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A federation fit for purpose

By Alex Sanchez and Michael Potter - posted Friday, 1 May 2015


Significant debate is ongoing about collecting the GST and distributing it to the States. The West Australian Premier, Colin Barnett, was apparently ‘furious’ over the GST split provided to WA, with the state getting less than 30 cents in the dollar of GST revenue. The other states retorted that Western Australia signed up to the current system, and should therefore live with the consequences. And the commonwealth, like a parent turning away as the kids squabble, utters that it’s the responsibility of the states themselves to agree. Meanwhile, the federal government is proposing to apply GST to online services such as Netflix and clamp down on GST avoidance through the cash economy, and others are contemplating an increase in the GST rate.   

However, the fixation by commentators and policy makers on how much GST is collected and how it is distributed tax revenue means that the bigger question, what taxes should the States collect, is overlooked.

The starting point is that the Federal Government raises much more tax revenue than it needs, while the States raise much less. So the Fedstop up State Budgets by distributing revenue (the GST) to the States. It is this distribution formula that WA is complaining about, a more vehement version of similar complaints recently by other large States (NSW and Victoria).

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The issues get worse. Despite being sold the GST as a growth tax, GST revenue is growing more slowly than expected. A lot of this structural (growth in the consumption of GST exempt goods such as health) while some it cyclical (we are saving more and spending less). Whatever the case, the largest states, WA in particular, are hit by a double whammy: GST growing slowly, and then being distributed to other States.

But for all the sound and motion on this issue, theneed for State tax reform as a means of fixing State budgets and growing their economies is sadly missed. While reform of the GST and its distribution are important, these are not themost urgent or most beneficial reforms. The largest benefits, in fact, will come from reforms to State taxes, particularly stamp duty, land taxes, insurance taxes and payroll taxes. This should be the first order priority for the Federal and State governments. Distribution issues should be secondary.  As they say – a rising tide lifts all boats.

A recent analysis by the Treasury makes the opportunities clear. In simple terms, stamp duties are the worst tax; and taxes on land are the best. Stamp duties are worse than taxes on companies; and land taxes are better than the GST. There are similar results in many other studies, including modelling conducted for the Henry tax review by KPMG Econtech.

It should therefore be pretty clear that a big cut to stamp duties, paid for by an increase in land tax, will provide considerable upside to the economy. Using a higher GST to pay for a lower tax on companies is also beneficial of course, but nowhere near as beneficial as using land tax to pay for a cut to stamp duty.

It is somewhat mystifying why this reform option is always missed in all the huffing and puffing over the GST and company tax. Perhaps it is because stamp duty is paid by only a small number of people, while there are many more paying company tax and GST?  Or possibly because it would mean a tax that is paid infrequently (stamp duty) is replaced with a tax paid frequently (land tax). But if you took this view of the world, then why was the Wholesale Sales Tax replaced by the GST? 

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In any case, the politics of this reform is not as toxic as some might think. The ACT Government has forged a path with implementing this tax switch, and there should be useful lessons from this reform for other States.  Indeed, the ACT took such a tax reform package to an election, and notwithstanding some opposition, was re-elected.  Political commentators may need to have another think about just how “hard” reform actually is, after the examples of both NSW and the ACT. Both these governments have demonstrated that hard reforms stand up to strident opposition.

Although land tax offers both an efficient and equitable source of revenue, it is unlikely that State governments would accept replacement of all their grants and taxes with asubstantial increase in land tax. There are a number of other tax options worth exploring, particularly to substitute for grants from the Federal Government. The State Governments should fully explore these options before they retreat to crying poor or pathetically complaining about inadequate Federal Government funding.

Firstly, State governments could make better use of their payroll taxes. The States have made this tax fairly inefficient, mainly because they provide high exemption thresholds. Only larger businesses now pay payroll tax. As economists will often tell you, a broader payroll tax at a lower rate wouldbe fairly similar in its economic incidence to a GST.

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About the Authors

Alex Sanchez is a former adviser to Mark Latham, Leader of the Opposition. He was an unsuccessful candidate for preselection in the federal seat of Fowler in south-west Sydney. He is married to a working wife and has two children. He can be emailed at alex.sanchez@bigpond.com.

Michael Potter is an economist and public policy commentator and authored the papers Fix it or Fail: Why we must cut company tax now and The looming crisis in business investment for the Centre for Independent Studies.

Other articles by these Authors

All articles by Alex Sanchez
All articles by Michael Potter

Creative Commons LicenseThis work is licensed under a Creative Commons License.

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