments and for the not-for-profits. Now, ideally a land tax would be on the rental income, that’s what you’re taxing, the rent, the return over and above what’s required to provide that land because once provided the land is zero, free good. For simplicity we put a tax on the asset value and so you can link those together. So if we take, for example, the current land rent rates, anywhere from 1.5-3% on land value, the asset value, that’s more like a 40% tax on rental income, it’s a much higher tax rate.So what’s wrong with that narrow base? Well, it distorts the efficient allocation of land. Think of the case of two uses of land, I can use it for owner-occupied housing that’s tax exempt or I can use it for rental housing that’s taxed. So what’s this differential tax do? Well, it encourages people to own their own home and puts up the price on rental housing. Interestingly, who are amongst the poorer people in the country? Those who rent. A lot of that land tax that’s on selective land is not on the rental landlord. Because you have the option of shifting land around, the supply of land for rental is not perfectly elastic, it’s got a slope, it can be used for owner-occupied housing. So renters actually end up bearing a whole lot of the land tax and we’re encouraging too many people to have owner-occupied homes versus rental. Now who cares about that? Well if you had the same job from age 20 to age 65, you never shifted, you wouldn’t want to change your house. If you got married at age 25 and you only had one or two kids and you never got divorced or re-married, you never lost your spouse, and you sort of wanted to walk between these empty bedrooms, stopping in the same house forever and ever is not a bad idea. But how many people fit into that category? Just think amongst yourselves. We had no kids it was great, we had three kids it was a bloody nightmare. My missus pissed off, wonderful. Then I stupidly married again and she brought in five kids, so I had to build the house up. And then when these kids were 30 they finally pissed off. And now my new missus is complaining, “I’ve gotta clean this great big bloody house”. We’re locked into stupidity.So what should we do? Well, we should really have a comprehensive tax base on the unimproved land value with minimal exemptions, bring owner-occupied housing into the net, bring primary production into the rent, tax other governments and tax special uses, and you’d have a nice single flat rate, not the progressive rate. Remember, Canberra with its income tax system is doing the progressive income taxation. What the progressive rate does is cause enormous distortions. Australia Post would actually like to own all its post offices. It would have enormous efficiency gains, but it would be a massive landlord paying a 4% land tax. The way it gets out of it is it franchises out every post office to some littlie who pays zero or 1% land tax. It creates all sorts of organisational and inefficiency problems. Now, the simplest way to do it is just hop on the local government land base, that’s the easy way.So what I am proposing is a revenue neutral package, replace the current state land tax, replace conveyance duty and property, and up the local government rate, and if you basically double that that’ll be revenue neutral. What do you get for that, for that revenue neutral package and you might want to go further, particularly this organisation? You can remove distortions to the best use of land; I’ve got now a neutral treatment of residential, whether it’s owner-occupied or rental; I’ve got neutrality between commercial and residential; I’ve got neutrality between big land lots and little land lots; and all of the burden is on landholders. Now, there won’t be big changes, but there will be some. The interesting thing is that asset values depend on the discounted stream of after-tax economic rents. So if you’re changing the after-tax rate on those economic rents, those where it goes down will get a windfall capital gain, those where it goes up will get a windfall capital loss and then it’ll all be back to neutral. So we get lots of griping and lobbying for 12 months, do it in the first year of a four year term and most of the grizzle will be gone by the time you go to the next election. I’m not a politician.

What about payroll tax? Well, we’ve got a narrow base. Small businesses are exempt so that varies: a small business in the ACT is 1.75million; a small business in Victoria is only 500,000. It means about 50% of employees are exempt. It means about 90-odd percent of businesses are exempt, but it’s employees that account. And then there are special exemptions for, again, the non-profits, for other governments and so on, a flat marginal rate that varies from 4.75% up to 8% in the ACT. So what are the effects? Well, exemptions distort the choice of business structure, so we are favouring small business over big business. And work by Peter Dixon and his group at the Centre of Policy Studies, formerly at Monash suggests that probably costs 3-10% of the revenue, that’s the efficiency cost.

What’s really interesting is about the incidence of that tax. The claim is that this is borne by business paying the tax, well, what happens? A tax falls on big business so the cost of labour goes up in big business and they say, “Shit, labour’s expensive I’m not going to hire quite as many people”. Those people that don’t get employed by the large businesses run around and say, “Shit, I’d better get a job in small business. I’ll take a slight wage cut”. So what happens is the tax in large businesses is largely cushioned by large business by them employing less but paying a higher wage rate, which covers their payroll tax. Small business are employing more people but they’re only going to employ more people if wages fall, so the market wage of small business falls, the take home pay of large business employees, yes, the market wage has gone up or market cost, but the wage rate less the tax has actually come down. Employees in both large business and small business wear most of the payroll tax. Does this happen overnight? No. Small business go on with all this bullshit, “We are the big creators of jobs, we are the great innovators, we are the earth of society”.

Well, actually big business employs 50% of the workforce, an awful lot of the R&D and technology and new products is done by big business. Some is done by small business, it varies. There is no reason to discriminate between big business and small business. What the tax system does is get them to do tax-effective things. Instead of a large business hiring its own cleaning service or its IT people or its marketing people and it would have to pay payroll tax, it says, “Now, let me try something that avoids that tax. It’s slightly more inefficient, but it avoids the tax. So I’ll employ a small company to do my cleaning because then I don’t have to pay payroll tax. I’ll employ a small company to do my IT because they don’t pay payroll tax”. That’s the sort of nonsense crap that we’ve created.

So what would we want to do to fix it? Comprehensive labour remuneration on everyone, big business, small business, flat rate that we’ve got but the states can vary it for their hard budget constraint. And if you want to simplify it, you’ve got a state Workers’ Compensation tax base or you’ve got a Commonwealth pay as you go tax base. Why have a separate state payroll tax base? Well, to protect somebody’s bureaucratic empire. Well sorry, I have no sympathy for the third empire. Get rid of them, simplify. So what would the reform package do? Well, you could have a lower rate and collect exactly the same revenue, that would get rid of distortions to business structures, probably save you 10 or 15 cents per dollar of revenue collected, there will be almost no changes in wage rates. Employees would not be losers. Big business would be winners, small business would be losers, we’d hear from them. But employees, hey, you guys are gonna be no worse off. Or we could increase the revenue. Okay, that’s payroll.

Stamp Duties on Property Transfers:

What about conveyance duty? So this is paid on the transfer of property, which includes the value of land, improvements and buildings, it’s got a progressive rate. So it’s about the most inefficient tax rate we’ve got. Why? Well, it’s a form

of indirect tax. So you’ve already got the GST and then, if it’s involved, planned and particularly buildings, there’s an additional indirect tax, the GST plus conveyance duty. Well why in hell would you want to have a higher indirect tax on buildings than, say, labour or machinery? They’re both inputs into production. You ought to have a neutral playing field. And a lot of buildings are commercial buildings, business buildings; they’re not just home buildings. The really important distortion is if you stop in your house forever you don’t pay conveyance duty, but if you change your house you pay conveyance duty. So what’s that encourage you to do? Well there I am, I bought this great big house, I had this wonderful wife and five kids and, bugger me, she pissed off, she divorced me. I’m left with this great big bloody house. The sensible thing is I should sell it and buy a small flat but, hell, if I sell it I’ve got to pay conveyance duty.

Or, you know, I lived in Clayton, I had this wonderful job at Monash University. It was nice and close, no travel, not much pollution, and, lo and behold, I fluked a job at the University of Melbourne. Sensible thing is I sell my house in Clayton and move closer to the University of Melbourne but, shit, no way, I have to pay conveyance duty if I do that. I’ll just add to the traffic jam and the congestion and avoid conveyance duty. That’s why conveyance duty is such an expensive, distorting, stupid tax. It’s top of the list to get rid of. It’s also pretty inequitable, you know, mum and dad who stop in the same house forever and ever, put up with each other, put up with the kids and then have the grandkids come back in and don’t change, don’t pay any stamp duty. The upwardly mobile person who’s innovative and moves jobs, moves countries, buys and sells houses half-a-dozen times pays stamp duty half-a-dozen times. Why should he or she be double taxed relative to the stick in the mud? It’s not equitable and, again, from the state’s point of view it’s the most volatile source of their revenue. Property prices go up and down, sale rates go up and down, conveyance duty goes up and down. So it’s tops to get rid of.

Replace Stamp Duties with Higher Council Rates:

So the obvious replacement is a higher land tax rate, as I suggested, double government rates. Huge efficiency gains, give up a tax that’s costing you 80 cents per dollar transfer, for land tax it’s probably costing you less than 10 cents, 70 cents free money. Long run equity effects, well, you are shifting some of the burden from buildings and their suppliers to landholders, so there will be some increase in landholders. And of course, here’s going to be the noisy political losers, the infrequent property sellers. They’re going to complain like hell but, of course, they are the unreal gainers of the current system. Why should we give breaks on tax to people who stop in their house forever and ever and beat the hell out of those who move for flexible reasons, their family structure changes, their job changes or business wants to change? And then, of course, we’ve got this other group who will be with Tracy Grimshaw, “I’m on this $40million house in Toorak, but my old man didn’t leave me much money. I can’t – I’m asset rich, I’m income poor. If I stop where I am I don’t pay stamp duty, I’m viable. If you put on land tax, shit, I’ve gotta shell out 20 grand a year, I can’t do it”. Have you ever heard of a thing called a reverse mortgage? Not very hard to do, even an incompetent University Professor in Economics like me can do that. You can get through it, but we are going to hear from that. Now, the people who have shown us how to do it is the ACT, they are phasing out conveyance duty for land tax. Now one of the nice advantages of the ACT is it’s also the local government, so it has access to a local government land tax. It’s a bit more challenging for the states because they’ve got to sort out their land tax as well.

What about stamp duties on insurance? Well, currently you pay GST on insurance and you pay another 8-11% on the gross premium. Surprise, surprise, insurance is a pretty bad deal. There’s a lot of tax on insurance and so a whole lot of people underinsure or don’t insure and, what’s worse, it’s the poor people. So when we have bushfires and floods we find out there’s this whole pile of people who haven’t insured and, of course, we get these horrific shots on TV and it is awful and then we pour money out to look after these people. That doesn’t really encourage people to locate sensibly. I was brought up in Central West New South Wales next to a town called Forbes, which is right on the Lachlan River and the Lachlan River used to flood about every two to three years and 20% of Forbes got flooded. And every time there was a flood the state government paid each of those flood-affected people almost enough to rebuild their house. So what did they do? They rebuilt it exactly where it was. Two years later it got flooded. That’s what this sort of system does. So it’s one of the highest priorities to remove. The challenge is what are you going to replace it with? Well, you could augment the land tax, which is pretty much the way the fire service levy was done, you can have a larger payroll tax, have larger GST or, as the Commission of Audit on Finance, give them an income tax and they don’t have any particular choices.

Taxes on Motor Vehicles:

What about taxes on motor vehicles? So at the moment there’s the Federal fuel excise it’s 34.5 cents per litre for on-road use and then there’s state levy stamp duties, registration fees, parking fees, licence fees and so. These are kind of historical ad hoc collections of taxes. What’s kind of interesting is they collect a little bit more money than what the Commonwealth, states and local spend on road construction and maintenance. If you were to feed in what governments spend on policing of roads, ambulance services and hospitals then the expenditure is probably roughly balanced. So what the Henry Review and the recent Productivity Commission Report said, “Let’s sort of sort out this historical mix of rubbish taxes and have explicit user fees”. So there would be a user charge for road damage, so that would depend on how many kilometres you travelled and on the weight per axle, the amount of damage you do. Cars do almost no damage, very little charge. Big trucks, not much damage on freeways but a lot of damage on off-roads. You’ve got all the modern technology, the big truckies now know exactly where their trucks are, what they’ve travelled etc. You could do that very easily. You can have congestion fees. We actually measure now how long it takes you to go on various freeways, when there’s a big queue and it’s long you put on a big fee; when it’s off-peak it’s free. And then you can have pollution charges. You know, that’s all set out in the Henry Review, it’s all ready to be done. Now, my guess is the states could do the user fee and the congestion charge, it’s just got to be articulated.

Gambling Taxes:

What about taxes on gambling? This is wonderful one. We have very different taxes on different tax rates. To my wonderful surprise, when you go the races the tax rate on a win is about 16%, the tax rate on a trifecta is 18%, and the tax rate on a quadrella is 20%. Why in the hell do you have different taxes on different combinations of horses running? And then if you go to Keno another set of tax rates, poker machines another set of tax rates, gambling machines another set of tax rates. It’s pretty complicated. Now, there is a logic for having special taxes on gambling. What we know is that most of us go into Crown Casino and say, “Well, I’m going to spend 50 bucks and if I pull a good number and I win $150 hey, freebie and it’s your shout”, and you get pleasure at getting the shout. If I’ve done my 50 bucks in about 15 minutes I then turn around and say, “Karl, I’m having a really bad day, it’s your shout”. He spent a little extra money, but we both leave at midnight a couple a hundred bucks short. We’ve had a good night, no problems. But then I do have my mate next door who says, “I’ve put in a 100 bucks and I’ve got so close to the jackpot that if I put in another 50 yippee, I’ll make it”. Well of course, he puts in another 50 and another 50, and then he goes home and says, “I’m sorry we can’t pay for the electricity this month”. That’s the problem gambler.

Now the question is if we put a tax on gambling am I really going to deter that person? And the Productivity Commission says “Probably not”. The way to hit gambling is not by putting a tax on gambling, it’s some sort of advisory etc. services. So the Henry Review said, “No, that won’t work”. The Henry Review said, and this should appeal to you people at Prosper, “A lot of gambling generates enormous economic rents”. The government says, “You can have so many machines. Can’t have as many as you like”, it’s like taxi licences. You can have one casino and generate economic rents So tax the economic rents. Now in fairness the Victorians do that, but not as much as they could. The other story is, of course, is if gambling is not responsive to prices then it’s almost like an economic rent. The demand for gambling’s almost perfectly elastic, then tax it. So an old tax is a good tax, maybe keep it. So I’m happy to say simplify it, let’s say whatever dollar you spend at the race course, whether you pick a winner, a double or a trifecta, pay the same tax. Better simplicity please.

Freebairn’s State Reform Package:

So what about my state tax reform package? I have land tax broader base flat rate; payroll tax broader base, flat rate; get rid of stamp duties; rationalise motor vehicle taxes; gambling taxes, focus on economic rent. The final point I want to argue is with all those good arguments why don’t states do it? The rationale is most of the pain of state tax reform would be borne by the states. Most of the benefits of state tax reform would be reaped by the Commonwealth, the larger and more productive economy. Who gets the benefits for the larger and more productive economy? Well, states get a little bit of extra payroll tax, but the big winner is the Commonwealth, big gains in income tax, big gains in corporate tax. So this has got to be a discussion between the Commonwealth and the states. Tax reform done just at the Commonwealth level won’t do it. Tax reform done just at the state level won’t do it.

So, one hopes that the white papers on tax reform and on Commonwealth/state financial relations will actually realise that there are some synergies between the two. And if I was to have any say I would do something like the 1990’s National Competition Reform, that essentially said to the states, “If you reform your state taxes in various ways, we the Commonwealth will pay you some compensation, that is a share of the net national gains”. And then you can partly get over the political problem. The states can argue, “Hey electors, we didn’t really, really want to do that tax reform and hurt you, but because we’ve done it the Commonwealth has paid us these billions of dollars. You’re a winner”. And then the Commonwealth will say, “God, we had to shell some money out, but that was only to get those incompetent buggers in the states to get their act together, and we’re all winners”. And so while the pollies are blaming each other, you and I are confused that the economy’s better. That’s my hope for the future. Thank you.

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Category: Taxes

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