Title : Preface to Review of Western Australian State Taxes Author : Tax Policy Elective 1993 Organisation : School of Law, Murdoch University Language : English Keywords : TAXATION, WESTERN AUSTRALIA, EQUITY, : EFFICIENCY, SIMPLICITY, REFORM. Abstract : This document and its related chapters also : in this issue of E Law constitute a review and : assessment of several taxes levied by the State : of Western Australia, but which are common in : many other jurisdictions. They include land : tax, stamp duty, financial institutions tax and : debits tax, payroll tax, business franchise : licence fees (imposed on tobacco, petroleum and : alcohol) and betting taxes. The review is : particularly concerned with issues of equity, : efficiency and simplicity in the imposition of : the taxes reviewed. Criticisms are made on : the basis of these characterisitcs of an ideal : tax. Many recommendations are made for the : improvement of the method of taxation and : assessment. Statistics and graphics included : in the original work are not reproduced here : due to technological constraints but can be : obtained from the author. Contact Name : The Editors, E Law Contact Address : Murdoch University Law School, PO Box 1014, : Canning Vale, Western Australia, 6155 Contact Phone : +61 09 360 2976 Contact Email : elaw-editors@csuvax1.murdoch.edu.au Last verified : 23 April 1994 Last updated : 23 April 1994 Creation Date : December 1993 File Size : 61,498K File Type : Document File Format : ASCII Publication Status: Final COPYRIGHT POLICY : Material appearing in E Law is accepted on the basis that the material is the original, uncopied work of the author or authors. Authors agree to indemnify E Law for all damages, fines and costs associated with a finding of copyright infringement by the author or by E Law in disseminating the author's material. In almost all cases material appearing in E Law will attract copyright protection under the Australian _Copyright Act 1968_ and the laws of countries which are member states of the _Berne Convention_, _Universal Copyright Convention_ or have bi-lateral copyright agreements with Australia. Ownership of such copyright will vest by operation of law in the authors and/or E Law. E Law and its authors grant a license to those accessing E Law to call up copyright materials onto their screens and to print out a single copy for their own personal non-commercial use subject to proper attribution of E Law and/or the authors. ISSN: 1321-8247 URL: gopher://infolib.murdoch.edu.au:70/00/.ftp/pub/subj/law/jnl/ elaw/comment/watax/preface.txt --------------------------------------------------------------- 1 PREFACE This review of Western Australian State Taxes has been produced by students enrolled in the course Taxation Policy. Taxation Policy is an elective subject in the Bachelor of Laws degree programme offered in the Law School at Murdoch University. The authors were broken into six groups, each with primary responsibility for one of the six main chapters in the Review. The Commissioner for State Taxation kindly made officers of his department available to each of the group. This enabled us to complete our research more quickly and completely than might otherwise have been possible. We are grateful for the assistance lent us. Naturally, the opinions expressed in this Review remain entirely those of the Taxation Policy Elective itself. Each group presented their chapter both in seminar form and as a draft, allowing for significant feedback from other members of the Elective throughout the writing-up period. Each member of the Elective also produced an individual paper critiquing the various draft chapters and suggesting directions for the review. My Introduction to the review draws heavily on those papers, and in particular on a paper by Grant Gernhoefer - with the delicious opening paragraph coming from Terry Hall. On the other hand, readers will detect differences of approach in the various chapters as alternative approaches to vexed issues (such as the appropriateness of progressive tax scales) elicited different responses in different contexts. The purpose of the Review is to offer a policy based critique of the State tax system, with a view to stimulating further discussion and research into one of the most important areas of our federal system of government. The members of the 1993 Taxation Policy Elective were: Dr Neil McLeod (course co-ordinator and editor) Jim Borshoff Jeremy Malcolm Grant Gernhoefer Susan Meaghan Terry Hall Barry Padman Nanthakumar Kanagalingam Sarah Tapper Mark Lane Shannon Turner Colin Ligman Kate Wholley Paul McEvedy Jenny Wiggins Bob McKenzie Jack Wong Hing Man Neil McLeod December 1993 CONTENTS OF 1993 REVIEW OF WESTERN AUSTRALIAN STATE TAXES 1 INTRODUCTION 2 LAND TAX 3 STAMP DUTY 4 FINANCIAL INSTITUTIONS DUTY & DEBITS TAX 5 PAYROLL TAX 6 BUSINESS FRANCHISE LICENCE FEES 7 BETTING TAXES Implicit in any discussion of state taxation reform is a search for the 'ideal' or perfect tax. This elusive levy must: affect most people but offend none; be easy and inexpensive to collect, and impossible to avoid; it must not distort investment patterns, but must take from the rich more than from the poor; it must also satisfy constitutional prerequisites and take account of Commonwealth/State and inter-State policy differences; and finally, the 'ideal' tax must not impact adversely upon the career aspirations of politicians who sponsor it. In the more prosaic language of public finance theory, the ideal tax should be equitable, efficient and simple. 2 EQUITY The notion of equity brings us straight back to the political arena. What is fair or just within the philosophy of one taxpayer may seem otherwise from a different ideological perspective. The simplest element of 'equity' is the notion of horizontal equity. This is the notion that individuals with identical abilities to pay tax should bear identical tax burdens. The narrower the base of a tax, the further the tax is likely to depart from the ideal of horizontal equity. A tax on the registration of dogs will be borne only by those who register dogs. (The horizontal inequity of such a tax may be mitigated by other taxes which impact more heavily on non-dog owners, such as a tax on insurance premiums - if we assume that dog-owners face lower premiums.) Naturally, many taxpayers in fact have significantly different capacities to pay tax. The notion of vertical equity requires a greater tax burden to be borne by those with a greater capacity to pay. Of course, a flat rate of tax will usually extract more tax from the wealthy than from the poor. At least this will be so where the wealthy enjoy greater access to the relevant taxed good or taxed receipt. Where that condition is met, a `rich' person will be taxed more in absolute dollar terms than a `poor' person. This `minimalist' concept of vertical equity is not the one that usually finds favour in modern tax policy literature. A flat rate of tax may still be considered `regressive' if it claims from the `rich' person a smaller proportion of their wealth than it does from the `poor' person. Modern public finance theorists often consider the redistribution of wealth to be one of the legitimate responsibilities of government. It is a societal objective that a market economy itself is unlikely to deliver optimally. This leads theorists to argue for progressive rates of tax. Progressive rates are scaled rates, with the higher rates applying to those with higher capacities to pay tax. Progressive rates bring their own problems, however. They tend to compromise the criterion that a tax should be simple to apply and to collect (discussed below). By creating differentials in tax treatment, they foster schemes to exploit the existence of the lower tax scales. Most importantly, for a progressive tax scale to have legitimacy in terms of vertical equity, it must be shown that there is a correspondence between those persons attracting the highest rates of the tax and those persons having the greatest ability to pay. A flat rate tax on the receipt by taxpayers of Christmas food hampers from charitable organisations would be regressive. But a `progressive' scale under which the rate of tax imposed increased with the value of the charitable assistance received would likely be even more regressive in its impact. By way of illustration, the reader will find (in Chapter 2) that it is not clear to the members of the Taxation Policy Elective that there is a sufficient correspondence between the unimproved value of land held by taxpayers and their capacity to pay tax. As a consequence, we have recommended the introduction of a flat rate of land tax. In order to achieve vertical equity, there needs to be a correlation between the incidence of the tax itself, or of the higher rates of the tax, and the ability of the taxpayer to pay the tax. A tax will be most likely to achieve horizontal equity if it is broadly based (i.e. if the incidence of the tax is upon as many tax payers as possible) and contains as few exemptions as possible. The difficulty of designing taxes which achieve vertical equity is obvious, and advances in sophistication in the design of a particular tax may lead to losses in terms of simplicity. They may also give rise to opportunities for sophisticated schemes for avoidance. If there is a correlation between the capacity to pay tax and the capacity to pay tax advisers, then those who best avoid the tax may well be those for whom the complexities were specifically included. Western Australian, in common with all the States, is severely limited by constitutional and political realities in the design of taxes which achieve horizontal, let alone vertical, equity. Income tax, which does allow some direct correlations with the ability to pay, has been effectively denied to the States by political manoeuvring at the federal level. Broad based consumption taxes have been denied to the States through the High Court's interpretation of section 90 of the Commonwealth Constitution. (See Chapter 6.) It is arguable that the States will tend to overreach themselves if they attempt too much in terms of equity, especially vertical equity. There are other ways in which income redistribution can be achieved. Firstly, the federal Government is better placed to levy taxes which attempt to achieve vertical equity, and has in fact done so. Secondly, direct assistance in terms of the provision of Government services aimed at those in society most in need of Government support is a more direct, and arguably more effective, method of obtaining economic equity than tax breaks (or 'tax expenditures'). 3 EFFICIENCY One of the perceived virtues of a market economy is that the prices obtained for inputs and commodities, and the rewards available from investments of capital, will offer clear directions to taxpayers as to the most productive use of their various resources. One of the criterion by which taxes are judged is the extent to which they distort those prices, those rewards, and those uses of resources. The less distortion a tax causes, the more efficient (or economically neutral) it is considered to be. A particular tax may impinge disproportionately on some forms of resource use, reducing their relative attractiveness in comparison with alternative forms. This may well distort investment away from the more heavily taxed forms of production into less productive areas which offer greater `after-tax' returns. Similarly, if a tax is placed predominantly on a commodity that offers a high level of utility, it is likely that there will be some leakage of consumption into its less satisfactory substitutes. A tax is most likely to be economically efficient if it is broadly based and contains as few exemptions as possible. 4 SIMPLICITY Complex taxes impose costs of collection not only on Government tax officials but also on the taxpayers themselves. These costs include the costs of setting up and operating the mechanisms necessary to calculate the tax, employing and training staff to perform the necessary collection functions, the seeking of accountancy advice and legal advice, and the cost of litigating disputes. The benefits of any change to a taxation regime must be measured against the initial costs in terms of altering the ways taxpayers and Government officials must operate in order to collect the tax. Taxes will tend to be `simpler' if they have few exemptions and relatively few collection points (i.e. if the legal incidence of the tax rests on relatively few tax payers). A tax which has relatively few collection points is not necessarily a narrowly-based taxed when viewed from the perspective of `horizontal equity' or `efficiency' (though it may be). The extent to which it does offend the latter principles of good tax design will depend on the extent to which the legal incidence of the tax varies from the true economic incidence. A tax on the wholesalers of a particular type of commodity may simply be built into the price of that commodity. (The extent to which this will be possible will depend on a number of factors including the elasticity of consumer demand for that commodity and the availability of close substitutes not subject to the tax.) If the tax is passed on in this way it will ultimately be borne by the consumers of the commodity so that the tax will have a substantially broader base than it would at first appear. The `ideal' nature of the criteria by which taxes are usually judged must always be kept in mind. It is unlikely that the practical application of any tax would satisfy even one of the criteria perfectly . As those criteria are frequently in conflict with each other, even theoretical tax design becomes a matter of compromise. For example, progressive rates and tax-free thresholds designed to achieve vertical equity usually involve costs in terms of the objective of simplicity. Nevertheless, the various tax policy criteria suggest that Governments should favour broad based taxes with as few exemptions and concessions as possible. 5 REVENUE RAISING It is important not to lose sight of the fact that the prime objective of most taxation is the raising of revenue. It is true that tax breaks and tax levies can be used as indirect incentives in the pursuit of social and economic policies - though taxation is arguably too blunt a tool to be as effective as direct expenditures or penalties. Changes to tax regimes may produce gains in terms of equity, efficiency or simplicity. But their net effect will be a retrograde one if they significantly compromise a tax's revenue-raising capacity. Proposals for tax reform are best made in the context of `revenue neutrality'. It must be shown that any loss of revenue can be made up by other taxation measures, and that those additional measures do not in turn undermine the policy gains which motivated the change in the first place. Again, a broadly-based tax is likely to be one which holds up well in terms of revenue yield. Narrowly-based taxes may, in general terms, be more subject to the idiosyncrasies of the markets on which they impinge. In general, the proposals for reform contained in this Review tend towards broadening the base of the individual taxes and imposing the taxes at a flat rate or uniform rate. In line with our discussion above, a broader tax base is considered to improve the equity and efficiency of those individual taxes(1) and to improve simplicity where the broader base results from reducing or removing exemptions from the taxes.(2) Adoption of a flat or uniform rate is also justified on the grounds of equity, efficiency and simplicity.(3) However, one needs to be cognisant of the constraints upon reforms in the area of tax policy(4) and any recommendations need to be assessed with these constraints in mind to determine if they are realistic or not. Once these constraints have been identified, means of minimising the effects of these constraints need to be examined. 6 INTERNAL CONSTRAINTS Budgeting, political and departmental resource constraints are internal constraints insofar as they relate to aspects within the control of Western Australia. The main budget constraint is the State's need to raise a certain level of annual income to fund its activities. Changes to the tax system must ensure that this level of income is maintained. Revenue neutrality needs to be attained overall, either by ensuring that any changes made within a particular tax are revenue neutral or by ensuring that a decline in revenue from one area of taxation is compensated by a rise in another area. The changes proposed for land tax could achieve a revenue neutral result for the tax itself(5) or, with increases to the rate, achieve revenue neutrality for the system as a whole by compensating for changes in the tax mix.(6) Revenue neutrality could be maintained in most areas of Western Australian taxation, especially where we have recommended an increase in the respective tax bases (the exception being stamp duties where there are proposals for abolishing many areas of duty). Increases in rates for taxes which are inherently broad- based (such as Land Tax, FID and, arguably, Payroll Tax(7)), as well as those which have the potential to become broad- based (such as Debits Tax and Business Franchise Fees(8)), could be used to achieve revenue neutrality in the tax system where there are changes in the tax mix. The broader the tax base, the less the rate would have to be increased to realise the extra revenue required to achieve neutrality for the system. However, the ability to increase rates is also subject to other constraints, as will be seen below. The political constraints on tax policy reform include the reluctance of governments to make changes where there may be political ramifications such as electoral backlash. Whereas the abolition of areas of stamp duty may not give rise to this problem, it would inhibit the abolition of many of the exemptions to taxes which have been proposed, especially those relating to primary industries, charitable and non-profit organisations and the family home. There are techniques which could be applied in marketing and implementing the removal of these exemptions which could improve their public acceptability. However, it may be over- estimating the political boldness (or naivety) of our elected representatives to suggest that they would contemplate implementing these changes.(9) Political constraints may remain a substantial impediment to meaningful reform. While many of the proposals contained in this review may be considered to be politically impossible when considered in isolation, it is possible they may be somewhat more palatable when taken as a package and placed into the broader political context. In its own taxation reform platform, the current government has emphasised a lessening of the pay-roll tax burden on business as a mechanism for encouraging an expansion in employment. The abolition of pay-roll tax does not seem feasible at this stage. But the abolition of certain stamp duties in favour of more broadly-based financial transaction taxes may offer some relief to business: and the broadening of the land tax base certainly would. It would be hard to overestimate the likely extent of resistance to the abolition of the major land tax exemptions. But on the other hand, these are so extensive that abolishing them would allow for a substantially reduced rate of land tax. That new lower rate of tax would be substantially less unpalatable than the current rates. The public might find more palatable still a compromise under which a tax-free threshold is applied for those currently in the exempt categories. While such a measure lessens the attraction of the reform from a pure policy point of view, it would still allow substantial improvements in the tax regime to take place. Similarly, given the political realities, we have recommended the retention of the current threshold for pay- roll tax. It would be difficult for the current government to broaden the pay-roll tax base. However, if the flat rate of pay-roll tax that we have recommended were to be adopted it is likely that many of the arguments against imposing the tax on smaller businesses would carry less weight: the tax would be simpler to collect and most of the information needed to calculate it is already be compiled by such businesses for other purposes. Again, a broader base would allow for a lower rate of tax - any added costs to particular businesses could be seen to be offset by falling rates of land tax and some reduction in stamp duty costs. More particularly, if the decision in the Capital Duplicators Case (see chapter 6) has the effect of rendering current business franchise licence fees unconstitutional, then the political environment will be much more suitable for radical taxation measures. The resources available to the Taxation Department are also a constraint on tax reform. There are limited staff and facilities available to implement and monitor changes to the tax system. However, because most of the reforms suggested in these pages contemplate simplifying the tax structure by removing exemptions and adopting flat rates, resources at the Taxation Department should in fact be freed up. 7 EXTERNAL CONSTRAINTS Other constraints to tax policy reform - constitutional, Commonwealth policy (Grants), mobility of the tax base and harmonisation - can be considered as external constraints on reform. They are external in that they are factors largely outside of the direct control of the State. Obviously, there is less chance of minimising the effects of these constraints than of the internal constraints and they are not matters that we have dealt with in detail in this review. However, they warrant some examination in the interests of determining long term or more ambitious reforms to the tax system. The constitutional constraint arises from the division of power between state and federal governments in the Commonwealth Constitution, particularly the exclusive jurisdiction of the Commonwealth to make laws with respect to excise duties.(10) It is not so much the division of power expressed in s 90 which has restricted state tax powers but the way s 90 has been interpreted. This is discussed in chapter 6. It has been suggested that changes be made to the Commonwealth Constitution by removing from s 90 the words "and of excise" to enable the states to broaden their tax base.(11) Although the chances of this occurring may be uninspiring, it is a worthwhile long term ambition. In the meantime the Capital Duplicators case presents itself as being a chance for the High Court to widen state taxation power enough to enable a broad-based consumption tax to be implemented. This outcome would enable the tax mix to be altered so some of the more inefficient and inequitable taxes (such as some stamp duties) could be removed. The constraining effect of Commonwealth Policy arises from the power of the Commonwealth, under s 96 of the Constitution, to make grants to the States on such terms as it thinks fit. The discretionary nature of this power effectively confers on the Commonwealth a financial control over the States sufficient to constitute a serious constraint in the direction in which the States' tax policies proceed. This is another area which warrants constitutional reform, or judicial re-interpretation,(12) to prevent the clandestine use of Commonwealth funding to effect State taxation policy. The final two external constraints on tax policy can be linked. The mobility of the tax base has been indicated as a constraint on substantially increasing the rates of duty on financial institutions and it was suggested that in order to increase the rate there should be uniformity between the States.(13) It is because there is variation in rates between the States that taxpayers will attempt to be taxed in one jurisdiction rather than another. The threat of losing part of the tax base due to the lack of uniformity between the States acts as a constraint on the States making changes which could improve the efficiency and equity of the tax system. Mobility of the tax base can be addressed by taxing activities or objects which can only occur within the State (land tax is an excellent example) or by imposing taxes which operate extra-territorially, where liability is based on some nexus with the State even when the activity occurs outside the jurisdiction (some stamp duties operate extra- territorially). One disadvantage of taxes which attempt to combat loss of the tax base is that they become complex, inefficient and difficult to administer. Perhaps a better solution is to promote harmonisation between the States. Increased co-ordination between the States in implementing tax policy would allow States to minimise the extent to which they compete with each other for the tax base. Better communication between States could identify areas of common taxation with potential for changes which could benefit all States if applied uniformly. Apart from allowing existing taxes to be improved, harmonisation could allow new taxes or taxes previously lost to competition between the States, such as inheritance tax,(14) to be reinstated. Admittedly the differing political agendas of each State may make harmonisation in some areas difficult. However, as States are marginalised more and more by Commonwealth initiatives they may see the need to unify in order to maximise their financial independence. Among the matters considered by the Elective were suggestions for pollution taxes and a comprehensive service tax as well as the ramifications of the current land tax for native title. However, the following chapters concentrate on a review of existing State tax regime. 8 OVERVIEW OF RECOMMENDATIONS In the short term changes should be sought to remove as many exemptions from existing tax bases as possible. Removal of exemptions offered to charitable and non-profit organisations could be removed with relatively political pain. Removal of land tax concessions given to primary producers and the family home would require a little more planning and may be medium term objectives. Proposals for implementing a broad-based sales tax should be examined in anticipation of a narrowing of the Commonwealth excise power. Betting taxes, stamp duties and existing business franchise licences should be "tidied up". The rates of betting tax should be standardised and many inefficient and inequitable stamp duties should be removed. The aspects of business franchise licences which have been identified as being possibly unconstitutional should be amended. Greater harmonisation with other states should be pursued to allow changes to be made to financial institutions taxes without incurring loss of tax base in this area. Harmonisation would enable the standardisation of payroll tax legislation so as to improve simplicity. To assist in implementing medium term reforms, more research needs to be undertaken to examine the likely economic effects of taxes such as payroll tax and gambling taxes and the likely effects (and associated benefits) of removal of exemptions for primary producers, charitable organisations and the family home. The possibility of establishing a hardship tribunal to deal with the new areas of tax should be examined. For the medium to long term, changes to the basic federal structure need to be examined. The existing relationship between the Commonwealth and State governments creates inefficient and inequitable taxation practices. Changes could be made to the Commonwealth Constitution, with the push at the federal level for Australia to become a Republic perhaps creating a greater willingness to re- examine some of the more troublesome provisions of that document. Notes: (1) See for example the chapters on: Land Tax pp 26-7; FID & Debits Tax pp 63-4 and 66-7; Payroll Tax pp 78-9. (2) See for example: Land Tax pp 22 & 25; Stamp Duties p46. (3) See for example: Land Tax p 25; Stamp Duties pp 39 & 48; FID & Debits Tax pp 69-70; Payroll Tax p 80; Betting Taxes p 167. (4) As many of the authors of the individual chapters have been. See for example: Land Tax p 23; Stamp Duties p 48; FID & Debits Tax p 69; Payroll Tax p 80; Licences p 84. (5) See Land Tax p 20 at fn 43. (6) See p 27. (7) The broadness of the base of payroll tax depends on the likely economic incidence. This is seen to fall on employees and consumers: see Payroll Tax p 73, especially fn 144. (8) Broadening the base of business franchise fees would require a relaxation of the definition of areas of excise prohibited to the States, which may or may not occur after the _Capital Duplicators_ case is decided: see chapter 6 at p.87. (9) The failure of the Federal Liberal party to gain wide support for its proposed Goods & Services Tax prior to the last Federal election in spite of adopting many of these strategies may indicate how unappealing these kinds of changes may be with politicians. (10) Other aspects of constitutional constraints relate to freedom of interstate trade under s 92, and Commonwealth immunity from state taxation, which are discussed in the New South Wales Tax Task Force, *Tax Reform and NSW Economic Development: Review of the State Tax System*, August 1988, at pp 371-73. (11) Id, at pp 370-71. (12) Cf. the judgement of Dixon DJ in the _Second Uniform Tax Case (Victoria v the Commonwealth)_ (1957) 99 CLR 575 at 609. (13) See the FID & Debits Tax chapter at p 69. (14) New South Wales Task Force, op cit, p 378.