Monday, October 22, 2012

Business cons the states out of tax revenue

WHEN we see the mid-year budget review today, all eyes will be on the savings Wayne Swan will announce to ensure he still achieves a surplus this financial year. The measures will be needed because the weakness in tax collections is even greater than expected.

Deciding how much we should cut spending is one thing, but working out what to do about the budget's structural problems on the revenue side is quite another.

One way the Gillard government is seeking to reduce pressure on its budget is by demanding bigger contributions to joint projects by the states. They, however, always see themselves as recipients of federal spending, not contributors.

I have a fair bit of sympathy for the states. They have primary responsibility for the big-ticket spending areas of education, hospitals, law and order, roads and transport, and much else, but their revenue-raising power is limited, having been progressively whittled away by the High Court.

That's why John Howard bequeathed them all the proceeds from the goods and services tax. But the GST is no longer the growth tax it seemed to be. Consumer spending will never again grow as strongly as it did during the tax's first seven years, and an ever-growing proportion of consumer spending goes on items excluded from the GST base.

Because the revenue-raising capacity of the two levels of government is so unequal, any serious funding problem for the states ends up being the federal government's problem.

But it's harder to feel sorry for the states when you remember - as prompted by the secretary to the Treasury, Martin Parkinson, in a recent speech - the way they have knowingly and over many years perverted one perfectly good tax in their possession, payroll tax.

The states' limited taxing ability is an old problem. As long ago as the early 1970s, Billy McMahon sought to fix it for good and all by giving them the federal payroll tax.

Clearly, it didn't work. For a while the states raised the rates of their payroll taxes, but soon enough they began cutting rates to curry favour with business before election campaigns and eroding the base, thereby turning it from a reasonably neutral tax into one that distorts business choices.

Advocates of a federal system like the idea it allows a degree of competition between the states. But when the states compete to lower tax rates - or use offers of tax holidays to attract investment projects away from other states - they all lose. Business plays them off a break. The standard argument against payroll tax is that, by raising the cost of labour, it discourages employment. But this is ill-considered.

In the end, you can tax only three things: land, labour or capital. Income tax is largely a tax on labour; tax economists say company tax is largely a tax on labour, the GST is largely a tax on labour (most consumer spending is done from wages) and payroll tax is also a tax on labour.

Business people tend to approve of the GST - they're always saying its rate should be increased - but invariably oppose payroll tax, even though, in principle, the two are quite similar. Business people know the burden of GST is passed on to consumers, but many seem to imagine the burden of payroll tax remains with them. In both cases, who writes the cheque that goes to the tax man doesn't tell you who ultimately bears the tax.

Business people lap up the fashionable idea that, in a globalising world of ever-greater mobility between economies, we should be relying more on taxing land and labour, and less on taxing capital. But all the while they're inveigling the premiers into reducing payroll tax.

When Parkinson spoke in defence of payroll tax (merely echoing the opinion of all treasuries, federal or state), the states responded that the tax was bad for small business. This is pretty much the opposite of the truth.

Apart from cutting the rate at which the tax is applied, the main way the states have undermined this - the biggest of their own taxes - is by regularly raising the threshold at which the tax applies to a business's wages bill.

So high is the threshold in the various states that genuine small business doesn't pay the tax. It's actually a tax on big business. It's really medium-size business that's most affected by where the threshold is.

Although payroll tax is an efficient, non-distorting tax in principle, its way-high threshold makes it distorting in practice. It's a tax that favours small business and penalises big business.

The obvious reform, which would gradually reduce the distortion of business choices and aid the states' revenue problem without involving too much political pain, is simply to leave the threshold where it is in nominal terms, allowing wage inflation to progressively lower it in real terms.

The insouciance which has allowed the premiers to fritter away their strongest and soundest source of ''own-revenue'' makes you suspect they're privately perfectly happy with the ''vertical fiscal imbalance'' whereby the federal government gets most of the opprobrium for collecting taxes, while the states are perpetual beggars at the federal table, only ever prepared to co-operate with federal reforms if they receive a big enough bribe.

The feds are unlikely to seriously consider changes to the GST until the premiers have shown a willingness to undertake the revenue-enhancing reforms that lie within their own control.