State Revenue and Taxation

CHAPTER 4

INTRODUCTION

The first thing to be said about State taxes is that there is no magic pudding.  There are no easy solutions, and the voters must know it.  The new government must deal with its fiscal inheritance, that is, the large burden of debt described in the preceding chapter.  To cope effectively with this inheritance, the government has only two options:  raising taxes or cutting spending.  Either will involve some political pain, but it is unavoidable.  The decision will be made all the more difficult by the structural bias, already noted, against taxpayers and in favour of more government spending;  and its consequences will be all the more important because of the large costs imposed on the economy by the inefficiency of the tax system.

The supporters of government spending are numerous, well-organised and well-connected, and have the illusory nature of the tax system and the hand-out mentality of the political system working in their favour.  Taxpayers are less well organised, and often are not even aware that they pay certain taxes.  On the other hand, State taxes and charges come at a very high cost.  Taxes per se act as a significant disincentive to firms and individuals to invest, to save, to employ people and even to remain in the State.  Interstate competition, particularly from Queensland -- a very low-tax State -- will to some degree bring the cost of taxation into focus.  Unfortunately, the cost of taxation is often invisible, or at least hard to verify;  yet the benefits of government spending are obvious and often exaggerated.  The result is high taxes, too few jobs, and too much spending.

The task facing the government will be to manage, fairly and effectively, its unfortunate legacy, and at least to begin the task of reforming the tax system.  To achieve these tasks, the government will have to break completely from the ways and means of the past.

The first issue that needs to addressed -- because past governments have proclaimed it so vigorously to be the case -- is whether the State suffers from a chronic and structural revenue deficiency.  Then, if there is no structural deficiency, is there still a need for more revenue, or is there scope for tax cuts?  If taxes are to be increased, under what conditions and from what sources?

The new government must also face the issue of the reform of tax design.  The State tax system is a mess, and acts as a hindrance to improving the accountability of government.  Tax reform is, however, a political minefield, and has a history of being used to disguise increases in tax effort.  It also has a history of abject failure, in the sense of yielding a system less equitable, less efficient, more complicated and less transparent than should reasonably be the case.

STATE REVENUE:  NO CHRONIC SHORTAGE

Throughout the 1980s, Western Australian governments continuously claimed that the State public sector was systematically starved of revenue -- mainly by the Commonwealth.  Indeed, one of the principal justifications advanced for the various ill-fated WA Inc ventures was that they would overcome the "excessive" restraint imposed on the State's funding by the Commonwealth's limiting the growth in grants and hindering access to a "growth" tax.

Contrary to this view -- one still officially promoted, and, in some quarters, looked on as received wisdom -- Western Australian governments in fact enjoyed a substantial increase in revenue over the last decade.  Although the State public sector has since 1986 experienced a period of comparative restraint, neither the large accumulation of debt nor the structural deficit resulted from a "shortage" of revenue.  More specifically, the State public sector is not facing a chronic deficiency in revenue.  Indeed, the new government will inherit a superior revenue position relative both to other States and to this State's own recent experience.

During the 1980s, Western Australia, like most other States, experienced an unprecedented increase in State tax revenue.  One of the most costly legacies of the 1980s was the squandering of these huge windfall gains, reaped during the asset boom, from stamp duties and land tax.  These temporary gains were not only spent;  they were, to a large degree, used to fund an increase in on-going expenditures.  Moreover, when the boom collapsed and the related tax receipts declined, the government not only failed to cut back adequately on spending, but instead resorted to higher borrowings and taxes,

Figure 4.1:
WA Budget Sector Revenuw, 1973-1993 (Real terms, $ per capita)

* Note:  Figures for 1993 are the author's esitimates.

Source:  ABS and 1992-93 WA Budget Papers

Revenue Growth Has Been Substantial

During the early years of the last decade (1982-86), Western Australia and other State governments experienced significant increases in revenue (Figure 4.1).  In the four years between 1982 and 1986, the revenue available to the State general government subsector grew by 75 per cent in nominal terms or by 11 per cent after adjusting for population growth and inflation (Figure 4.1).  The public sector as a whole experienced an even faster revenue growth

After 1986 and through to 1992, the growth in revenue available to the general government subsector slowed, and in real per capita terms declined by 0.5 per cent.  This resulted from cuts in Commonwealth grants (which were reduced by 14.2 per cent in real per capita terms between 1986 and 1992) and, more recently and to a lesser extent, a recession and a policy of no increases in State taxes.

Despite the comparative restraint of recent years, the State public sector and general government subsector still ended the 1982-92 period with substantially more revenue at their disposal in real per capita terms:  20 per cent more in the case of the total public sector, and 11 per cent more in the general government subsector.  Revenue in both the total public sector and in the general government subsector is expected to grow again in 1993, albeit modestly, and as a result is expected to approach, and in the case of the general government subsector exceed, the record level reached during the revenue horn of 1988.

Large Increase In State Taxes

Western Australian governments, along with most other State governments, experienced a massive increase in State tax receipts over the last decade.  State tax receipts in Western Australia increased by 60 per cent in real per capita terns, and by over 30 per cent as a share of Gross State Product (GSP) (from 3.7 per cent to 5.1 per cent), between 1982 and 1992.  There was a marked and steady increase in tax receipts starting from 1983 (Figure 4.2).  The greatest increases in tax receipts, however, took place after 1986.  The main reason for the increase in receipts between 1983 and 1986 was greater taxing effort -- both higher tax rates and new taxes.  The post-1986 increase arose from a combination of huge windfall gains flowing from the asset boom and higher tax rates.  As shown in Figure 4.3, between 1986 and 1989, stamp duty receipts more than doubled in real terms.  Land tax receipts also increased, though later and more slowly, and payroll tax also increased markedly.  Stamp duty receipts fell back dramatically with the collapse in asset prices in 1990, but to a level still substantially above their pre-1986 level (Figure 4.3).  Moreover, the increases in other types of taxes, particularly land tax, payroll tax and franchise fees, allowed the huge gains in tax receipts made during the asset boom to be sustained (Figure 4.2).

The growth in State tax receipts in Western Australia stands in sharp contrast to Commonwealth taxes.  Until 1982, the tax receipts of the State and Commonwealth governments grew at about the same rate in real terms (Figure 4.2).  After 1983, there was a sharp divergence:  Commonwealth taxes continued to grow at about the same rate as in previous years, while State tax revenue shifted into near-exponential growth.  Between 1983 and 1992, State tax receipts in Western Australia almost doubled in real tern, whilst Commonwealth taxes grew by a relatively modest 30 per cent.

Squandering Of The Tax Windfall

Just as all the State governments received this huge tax windfall during the 1980s, all States but one consumed rather than saved this rare gift.  It was the asset boom of the 1980s which gave rise to the massive increase in asset-based tax revenue such as stamp duty and land tax (see Figures 4.2 and 4.3).  Despite the seductive euphoria then prevailing, it would have taken only a modest degree of wisdom or foresight to realise that this increase was to be of a temporary nature.  The rational policy response should therefore have been to save the windfall by using it (or most of it) to cut the deficit.  In Western Australia, a large portion of the windfall was instead used to provide the initial funding for the large increase in recurrent outlays associated with the 1989 State election (recurrent outlays grew by $775 million or 24 per cent over 1989 and 1990). ⁽⁵⁰⁾  So when the asset bubble burst, the Western Australian government had no savings to fill the revenue gap, and was forced to increase borrowings, to raise taxes and (to a lesser extent) to restrain the growth of spending.

Figure 4.2:
Growth in Total State Taxes (WA) and Commonwealth Taxes
(1984/85 prices;  1972/73 = 100)

Source:  ABS National Accounts, various years.

Figure 4.3:
Growth in Selected State Taxes (WA), (per capita), (1984/85 prices;  1972/73 = 100)

Source:  ABS National Accounts, various years.

WA Public Sector Is Relatively Well-Off

Relative to other States, the Western Australian government is very well endowed with revenue.  Throughout the last decade, the State's public sector, even after subtracting moneys passed on to Local government, received more revenue per head of population than any other State government except Tasmania.  In 1992, the Western Australian public sector received about 6 per cent more revenue than the all-State average:  that translates roughly into a bonus of nearly $400 million per annum. ⁽⁵¹⁾  The State's general government subsector received more revenue than any other State, again except Tasmania, and about 3 per cent above the all-State average.

The main reason for Western Australia's relatively good revenue position is that it does well -- in terms of revenue -- out of the existing grants system;  it receives a higher level of mineral royalties;  and its Public Trading Enterprises (PTEs) impose higher charges.  Because the Western Australian public sector is estimated by the Grants Commission to have significant expenditure disabilities (that is, both higher costs and a revenue-raising capacity slightly below par), it receives more general purpose grants per person than the more populous States.  In 1992-93, Western Australia is expected to receive $1639 million in general purpose grants, which, on a per capita basis, is 19 per cent above the all-State and -Territory average, and nearly 50 per cent above the level of New South Wales. ⁽⁵²⁾  Western Australia does slightly better than Queensland, and slightly worse than South Australia and Tasmania.  Specific purpose grants, which have been growing steadily as a proportion of total State revenue as well as of overall grant receipts, are allocated on a variety of bases and are often dominated by political considerations and special circumstances.  Nevertheless, Western Australia has in recent years received a share of total specific purpose grants in proportion to its population

The main reason for the increase in public sector revenue expected in 1993 is the sharp increase in specific purpose grants flowing from the stimulatory fiscal policies of the Commonwealth.  Although general purpose grants are to increase in line with the rate of inflation in 1993, specific purpose grants are to increase by 10.l per cent. ⁽⁵³⁾  This is likely to be a temporary phenomenon, as the Commonwealth will not continue with its expansionary policies beyond 1993;  and is, in fact, more likely to cut back steadily on grants, particularly general purpose grants, once the Federal election is out of the way and as the economy recovers.

As discussed in the previous chapter, the Western Australian government receives a substantial amount of revenue from mineral royalties -- over twice the level of other States.  Royalty income has, moreover, grown significantly (84 per cent in real per capita terms) over the 1982-92 period, and is expected to continue to grow at a rapid rate over the term of the next government. ⁽⁵⁴⁾

The State's public sector also receives a comparatively high level of income in the PTE sector.  In 1992, Western Australia's PTEs produced a net operating surplus of $466 per capita, which was around 20 per cent above the all-State average and on a par with Queensland's. ⁽⁵⁵⁾  The question is, to what extent does the higher operating revenue come from higher charges and to what extent is it the product of lower costs and greater productivity?

Although it is not possible comprehensively to compare PTE charges across the States, the limited available data indicate that Western Australia does impose relatively higher charges.  The State Energy Commission of Western Australia (SECWA) and the Water Authority of Western Australia (WAWA), which account for around 75 per cent of total PTE sector revenue, do impose relatively high charges.  The average price of electricity charged by SECWA was, in 1991, 43 per cent above the national average, ⁽⁵⁶⁾ and in 1991, WAWA was estimated to have imposed, on a representative customer, the highest sewerage charge of any State and the second highest urban water charge, after Queensland, of any State. ⁽⁵⁷⁾  It is also true that some PTEs, such as Transperth (the urban transport authority), impose a relatively low level of charges.

Relative To Most States, WA Is Not A High-Tax State

Western Australia is not a "high-tax" State when judged relative to the national or all-State average.  That this is the case, however, is because most States dramatically increased taxes over the last decade, and because Western Australia started the decade as a markedly "low-tax" State.  Thus, over the last decade, State taxes in Western Australia have increased both in absolute terms and relative to other States, but still remain below the level of most other States.

In 1991-92, the Western Australian government collected $1200 per capita in taxes, fees and fines (hereafter referred to as taxes). ⁽⁵⁸⁾  This is about 9 per cent below the all-State average.  It is, however, inaccurate to assess tax policy simply by comparing per capita tax receipts.  Tax receipts vary across States for two basic reasons:  differences in tax capacity or the size of tax base, and differences in tax effort or the amount taken in taxes as proportion of the potential tax base.  It is the latter -- tax effort -- which is of greatest relevance to the assessment of tax policy,

The Commonwealth Grants Commission provides data on tax effort for each State. ⁽⁵⁹⁾  The Commission's data show that tax effort in WA during 1991 was on a par with the all-State average.  In the two yean since 1991, however, the Western Australian government has not increased tax rates or introduced any new taxes;  whereas all the other States, except Queensland, have increased taxes -- some substantially.  Western Australia's tax effort relative to the all-State average has, therefore, declined, and Western Australia must be considered a low-tax State in comparison to the national average.

Even though Western Australia is not currently a high-taxing State, it has increased its level of taxing effort relative to the other States markedly over the last decade.  As shown in Figure 4.4, the Western Australian government increased its taxing effort relative to all other States between 1982 and 1991 by over 17 percentage points.  Even though tax effort in Western Australia has declined in relative terms since 1991, it undoubtedly remains above its 1983 level.

Relative To Queensland, WA Is A High-Tax State

In comparison with Queensland -- the State with which Western Australia must chiefly compete -- Western Australia is a very high-tax State.  In 1990-91, Western Australia imposed a level of tax effort 37 per cent above that of Queensland. ⁽⁶⁰⁾  Since Queensland has, like Western Australia, not increased taxes, the relative position of the two States has changed little since 1991.

Figure 4.4:
Western Australian State Taxes, Relative to the All-State Average and to Queensland

Note:  Data are corrected for differences in tax capacity (ability to pay), thus the data measure taxing effort.

Source:  Commonwealth Grants Commission

As shown in Figure 4.4, the State's taxing effort has grown very rapidly relative to Queensland's.  In 1982, the State government imposed a level of tax effort only 7 per cent above the Queensland level.  The differential had blown out to 48 per cent by 1986, before declining to its current level.  This means that over the 1980s State taxes in Western Australia increased by 30 per cent in per capita terms relative to Queensland.  The relative increase in Western Australia's taxing effort is even more dramatic given the short period of time involved (the increase took place primarily between 1983 and 1986), and the fact that Queensland achieved a balanced budget throughout the period whilst Western Australia more than doubled general government debt.

DESPITE RICHES, NO SCOPE TO CUT TAXES

Despite the State public sector's relative abundance of revenue, and the very large increase.  in taxes that took place over the last decade, there is little scope for the new government to reduce taxes and other revenue.  Indeed, if one could be assured that any tax increase would be temporary, and that its proceeds would be devoted exclusively to reducing State debt, a strong argument could be sustained for increasing taxes.

The first priority of the government should be to reduce debt and to balance the budget by the end of its first term.  This will require a substantial fiscal adjustment, and can only be achieved by raising more revenue, by cutting spending, or by a mixture of both.  The experience of the last few years shows how difficult it is to achieve large, real, sustained spending cuts.  The proposals in other chapters of Reform and Recovery, if put in place and pursued vigorously, will achieve significant savings over time, but there is a high level of risk that the requisite spending cuts will not be achieved.  There is also a very high probability that additional spending priorities will be created over the term of the government.

It is extremely likely that the Commonwealth, during this time, will again cut grants to the States and thereby diminish the State's ability to reduce taxes.  All major parties at the Commonwealth level are committed to achieving a Commonwealth budget surplus over the next four years;  while the nation's large foreign debt, its low level of domestic savings, and the need to expand private investment are likely to guarantee that this commitment will be carried out.  At the very least, this set of circumstances will translate into little if any growth in grants to the States, and is more likely to result in sizeable real cuts, particularly if the States do not voluntarily reduce their borrowing.

There is, moreover, no reason to expect any sizeable growth in the State's own-sourced income, other than mineral royalties, over the next four years.  The States do not currently impose (with the possible exception of payroll tax) any major tax that we could think of as a "growth tax".  State taxes tend to grow at or below the rate of the economy, and do not provide scope for "bracket creep".  This is, in fact, a healthy situation:  the lack of such a tax limits taxation by stealth.

ANY TAX INCREASE SHOULD BE QUARANTINED

Given the priority accorded to reducing debt and debt-servicing costs, and given the political uncertainties associated both with achieving the requisite reduction in spending and with maintaining existing levels of revenue, an increase in tax or other State-sourced revenue should be considered.  The problem here is that, on past evidence, such an addition to revenue may have no effect on the deficit or the level of State debt, but simply be used to expand spending.

The political and bureaucratic propensities codified by C.  Northcote Parkinson nearly forty years ago in his Second Law are still current:  whatever the revenue may be, pressing needs will always be advanced to spend it;  with the inevitable consequence that government expenditure characteristically will rise to meet income. ⁽⁶¹⁾

The fiscal behaviour of successive Western Australian governments tends to support Parkinson's prognosis.  During the 1985-89 period, State governments dramatically increased State taxes, with tax receipts outstripping inflation plus population growth by nearly 50 per cent.  Tax receipts also increased sharply as a share of GSP, and as a share of total government revenue.  This massive increase in tax receipts had no discernible impact, however, on the level of borrowing or spending.  During the same six- year period, State debt grew by 82 per cent or by nearly $4000 million, whilst spending grew by over 12 per cent in real per capita terms. ⁽⁶²⁾  Admittedly this was a period distinguished by an even greater than usual absence of fiscal responsibility.

Parkinson's Second Law and recent history suggest that unless some explicit caveats or limits are placed on the level and use of taxes, any increase in tax receipts is likely to be used primarily to fund more spending, and not for the more pressing need of reducing the deficit and debt.

More specifically, tax increases should only be undertaken if the proceeds are specifically earmarked for reducing a clearly identified stock of debt;  for example, the $150 million debt accruing to the State government from the underwriting of Western Australian Government Holdings Ltd (WAGH).  When additional revenue is drawn into consolidated revenue, it loses its identity and invariably is spent on the unlimited "needs" facing governments.  Any tax increase should also be for limited duration;  for example, for a three-year period, with a "sunset clause" to that effect attached.  Otherwise the tax increase will become part of the customary revenue base.

Any tax increase should also be imposed directly on individuals and not on businesses.  As discussed below, the proportion of State taxes imposed on businesses is already too large;  resulting in an excessive loss of jobs and investment, and a tax system that offends against both fairness and accountability.

There are a number of possible tax- or revenue-raising measures worthy of consideration, including:

• a community debt charge, as recently introduced in Victoria, which in Western Australia could appropriately be labelled a "WA Inc Tax";  and which should take the form of a fixed-sum, annual tax of $150 on the owners of residential properties;
• privatisation and asset sales -- there remains significant scope for increasing the level of asset sales, and for the sale of public sector businesses as going concerns;  in fact, privatisation has yet to begin;
• user charges -- there remains substantial scope to increase charges for use of some government services, particularly in the areas of public transport and water, and in most general government agencies;  although care needs to be taken to ensure that the funds raised from these sources do not simply lead to more spending;
• auctioning of mineral deposits -- the State can, as do many overseas countries, allocate mineral rights by auction;  this not only has the potential to improve the efficiency of the allocation process, but also to raise more revenue.

TAX SYSTEM:  TO REFORM OR NOT TO REFORM?

The case for reform of the State tax system is strong.  The existing system acts as a major impediment to economic growth;  it is costly to administer;  it is unfair;  and it diminishes the accountability of government.  On the other hand the case for retaining the existing system, warts and all, is also strong.  Tax reform, to be effective, necessarily requires a very considerable degree of political will and skill.  It is, inevitably, politically costly, and will consume a large portion of the government's "political capital".  It may thus put at risk higher-priority reforms.  It will also run into numerous and significant constitutional, legal, and administrative impediments.  All these factors, taken together, mean that tax reform often has a propensity to fail seriously.

The question is whether or -- more accurately, given the unavoidable need for some minor changes -- to what degree, should we attempt to reform the existing tax system?

THE CASE FOR TAX REFORM

Fiscal illusion and the "free lunch" syndrome

Perhaps the most awkward feature of the existing State tax system is that few citizens are aware that they actually fund the State government.  Most citizens, to the extent that they think about it at all, believe that "someone else" pays, particularly large and wealthy businesses.  This illusion inevitably means that a large proportion of voters share the belief that State government spending is a "free lunch".  Accordingly the demand for government services is more or less infinite, and spending grows inexorably.

But the truth is that everyone pays -- the poor, the wealthy, the employed, the unemployed, the young and the old -- because in the end the entire tax burden is borne by individuals in their capacity as owners of firms, as employees, or as consumers of products.  It is true that businesses bear the initial or statutory burden of most State taxes.  Indeed, approximately 75 per cent of all State tax receipts are paid initially by businesses.  In the end, however, these institutions invariably pass the burden onto individuals, usually in higher prices or through lower wages;  if they did not do so, they simply would not survive.

The "them-not-us" view is further reinforced by the States' dependence on Commonwealth grants.  Under the existing arrangements, the State government receives about 50 per cent of its total revenue from the Commonwealth in the form of grants.  Even though Western Australian taxpayers provide the lion's share of the funds paid back in grants to the State government, they are unlikely to know it, let alone to hold the State accountable for the use of these funds.  These taxes are paid to the Commonwealth government and not to the State government, and taxpayers hold the Commonwealth rather than State governments accountable.  The Commonwealth government does attach strings to the use of grants;  but Commonwealth scrutiny and control is a very poor substitute for direct accountability, and it makes the already weak link between State revenue-raising and spending very tenuous indeed.  State governments have long recognised this fact and have indeed characteristically preferred the Commonwealth as paymaster to their own voters.  As the long-serving Queensland Premier Sir Joh Bjelke-Petersen once said, from a State perspective "the only good tax is a Commonwealth tax".

The other main sources of non-tax revenue, including royalties, the sale of land, levies on statutory authorities, and interest earnings, are also derived in an indirect manner.

Successive State governments have further weakened the already frail link between spending and taxing by pursuing that approach to tax reform best described by Louis XIV's minister, Colbert, as "so plucking the goose as to derive the greatest amount of feathers with the least amount of hissing".  The States have judiciously provided exemptions to taxpayers with significant political sway, while at the same time increasing the rate of tax for those remaining in the tax net.  The prime example of this is payroll tax, the most lucrative tax currently imposed by State governments.

When the State first received the power to levy payroll tax in 1971, it was imposed at a flat rate of 2.5 per cent on almost all private sector businesses.  Over the ensuing twenty years, the tax has been steadily "reformed" by exempting more and more firms;  so that by 1993 just under 10 per cent of firms remain in the tax net.  At the same time, a sliding rate scale was introduced to allow variations in the tax burden, and the top marginal rate of the tax in Western Australia was increased to 10.2 per cent.  The total tax take has steadily increased, but the burden has been concentrated on a smaller, less politically articulate set of firms and activities.

The reaction to other State taxes from firms and individuals has also been muted, despite (or perhaps because of) the imposition of a large number of rather small taxes, such as FID, stamp duty on cheques, stamp duty on insurance, and the bookmaker's tax.  These taxes in aggregate collect a substantial amount of revenue, but since individual taxpayers pay out only relatively small sums on any one of them, the cost of lobbying makes opposition an expensive effort for individuals.

Of course, businesses are under no illusion about the impact of taxes.  They do resist tax increases and lobby strenuously for tax exemptions, sometimes effectively.  Other lobby groups are also active in ensuring that their constituents achieve, or, more often maintain, tax exempt status.  The existence and power of these anti-tax groups does much to make taxation rather more visible than debt;  that, in turn, tends to make governments reluctant to raise taxes and prone to resort to borrowing -- hence the need, already discussed, to give first priority to restricting borrowing.

Nevertheless, as we have said, most voters and interest groups believe, because of the amorphous nature of the tax system, that State government services are "free goods".  The "free lunch" syndrome engendered by the tax system will make it very difficult not only to achieve the identified debt targets, but also to achieve an appropriate level and mix of government spending.  Indeed this is a major reason why Parkinson's Second Law applies so accurately to State government expenditures.

Existing Tax System is Unfair

There are three principles of equity or fairness applicable to the assessment of a tax system, and the existing State tax system rates poorly under each.

The best-known principle is the one economists call "vertical equity", which is concerned with how a tax system treats persons of differing ability to pay.  On this principle, a tax system is said to be equitable (or progressive) if the ratio of the tax levied to the individual's income increases with the latter.  Conversely, a tax is said to be inequitable (or regressive) if the tax burden falls disproportionately on the less well-off.  As shown in Table 4.1, all existing State taxes, with the possible exception of land tax and gambling taxes, and the State tax system as a whole, are regressive, and, therefore, according to the vertical equity principle, are inequitable.  It must be recognised, however, that the regressivity of the State tax system is offset to a large degree by the progressive nature of the Commonwealth personal income tax system from which comes the bulk of grant revenue to the State.

Table 4.1:
Effective Incidence of State Taxes

	NSW Study	Victorian study
Payroll tax	Proportional	Mildly regressive
Franchise fees	Mildly regressive	Regressive
Motor taxes	Regressive	Regressive
Contracts and conveyances	Mildly regressive	Regressive
Other stamp duties	Regressive	Regressive
Gambling taxes	Uncertain	Progressive
Land taxes	Mildly regressive	Mildly regressive
All taxes	Regressive	Regressive

Source:  NSW Tax Task Force, "Tax Reform and NSW Economic Development:  Review Of the State Tax System", Government Printer, Sydney, 1988, p.86 and Committee Of Inquiry Into State Government Revenue Raising, "Report of the Committee into Revenue in Victoria", Government Printer, Melbourne, 1983, pages 184-186.

The vertical equity principle has been extensively and incorrectly applied in the design of the State's tax system.  State governments, in a purported attempt to improve the "equity" of the tax system, have increasingly exempted individuals and small businesses from the tax net, particularly from land and payroll taxes, and at the same time increased tax rates applicable to "large" firms.

The problem is that vertical equity as a principle is applicable only to individuals, and not to corporate entities.  Income levels relating to businesses, as for instance turnover, profit or payroll, bear no necessary relationship to the income of individuals.  Share dividends remitted by large firms may form part of the income of pensioners or of millionaires.  A small business may represent the sole and meagre livelihood of its owner or the minor investment of a wealthy person.  Moreover, most of the taxes collected from businesses are in fact passed on:  to customers, in the form of higher prices;  and to employees, in the form of lower real wages or less employment.  Whether the final impact of the business tax is in fact progressive or regressive bears no relationship to the size of a business payroll, its use of land, or the size of its transactions.  Take an example:  when we think about it, it hardly seems equitable to impose payroll tax on Coles-Myer -- in fact one of the largest payers of payroll tax in Australia -- which is largely owned by pension funds, sells predominantly "essential" goods such as food and clothing, and employs a high proportion of unskilled and young people, but at the same time to exempt an up-market jewellery store in Claremont which is owned by, and sells to, the rich and famous, and pays its few employees accordingly.

The second principle of equity, called horizontal equity, measures the way a tax system treats people with similar levels of income.  Under this principle, a tax is said to be equitable if its burden falls equally on all individuals having the same ability to pay.

Although there is little empirical evidence, it is nevertheless quite apparent that the State tax system is inequitable, and that government "reforms" have increased the inequity.  State taxes are characteristically imposed on a limited range of items and individuals.  For some taxes -- such as franchise fees, stamp duties, gambling taxes and motor vehicle fees -- the narrow base is inherent in the tax.  For other taxes -- such as payroll and land tax -- the tax base has been narrowed as a result of government policy.  The narrow and arbitrary incidence of the State tax system necessarily means that individuals having the same ability to pay will be faced with greatly differing tax burdens.

The third concept of equity is usually known as "the benefit principle":  it argues that an equitable tax system is one in which those who benefit from public services contribute directly to their funding.  Very clearly and explicitly, the existing State tax system is inequitable when judged by this principle.  Although, as we have explained, everyone shares to some degree the burden of State taxes, these taxes are largely indirect and are, for the most part, not imposed in relation to benefits received.  There are a few minor exceptions, such as the earmarking of petrol and tobacco franchise fees, and departmental user fees,

State Tax System Is Inefficient

All taxes have adverse impacts on economic behaviour;  more than most people realise, and certainly more than most politicians are willing to admit.  The level of taxation is thus of paramount importance.  It is not, however, the only factor.  The quality of taxation, in terms of the types and structure of taxes imposed, also has a large bearing on the costs of a tax system.

Seen in this light, the State tax system scores very poorly, both because of high tax rates and because of the type of taxes imposed.  The State imposes a large number of narrowly-based taxes, which impose different tax burdens on different outputs and on different inputs, and thereby distort both production and consumption decisions.  The cost of the tax system is made higher by the numerous exemptions and variable tax rates;  and higher still by the imposition of the greater part of the tax burden on businesses.  Although businesses do eventually pass the burden of taxation onto individuals, the process of shifting the taxes itself has, in the case of State taxes, very high costs, particularly in loss of private investment, of exports, and of employment.  In an effort to increase tax revenue and to fund the expanding level of tax exemptions, State governments have steadily increased the tax rates on those left within the tax net, and have significantly added to the dead-weight cost of the tax system

In theory, payroll and land taxes are potentially the most broadly-based and efficient of existing State taxes.  But these taxes in practice fall far short of their potential.

In theory, again, payroll tax can have very similar equity and efficiency effects to a broad-based goods and services tax. ⁽⁶³⁾  The reality, however, probably falls short of the theory.  The State payroll tax system has been significantly narrowed by the provision of exemptions.  Payroll tax in Australia is levied solely on businesses;  whereas many overseas countries impose it, at least in part, on employees.  As a result, the existing payroll tax distorts business decisions more than do similar taxes overseas and more than most broad-based goods and services taxes.  Other important characteristics of the Australian economy, such as a rigid labour market and dependence on imported capital goods, which diminish the degree to which payroll tax payments are shifted to the capital and labour markets, imply that the burden of a payroll tax will also be distributed in a less equitable and less efficient manner than that of a goods and services tax.  The burden of payroll tax in Australia is also aggravated by the large number of payroll-based taxes or levies, including the training levy, the superannuation levy, and workers' compensation (for the last of which the aggregate tax rate in Western Australia -- a State with a low overall rate -- is over 16 per cent).

The existing land tax system suffers from problems similar to those afflicting payroll tax, such as numerous exemptions (including all personal residences), disproportionate imposition on businesses (with the attendant distortion of business decisions), a high rate of tax, variable tax rates, and the superposition of numerous other taxes sharing the same tax base of land values -- including local government rates and sewerage rates.

High Compliance Cost

The total administrative and compliance costs of the State tax system are too high.  Although the system does not impose an inordinately large administrative burden on government, it does impose a large burden on businesses.

Since most State taxes are levied on businesses, most of the costs associated with administering the system are borne by business and not government.  The administrative burden of the system is made heavier by the high degree of discretion available to the tax office in determining the tax base (particularly for stamp duties), and the high degree of uncertainty arising from the frequent changes to tax law and regulations.  (It should be noted that the administrative costs of State taxes are no higher than those of the Commonwealth regime, and that the States have generally made a greater effort to minimise the administrative burden on business than has the Commonwealth.)

THE CASE AGAINST TAX REFORM

Political Costs Are High

The political cost of any effective reform of the State tax system will, as was pointed out earlier, be high.  There is no simple "magic pudding" (let alone Pareto-optimal!) solution to tax reform, although there are sizeable gains to be achieved in terms of higher efficiency.  Any effective and worthwhile reform will leave a good many people worse-off.  The essential political difficulties in the State system are that it is too narrowly based, it is imposed upon business, and its rates are too high.  Any tax reform worth having must tackle these problems, leaving no alternative but to remove exemptions and impose more taxation directly onto individuals.  The losers will cry foul:  and most individuals, who now believe themselves to be largely immune, will consider themselves to be losers;  while the many supporters of big and growing government will strive to preserve the illusion of the free lunch.  Even though there will be many winners -- in fact the whole of society should benefit significantly, particularly those looking for work -- the resistance of narrowly-focused interest groups, who possess inordinate influence under the existing political system, will be strong.

Co-operation of the Commonwealth and Other Governments is Necessary

Even though a State government can make a number of significant tax reforms by itself, it needs the cooperation of other governments, particularly the Commonwealth, to achieve the best outcome.  The Commonwealth directly controls 50 per cent of State revenue;  it also has the fiscal and legislative (or constitutional) powers to prevent States from imposing certain taxes, such as income tax, and it has the sole constitutional power to levy certain types of taxes, such as excise or a goods and services tax.  The Commonwealth also imposes a range of taxes or imposts that directly overlap or otherwise have an impact on State taxes, such as the superannuation levy has on payroll tax.  The cooperation of other State governments will also be needed to achieve the best results in many types of reforms.  Although there has been some success in cooperative reform of State-Federal fiscal relations in recent years, such reforms have in practice proven difficult to achieve and even more arduous to sustain.

There have been some signs that cooperative tax reform may be possible during the term of the new government, but nothing is guaranteed or even predictable.  Much depends on the composition of the new Commonwealth government.

Tax Reform Has A History Of Perverse Outcomes

Reforms in recent decades have with a few notable exceptions made State taxation worse.  The usual approach to reform of the State tax system, described above, has been to narrow the tax base and increase the rate:  in fact the precise opposite of what is required.  As with debt, it is difficult to believe that the traditional criteria of efficiency, equity and simplicity have had any significant bearing on the tax reform process.  The process appears rather to have been driven by the desire to get more revenue with as little awareness and pain as possible on the part of the voters -- that is, in conformance with Colbert's dictum, quoted above.  Given this history, tax reform should only be pursued if the forces that brought about the perverse outcomes of previous "reforms" can be overcome.

Tax Reform Can Prejudice Other Essential Reforms

Tax reform can put at risk other reforms.  Unless pursued with appropriate care, for instance, it could, at the State level, derail the debt management strategy we proposed earlier.  Tax reform has the potential to consume a significant portion of the government's political capital, and a large amount of its energy and will, and thereby jeopardise public support for other essential reforms -- to industrial relations, to the processes of government, and to debt management.

Tax Reform Can Increase Sovereign Risk

The tax system is a major part of the business environment, and changes to it can be a potent source of uncertainty.  The present tax system works, after a fashion, and raises the necessary revenue.  An economy adjusts to a tax regime, even as poor a tax regime as that applied by the States.  Changes, even if they introduce a "better" system, disturb this equilibrium and create uncertainty about the ultimate impact of the new tax regime.  An old tax, as the saying goes, is a good tax.

RECOMMENDATIONS:  MINIMAL REFORM OR RADICAL REFORM

The choice should be restricted either to minimal change or to radical reform.  The intermediate route, the usual route -- piecemeal reform, driven by short-term political interests -- should be avoided.  It has been taken about as far as it can go;  quite simply, there is little more tinkering that can be done to the present ramshackle system without causing more political and economic pain for little gain.

The time appears right for radical reform.  Indeed, the next term of government could well be a period noted for reform of the whole Australian tax system and State-Federal fiscal relations.  Radical reform is in the wind at the Federal level.  The Federal opposition is, at the time of writing, proposing massive taxation reform -- including the introduction of a VAT (or GST), the removal of State payroll tax with compensation to the States, and a large raft of other tax changes which would have direct ramifications for State taxes.  Although the Labor Party at the Commonwealth level is not currently committed to any similar degree of major reform, or to changing the allocation of taxing powers between State and Commonwealth governments, it may well change its mind, as it has in the recent past -- forced perhaps by fiscal circumstance.  Most States have also, to differing degrees, accepted the need for reform.  The public, and particularly the business community, seems to have accepted the idea, if not the precise nature, of reform.

Even though the present tax system needs reforming and reform appears to be possible, it will come at too high a cost unless it is well managed, is comprehensive and, so far as possible, depoliticised.  What is needed is a tax reform package, developed outside the political marketplace, which can then take its chances in the marketplace as a package.  This process would also allow the necessary research to be undertaken and the options to be considered as far as possible outside the political process.

Depoliticising Tax Reform

The design of a new tax system should be a technical exercise more than a political one, although political considerations can never be entirely ignored if reforms are to have a chance of being enacted.  The aim has to be to maximise the general benefit as clearly as possible, whilst minimising the damage to any particular group.  Sectional vested interests should as far as possible be ignored.  All Western Australians now and in the future share an interest in a better tax and revenue system.

The government should set up a committee to design a reformed tax system, which includes improvements to State-Federal fiscal relations.  The committee should be given a year in which to report, and should work in private.

The report should be published and the government should make it clear from the outset (that is, at the time the Committee is appointed) that the reforms are to be considered as a package -- take it or leave it, all or nothing.  The idea is to minimise the opportunity for vested interests to lobby for special favours, thereby reducing the inevitable strain on the government of resisting them.

The majority of the committee's members should be economists and tax specialists, although some political expertise might be useful.  The five or six representatives should be appointed for their personal qualities only, and not as representatives of interest groups.  The committee should work in private because it is virtually impossible for public hearings to be conducted without there being some indications of the committee's thinking and thus some inadvertent help to vested interests planning their opposition.  The government should set up the committee and then leave it alone, thus minimising the political capital it invests in the process.

The terms of reference should leave wide discretion.  Nevertheless, the tax reform committee must be asked to consider, among other things:

• efficiency, simplicity, perceived fairness and transparency in the tax system;
• the need to shift the initial burden of taxation away from businesses and more directly to individuals;
• the vertical fiscal imbalance between State and Commonwealth spending and revenue-raising powers, with a view to reducing Commonwealth taxation and making the States raise more of their own revenue;
• the alternative optimum reform agendas with and without the cooperation of the Commonwealth.

If the committee's proposals are widely accepted (and no proposal can possibly gain universal acceptance), the reforms should be implemented.  If not, the government should give up the idea of tax reform and continue a policy of minimal change.

REFORMS TO OTHER REVENUE SOURCES

Policies affecting non-tax revenue also need to be examined -- specifically royalties, other sources of capital revenue, PTE charges and dividend payments, and user charges.

Royalties:  Adopt the Mineral Revenue Inquiry's Recommendations

In the 1980s, the State government commissioned the most thorough assessment of royalties yet undertaken in Australia. ⁽⁶⁴⁾  The central recommendation of the inquiry was that "the State replace the existing royalty arrangements in so far as possible with a system that relates royalties more directly to net resource value (profit)".  The report went on to recommend a two-part royalty:  an ad valorem royalty of 5 per cent (on mines with revenue of at least $100,000 per year);  and a profit-based royalty of 20 per cent on large mines (with revenue in excess of $1 million per year), with the former being deductible in full from the latter.  The report also recommended that the exemption of gold from royalties be removed.  To date, these and the other recommendations of the report have not been acted upon, at least in an explicit manner.

It is our view that the recommendations of the report should be adopted in full, including the imposition of a royalty on gold.

Capital Revenue:  Earmark For Funding of Capital Outlays

As discussed in the previous chapter, a large proportion of the revenue collected by the State from capital sources, that is, from the sale of capital assets, has been used to fund recurrent expenditure.  This has contributed to the illusion that borrowing has been used exclusively to fund increases in capital stock, and has contributed to the excessive accumulation of debt.  These problems would be greatly diminished by the earmarking of all capital revenues -- including mineral royalties -- for the funding of capital outlays.  The earmarking of capital revenues would also counteract the very real incentive that exists, particularly in the context of a debt-reduction programme, to achieve a reduction in borrowing by disproportionately cutting back on capital outlays.  We recommend therefore that all capital revenue, including mineral royalties, be earmarked either to fund capital outlays or to reduce debt, and not to be used to fund recurrent outlays.

PTE Charges and Dividends

The revenue policies of the Public Trading Enterprise (PTE) subsector need an overhaul.  The PTEs employ too many tax-like instruments;  charges are in some cases too high, and in others too low;  charges, too, often bear little or no relation to costs;  and in most cases are subject to excessive political gamesmanship.  The dividend policy of the PTEs is also in need of an overhaul:  dividends are required of only a limited number of agencies;  the dividends that are levied bear no relationship to the agencies' rate of return on equity or even their ability to pay;  and dividends are increasingly (though less in Western Australia than in other States) being seen as revenue-collecting devices, rather than as tools to improve the efficiency and cost-competitiveness of the agency.

The logical starting-point for the reform of PTE pricing and dividend policy is now New South Wales.  The government there has been the leader among the States in developing systems to monitor, control and manage PTEs.  It was the first State to develop and implement a policy of corporatisation, and has taken the process further and in more detail than any other State.  Western Australia would benefit greatly from a through examination of the New South Wales approach.  Two New South Wales reforms are of particular relevance:  the pricing tribunal, ⁽⁶⁵⁾ and a comprehensive financial distribution policy. ⁽⁶⁶⁾

The New South Wales government has established a pricing tribunal which is responsible for regulating the prices of all PTEs which may have a monopoly market position.  The objectives of the tribunal are to depoliticise the process of price-setting in the PTEs, and to achieve a balance among the interested parties:  the shareholders (namely, the State government), the PTE managements, and the PTEs' customers.  More specifically, the tribunal acts to determine the maximum price for monopoly services supplied by the agencies (there is no reason to restrict the tribunal to PTEs) and to report on the pricing policies of those agencies.

A State Pricing Tribunal of this kind would be a very effective mechanism with which to control the tax-like powers of Western Australia's PTEs and to ensure that PTEs do not become revenue-collecting agents for the general government subsector.  Although the pricing policies of all agencies are in need d review, the highest priority area here is public transport, followed closely by water and sewerage, and electricity.

Although all States have introduced policies with similar intent, the New South Wales government's policy governing the transfer of moneys from PTEs to the general government subsector -- financial distributions -- is easily the most advanced of any State's, and provides an excellent starting-point for further reform of these transactions in Western Australia.

The New South Wales policy requires all PTEs to operate in accordance with targets for rates of return, on both equity and assets, agreed between Minister and PTE.  They are required, further, to distribute a specified minimum proportion of pre-tax profit, calculated after full allowance is made for community service obligations (which are themselves required to be established on a contractual basis).  The target for distribution of earnings is a minimum of 50 per cent of pre-tax profit, with distribution comprising a dividend and, in some cases, an additional taxation-equivalent payment.  New South Wales also imposes a credit rating-based fee on the outstanding debt of PTEs guaranteed by the government and requires PTEs to meet the interest cost on their outstanding debt.

The pricing tribunal and the financial distribution policy should ensure that the PTEs pay a fair return to shareholders, whilst limiting their use as surrogate tax-collectors for the general government subsector.  Moreover, the New South Wales model is consistent with the Queensland practice -- which is the practice we advocate -- of using realised productivity gains to reduce charges and to fund capital investment, thereby minimising borrowing rather than maximising dividend payments.  This could be easily achieved within the New South Wales framework simply by allowing each PTE to retain a larger specified portion of its profits.

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ENDNOTES

50.  ABS, Cat. No. 5501.0, 1992.

51.  Calculated using data taken from ABS Cat. Nos 5501.0 and 3101.0.

52.  ABS, Cat. No. 5501.0, 1992

53.  WA Treasury, "Budget 1992-93:  Economic and Financial Overview", August 1992, page 70.

54.  ABS, Cat. No. 5501.0, 1993.

55.  Calculated using data taken from ABS Cat. Nos 5501.0 and 3101.0.

56.  "Electricity Supply Industry: Performance Indicators 1987/88-1990/91", Electricity Supply Association of Australia Limited, 1992.

57.  NT Government, "Comparison of Selected Taxes and Charges", August 1992.

58.  Calculated using data taken from ABS Cat. Nos 5501.0 and 3101.0.

59.  "Report on General Revenue Relativities:  1992 Update", Commonwealth Grants Commission, March 1992.

60.  Ibid.

61.  C.N. Parkinson, The Law:  Or Still In Pursuit, Schwartz Publishing Group, East Melbourne, 1980.

62.  See Chapters 3 and 5 respectively of this volume.

63.  See John Freebairn, "Should A Consumption Tax Replace Payroll Taxes?", Review, Vol. 44, No. 4, 1991.

64.  Paul G. Bradley, "Report of the Mineral Revenue Inquiry in regard to the Study into Mineral (Including Petroleum) Revenues in Western Australia", WA Department of Mines, 2 Vols, August 1986.

65.  NSW Treasury, "Public Authority Pricing in New South Wales", NSW Treasury Research Paper, January 1992.

66.  NSW Government, "A Financial Distribution Policy For NSW Government Trading Enterprises", August 1992.