Australia's Future Tax System

Final Report: Detailed Analysis

Chapter G: Institutions, governance and administration

G2. State tax reform

G2–2 Current State taxes are not well placed to fund services in the future

The Australian tax system is highly centralised. Chart G2-1 shows that in 2007–08, 82 per cent of total tax revenue was raised by the Australian government.

Chart G2-1: Tax revenue by level of government, 2007–08

Chart G2-1: Tax revenue by level of government, 2007–08

Source: ABS 2009, Taxation Revenue, Australia, 2007–08, cat. no. 5506.0, ABS, Canberra.

The Australian government raises the majority of tax revenue in the federation and levies the largest taxes: personal income tax, company income tax, the goods and services tax (GST) and excises. To some degree, this accords with the principles for tax assignment: the company tax base is relatively more mobile while the personal income tax base is used for redistribution.

The high degree of centralisation in the Australian federation is also a function of the Constitution. In relation to taxing powers, the Constitution prohibits the States from imposing certain taxes, including:

  • customs and excise duties under section 90;
  • taxes that conflict with the provision in section 92 that 'trade, commerce and intercourse among the States … shall be absolutely free'; and
  • taxes on Commonwealth government property under section 114.

While section 90 provides the Commonwealth with exclusive power to impose customs and excise duties, it does not clearly define what these are. Successive High Court interpretations of the Constitution have restricted the States from imposing taxes on the production, manufacture, sale or distribution of goods. Australia's broad-based consumption tax — the GST — is therefore levied by the Australian government, although under present

arrangements, all the revenue from the GST is distributed to the States under the principle of horizontal fiscal equalisation.3

In 2007–08 the States raised $53.1 billion in tax revenue, which comprised around one-third of their revenue. A significant proportion (46 per cent in 2007–08) of the States' total revenue comes from the Australian government as either general revenue assistance (primarily GST revenue) or payments for specific purposes. As Chart G2-2 shows, the proportion of revenue that each State receives from the Australian government ranges from 39 per cent for the ACT to 71 per cent for the NT.

Chart G2-2: Sources of State revenue, 2007–08

Chart G2-2: Sources of State revenue, 2007–08

Source: ABS 2009, Taxation Revenue, Australia, 2007–08, cat. no. 5506.0, ABS, Canberra; Australian Government 2008b, Final Budget Outcome 2007–08, Australian Government, Canberra; ABS 2009, Government Finance Statistics, Australia, 2007-08, cat. no. 5512.0, ABS, Canberra.

The main sources of State tax revenue are payroll tax, conveyance duty and land tax, as well as taxes on motor vehicles, gambling and insurance contracts. In total, the States levy around 25 different types of taxes. While there are similarities in the main taxes used in each State, the thresholds, rates and range of exemptions often differ between States. As Chart G2-3 shows, there is variation in how much each State relies on different taxes, reflecting differences in revenue-raising capacities as well as differences in policy.

Chart G2-3: Sources of State tax revenue by State, 2007–08

Chart G2-3: Sources of State tax revenue by State, 2007–08

Note: As the ACT does not have local councils, 'Other taxes' for the ACT includes revenue from rates (around 15 per cent of their total revenue).

Source: ABS 2009, Taxation Revenue, Australia, 2007–08, cat. no. 5506.0, ABS, Canberra.

The States are facing increasing cost pressures

The suitability of current State taxes is closely related to how well they can contribute to the funding of future expenditure. As noted in Section G2-1, demographic change will affect different tax bases and types of government expenditure in different ways. In the only comprehensive assessment of the fiscal pressures facing both Australian and State governments, the Productivity Commission (2005) estimated that in the absence of policy responses, expenditure for all levels of government in Australia would increase by 6.5 percentage points of GDP between 2003–04 and 2044–45, resulting in a fiscal gap of around 6.4 per cent of GDP by 2044–45.

While the Productivity Commission's base case found that the States would bear a relatively small increase in cost pressures (0.8 percentage points of GDP), this was predicated on the assumption that specific purpose payments (SPPs) to the States grew in line with service needs. Under the alternative assumption that SPPs grow in real per capita terms, the gap the States face would be over three times as large (2.3 percentage points of GDP). Given that the States' own tax revenues currently account for around 4.3 per cent of GDP, these cost pressures are significant.

Narrow-based and complex State taxes hamper revenue sustainability

Assuming no change in expenditure responsibilities between levels of government, the States will need better access to sustainable tax revenues to deal with these cost pressures. Although the States currently have access to some significant taxes, the analysis of individual State taxes (or groups of taxes) throughout this report has shown that there are many problems with current State taxes.

Narrow-based taxes are not desirable

A significant proportion of State tax revenue comes from stamp duties, which are narrowly based transaction taxes on the value of conveyances, insurance contracts, motor vehicles (on the transfer of ownership) and other financial transactions. These taxes can impose significant costs. For example, taxing property only when ownership is transferred discourages people from buying and selling. Individuals and businesses may choose to continue to hold property instead of a preferred alternative simply to avoid the tax. Transaction taxes can also be inequitable as people with similar incomes may pay different amounts of tax because they buy and sell a taxed good more frequently.

Transaction taxes can also be volatile sources of revenue because the tax base is determined not only by the value of the good but also how often it is bought and sold (the volatility of conveyance duty revenue is discussed in Section C2 Land tax and conveyance stamp duty).

Tax bases should be broader

A broad consensus that has emerged from reviews of State taxes is that the States currently have two potentially very efficient taxes, payroll tax and land tax.4 To the extent that the burden of a broad-based payroll tax will fall on workers and a broad-based land tax on landowners, the immobility of these resources (relative to capital) make them good taxes for the States.

However, the current State payroll taxes and land taxes are not levied on the ideal broad bases. Payroll tax applies only to businesses with payrolls above a certain threshold and certain groups of employers and types of payments are exempt (see Section D3 Payroll tax). As a consequence, fewer than 100,000 of Australia's 2 million businesses are liable for payroll tax and around 95 per cent of businesses are exempt for one reason or another. Land tax is levied on land used only for certain purposes and its rate often differs between taxpayers according to the use of the land and the scale of landholdings. These features affect who bears the burden of these taxes. For example, because the land tax does not apply to all types of land, some of the burden of the tax is likely to be passed from landowners to renters (see Section C2).

Differences between States can create complexity

While the mix of taxes levied by each State is similar, there are many differences in the details of individual taxes from State to State. These relate to what is taxable, who is exempt from paying the tax, the rates and thresholds of the tax and when the tax must be paid.

  • of these differences are desirable because they allow State governments to modify their taxes to account for differences in geography, climate, industry structure and revenue needs. However, differences can also create complexity for individuals and businesses that operate in more than one State, or that move between States. Even though the burden of a tax may not fall on businesses, it is businesses that will often have to deal with the complexity of the tax system. More complex and uncertain tax arrangements across the federation can discourage business investment — affecting the sustainability of tax revenues more generally.
  • reform, increasing the rates of tax on existing State taxes would not be a sustainable way of funding increased cost pressures in the future.

Finding

Many of the current State taxes are inherently of poor quality while other State taxes need to be reformed. Increasing the rates of tax on existing State taxes would not be a sustainable way of funding services in the future.


3 Horizontal fiscal equalisation has been defined as follows: 'State governments should receive funding from the Commonwealth such that, if each made the same effort to raise revenue from its own sources and operated at the same level of efficiency, each would have the capacity to provide services at the same standards.' (Commonwealth Grants Commission 2002 p. 5)

4 For example, Gabbitas and Eldridge (1998) note that these taxes are relatively efficient, equitable and stable and have broad bases capable of raising substantial revenue. In its review of NSW taxes, IPART (2008) found that payroll tax is the highest ranking State tax in terms of performance against standard taxation principles while land tax is a relatively efficient tax, with substantial scope to improve its efficiency.