Architecture of Australia's tax and transfer system
The High Court's interpretation of the Constitution has restricted the States from imposing taxes on the production, manufacture, sale or distribution of goods. Without the ability to impose broad consumption taxes, the States have resorted to specific transaction taxes. Stamp duties on transactions, such as on motor vehicle purchases, insurance contracts and property conveyancing are significant sources of revenue. Such transaction taxes can reduce economic efficiency either through discouraging turnover (as tax is levied on the full value of the product each time a transaction occurs) or being embedded in the cost of production. Further, in some States insurance companies can also be required to contribute directly to the funding of fire services, a tax which is additional to the stamp duty. See Box 10.1 for a discussion of transaction taxes.
State tax revenues are also affected by a number of significant tax expenditures. This is particularly the case for payroll tax, where the States generally apply exemptions for certain institutions and allow tax‑free thresholds (though the States differ in terms of whether they consider the tax‑free threshold to be a tax expenditure). Land tax is another example, the main exemptions being for principal places of residence, land used in primary production and a tax‑free threshold (again depending on the State's definition of a tax expenditure). Such tax expenditures can considerably narrow otherwise broad bases. Section 2.6 provides a list of the main state tax expenditures.
Box 10.1: Transaction taxes
A tax that is levied on a good every time it changes hands is referred to as a transaction tax. The tax base for such taxes is determined not only by the value of the good but also the frequency of its transfer. In Australia, transaction taxes have generally been levied on a narrow set of goods and services and have a long history of use, probably reflecting their relative administrative simplicity.
Taxing on the basis of the frequency of transfer may discourage turnover of the good, such as housing, to minimise or avoid tax. Individuals and businesses may continue to use an existing good instead of a preferred alternative simply to avoid the tax. By reducing turnover, a high transaction tax can also make price discovery in a market more difficult. Reducing the certainty and quality of a price signal imposes additional risk on all those who engage in the market. The extent of these efficiency costs varies, and will be lower if the transaction tax is low relative to the benefit of undertaking the activity.
The narrow base of many transaction taxes and their interaction with other taxes can have an impact on resource allocation in the economy. For example, insurance products are subject to GST, insurance transaction taxes and, in some States, insurance companies can also be required to contribute directly to the funding of fire services. The interaction of these taxes increases the cost of premiums relative to other products, which may encourage people to take up less insurance than otherwise.
An additional efficiency cost arises where a taxable product is used as a business input, since the tax can encourage businesses to use a less efficient mix of inputs. In addition, such input taxes cascade through the production chain to affect the market price of the final product, reducing international competitiveness.
Transaction taxes also have equity implications as they tax only specific goods or activities. People may choose to engage in activities subject to higher rates of tax even though they have low incomes. Also, people with similar incomes may pay different amounts of tax because they turn over a taxed good more frequently. To address these equity issues, governments may narrow transaction tax bases to exempt certain types of people, such as some first home buyers for stamp duty on residential conveyancing. While of benefit to recipients, such exemptions add to the complexity of the tax system and increase the burden on the broader population.
Differences in tax policies between the States
While the mix of taxes levied by the States is similar, there are many differences in their application. As highlighted in Table 2.18, there are different thresholds, rates and ranges of exemptions between States.
There are, however, many similarities in the way these taxes operate. For example, all States that levy land tax exempt land used for primary production and individuals' principal place of residence. Further, the States have been working to harmonise payroll tax arrangements (other than rates or exemption thresholds). NSW and Victoria harmonised their payroll tax legislative and administrative arrangements from 1 July 2007. From 1 July 2008, Tasmania also harmonised its payroll tax arrangements with NSW and Victoria. The other States have agreed to harmonise initially over eight areas (including grouping provisions and vehicle and accommodation allowance exemptions) with work continuing on harmonising arrangements in other areas.
Access to their own taxes allows the States to modify the bases and rates to account for differences such as house prices, geography, climate, industry structure and revenue needs. This diversity can result in healthy tax competition between the States, in which the States face competitive pressure to adopt best practice in the design of their tax systems and the setting of tax levels, to minimise the adverse effects of taxation on economic activity. However, this can also lead to increased complexity for businesses operating in more than one state, particularly when there are definitional differences in the tax bases. In addition, if tax policies are driven by a desire to match other States, rather than the need to raise revenue, this may compromise the sustainability of the States' own source tax revenues. Such behaviour has largely been addressed through the Interstate Investment Cooperation Agreement (see Box 10.2).
Box 10.2: Interstate tax competition
Although there can be benefits from the States having the freedom to alter their taxes to meet their own constituents' needs, certain forms of tax competition between the States can be unproductive. As identified by Gabbitas and Eldridge (1998) there are potential problems if a State changes the rates and bases of their taxes in a 'bidding war' to deliberately attract business to their State.
The first problem is that a firm may have located in that State in any case as its decision may be more based on other commercial factors such as the proximity to associated markets and the skill set of the local labour market. Tax incentives offered by a State may have little influence on the decision. Secondly, while an individual State might gain some benefit from offering tax exemptions to certain businesses, this may be offset when the other States also offer similar exemptions to attract other businesses. To the extent that these exemptions simply move businesses between the States, there is no benefit for the nation as a whole.
Such tax competition can lead to significant erosions in tax bases. This is of particular concern if it occurs with relatively more efficient taxes, as the loss in revenue may be made up from increasing the rates of less efficient taxes.
In 2003, the treasurers of NSW, Victoria, Western Australia, South Australia, Tasmania and the ACT signed an Interstate Investment Co‑operation Agreement, whereby these States agreed to work together to eliminate unnecessary bidding wars and to restrict the use of financial incentives in seeking investments and major events. In 2006, these States, along with the Northern Territory, decided to extend the agreement for a further five years.
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