Australia's Future Tax System

Final Report: Detailed Analysis

Chapter D: Taxing consumption

D3. Payroll tax

D3–2 Current payroll taxes are complex and narrow-based

Payroll tax is levied by all States on businesses with payrolls above certain thresholds. Payroll tax was originally introduced by the Federal Government in 1941 to fund child endowment. Since the Australian government passed control of the payroll tax to the States in 1971, every State has used this tax to meet a significant part of its revenue requirements. In 2009–10, the States expect to collect $16.8 billion in payroll taxes, representing around 32 per cent of their own-source tax revenues.

The existing State payroll taxes are not as broad-based as they could be. Existing payroll taxes in all States include three major exemption categories (there are differences in the detail between States), including:

  • threshold exemptions — these exclude businesses whose total Australian payroll is less than a certain threshold;
  • activity exemptions — these exclude businesses according to their dominant activity (for example, charities, non-profit hospitals, local councils and the Australian government); and
  • payment exemptions — these exclude the wages of people in certain circumstances, such as payments for maternity leave and payments made to apprentices.

Each State has a different threshold exemption as well as a different tax rate (see Table D3–1).

Table D3–1: Current payroll tax rates, thresholds and revenue estimates for 2009–10

State New
South Wales
Victoria Queensland(a) South
Australia
Western
Australia
Tasmania Northern
Territory
Australian
Capital Territory
Rate 5.75% 4.95% 4.75% 4.95% 5.5% 6.1% 5.9% 6.85%
Threshold $638,000 $550,000 $1 million $600,000 $750,000 $1.01 million $1.25 million $1.5 million
Revenue $6,172 $4,074 $2,736 $915 $2,216 $257 $157 $267
  1. Queensland differs in that it does not provide a deduction equal to the threshold for all taxpayers. Instead it 'claws back' the threshold on payrolls between $1 million and $5 million. Above $5 million there is no deduction in Queensland.

Source: State revenue offices, State budget papers (mid-year update for Qld and Vic). Rates and thresholds are as at 1 July 2009.

Arguably, the threshold exemptions operate as a barrier to business growth as the compliance and payroll tax costs provide an incentive to remain small.

The overall effect of the exemptions is that a significant proportion of employee remuneration is not subject to the tax. A comparison of current payroll tax revenues with the amount that would be collected at current rates from its theoretical base — represented by the national accounts measure of compensation of employees — suggests that around 43 per cent of employee compensation is exempt (see Chart D3–3).

State government tax expenditure data suggest that the threshold exemptions explain most of the difference between theoretical and actual payroll tax collections. This exemption reduces the efficiency of payroll tax revenue, as it distorts labour use away from its highest value use (see Box D3–2). A narrower tax base also means the tax rate has to be higher to raise a given amount of revenue.

Chart D3–3: Exemptions from theoretical payroll tax base, 2008–09

image

Source: Treasury estimates.

The threshold exempts most businesses from being liable for payroll tax. For example, the current NSW threshold (which is lower than most other States) exempts around 91 per cent of NSW businesses from payroll tax (IPART 2008). State government departments are generally liable for payroll tax.

Payroll tax is particularly complex across State borders

Employers face a number of complexities in complying with their payroll tax obligations.

The definition of wages for payroll tax purposes differs from that for income tax and workers' compensation.

Exempt employers must ensure they remain eligible for the exemption activity. Employers must continually identify the instances where an employee's wage, in whole or part, becomes exempt or ceases to be exempt, and move those wages into, or out of, the payroll tax calculation as required.

Businesses close to the threshold are likely to have to calculate their payroll amounts regularly to determine whether or not they have a liability to register for payroll tax.

Threshold exemptions require complex grouping rules that deem related entities to be one business for the purposes of the threshold. These rules are necessary to prevent businesses from taking advantage of the threshold by artificially splitting up their operations into a number of smaller entities.

When payroll tax became an own-source of revenue for the States, payroll taxpayers operating in more than one State were required to submit regular (usually monthly) payroll tax returns and payments to each State in which they employed people. With business increasingly operating on a national and global basis, around half of payroll taxpayers now employ in more than one State.

To prevent business from receiving a full threshold deduction in each State, the threshold deduction is applied in respect of the employer's total Australian wages, but the liability is calculated in respect of the wages paid to workers employed in that State.

Where an employee works in more than one State there are complex rules for determining which State receives the payroll tax.

In 1971 the States enacted uniform payroll tax legislation with a uniform tax rate of 2.5 per cent. Over the following years, that uniformity was gradually eroded as States changed their tax rates and thresholds, extended the base to include other forms of remuneration, introduced anti-avoidance measures and enacted specific exemptions and rebates in response to local revenue and taxation issues. Recently, through the Council of Australian Governments' 'national seamless economy' initiative, all jurisdictions have taken steps to harmonise their payroll tax legislation, which has resulted in harmonised legislation in most States. However, States still differ on the basis of thresholds and rates.

Many submissions to the Review have highlighted how the compliance costs for businesses with employees in several States are higher than necessary due to these complexities.

Apart from the impact on employers, the duplication of revenue authority infrastructure, including administration, compliance staff and IT systems, increases the administration costs of Australia's tax system.

Finding

Exemptions in the payroll tax base introduce biases into the allocation of labour across the economy and lead to complexity in administration and compliance, particularly when the exemptions differ (even slightly) between States.

Reform of payroll tax has been mixed across States

Aggregate labour income as a percentage of GDP has been relatively stable over time (see Chart D3–1) so that even the current narrow-based payroll taxes are one of the more stable and predictable sources of State revenue (IPART 2008).

Over the past 20 years, the States have moved to broaden the payroll tax base and lower the rate. The major base-broadening decisions have involved the addition to the base of non-cash fringe benefits and superannuation contributions.

In New South Wales, Victoria and South Australia, base-broadening has also resulted from average wages rising faster than the level of the threshold. For example, Victoria's threshold has risen from $500,000 in the early 1990s to $550,000 today. During this time, average wages have nearly doubled, so it is likely that that a higher proportion of businesses are now liable for payroll tax in Victoria. This potentially reduces the efficiency costs of raising revenue from payroll tax as fewer businesses can now change their activities to avoid paying the tax.

Some other States have taken the opposite approach. Western Australia, Tasmania, Northern Territory and the Australian Capital Territory have narrowed their payroll tax base by increasing the threshold faster than the growth in wages. These States have generally been slower to reduce their payroll tax rates. Chart D3–4 compares two States with similar threshold exemption levels in 1992–93, and contrasts their actual level over time to what the threshold level would have been had it been indexed to the movement in average wages.

Chart D3–4: Level of payroll tax thresholds in two States, compared with
hypothetical indexation of the 1992–93 level to average wages

Chart D3–4: Level of payroll tax thresholds in two States, compared with hypothetical indexation of the 1992–93 level to average wages

Source: Treasury estimates, NSW Treasury (2009), ABS (2009f).

On average, these changes made by the States over the past 15 years have increased the payroll tax base from around 45 per cent to 57 per cent of its theoretical level across all States (see Chart D3–3). At the same time as the base has been broadened, there has been a general decline in rates. For example, Victoria has significantly reduced its rate, from 7 per cent in 1990–91 to 4.95 per cent today.

Finding

Some States have broadened their payroll tax base by limiting growth in the payroll tax threshold, while other States have narrowed their base by rapidly increasing the threshold.