I habitually mock journalists who descant upon the theme of ‘reform’ without specifying what exactly they want amended or why—so due credit to Peter van Onselen, who had a go at saying, in moderate detail, what he thought should be done to the Australian tax system.
On the other hand, much of what he suggests is based on some pretty basic misunderstanding of the economics of tax. I don’t have the time to go through it all, but I was particularly amused by his suggestions on payroll tax (boring disclosure: years ago, I did a summer internship in the Tax Economics unit at Treasury and was assigned the thankless task of completing the once-a-decade updating of the payroll tax briefing note). Van Onselen says:
Upping the GST, which is distributed to the states, should be incorporated into wider federation reform, which would see the commonwealth take over payroll taxes, putting them up at the same time as reducing the corporate tax rate. While payroll taxes are seen as a barrier to businesses employing more people, that’s not the case if they go up in line with company tax reductions.
A Commonwealth takeover of payroll tax is actually not the worst idea in the world—it was in fact originally a Commonwealth tax, handed over to the states to allow them to levy their own . Since the 1970s, though, the States have turned what was originally a reasonably efficient tax into a reasonably inefficient one. Instead of levying a low rate of tax on a lot of businesses, the States have historically demanded higher statutory rates of tax from increasingly few businesses, by granting thresholds that exempt many firms with small payrolls from paying anything. As with the ludicrous abolition of death taxes (an act of fiscal vandalism for which you may blame Joh Bjelke Petersen), competition between the states has actually had rather deleterious impacts on their tax systems.
The existence of higher thresholds has some positive economic effects—it reduces the compliance cost of raising tax, since fewer firms have to do any administrative work to pay it. If it’s true that small or young businesses are inherently valuable (because they grow into big firms, for example, or they employ people who otherwise might not be employed, or they increase competition in markets) then the thresholds could also have positive effects. On the other side of the ledger, thresholds distort the labour market by decreasing wages in larger firms relative to wages in smaller firms. (This will probably be levelled out by workers moving from large to small firms, but this is another kind of distortion.) Larger firms are also likely to invest more in R&D and to export (which can be a mechanism of innovation), so taxing large firms more than small ones can have negative effects on productivity growth, too. Most of the economists I’ve talked to about it think that the efficiency cost of currently high thresholds probably outweight the benefit.
A Commonwealth takeover of the payroll tax could help with the problem of states competing to raise their thresholds in order to attract firms to their state. Interestingly, Van Onselen, while he recommends ‘putting…up’ payroll taxes, doesn’t specify whether he means lowering the thresholds, thereby increasing the tax base, or raising the tax rates. There’s a big difference between the two.
But the real problem I have with Van Onselen’s column is the suggestion that payroll taxes replace company taxes.
Company taxes are levied on the profits enjoyed by firms; payroll taxes on the wages that firms pay. So aren’t they just different ways of taxing companies? No, not exactly. As anyone who’s ever studied first year microeconomics knows, the legal requirement to pay a tax doesn’t mean that you actually pay the tax, in the sense that your income or welfare declines because of the tax. Whether you pay a tax in this economic sense depends on the particular characteristics of the market that you’re in. In general, we tend to think that payroll tax is largely passed on to workers through lower wages and possibly to consumers via higher prices.
Who pays the corporate income tax is a much more contested issue, although in a small open economy like Australia’s it’s generally thought that because capital is quite mobile, at least some—possibly quite a lot—is, as with the payroll tax. paid by workers and consumers. However, a lot of us suspect that the Australian economy is also riddled with location-specific rents (for example, the existence of valuable minerals that many companies obtain access to quite cheaply, and the rents enjoyed by the big banks who get privileged market positions because of government policy). If that’s the case, then capital will be less mobile, and the incidence of the corporate income tax will fall more on capitalists.
What’s weird about the article is that Van Onselen seems to understand why payroll taxes are more efficient than corporate income taxes—because they fall on labour that, unlike capital, finds it difficult to relocate:
If major parties are serious about multinational tax avoidance (more politely described as offshore profit-shifting), this reform is the answer. Businesses can’t get around payroll taxes, and the lowering of company taxes may even see profit-shifting work in Australia’s favour, with more companies choosing to base themselves here because of a low company tax rate in a stable democracy.
Why can’t businesses avoid payroll taxes while they can avoid profit-based taxes? Well, because labour is much less mobile than capital. But this very fact is a good reason to believe that the incidence of these taxes falls more heavily on workers. The upshot of all this is that, if payrolls taxes work like we think they do (and are eventually paid by workers, because of lower wages) and if capital-owners assume some of the burden for corporate income tax, then increasing payroll taxes while decreasing corporate income tax means that you’re actually just hitting workers more and capital owners less.
And because capital tends to be owned by people who are richer, the effect of replacing corporate income tax with payroll taxes is regressive in the same way that Van Onselen’s desire for higher GST in exchange for lower income tax will likely be regressive. Van Onselen’s grand plan for federation and tax reform seems to be: make the poor pay more. That’s a defensible position, I guess, but I he should make that clear, rather than just pretend that he wants to tax companies differently.