Give States Back Their Ability to Raise Revenue

Malcolm Turnbull’s announcement on March 28 this year to give part of income taxing powers to states was received well by federalists. This however was not well received by the premiers of each state, excluding Colin Barnett, and resulted in Turnbull shelving the proposal three days after announcing it. The justification for this policy shift was that currently the states are left with the most inefficient taxes to raise revenue, and little ability to raise it themselves. This is shown when we see that state governments only raised $68.7billion of $435.9billion revenue raised by all levels of government in 2013-14, with the federal government raising the lion’s share at $353.1billion.[1] The three biggest revenue raisers for government being income tax, corporate tax, and the Goods and Services Tax respectfully which are all collected on a federal level.

This leaves state governments’ heavily dependent on the federal government to help pad their coffers, with over $50.2billion[2] being returned to the states from revenue raised on GST in 2013-14. And this is why the Turnbull government was looking at the option of returning part of the income taxing powers to the states as it would mean that the federal government wouldn’t haven’t to foot the bill for various state government projects, helping remove bureaucratic inefficiencies from double handling. But when we look at competitive federalism we need to be able to have efficient competition, and while income tax competition does that in part it doesn’t address the source of the problem.

When we bring competitive federalism into the fold we need to look at what is best going to affect supply in those areas, resulting in the boost in economic activity. Dropping income taxes may result in an increase in the labour supply but in general people will not be moving from areas where they hold a job to areas they don’t just for a percentage point or two reduction in their income tax. This would likely hold true if there were great opportunity interstate but unless there are other competing factors in other states and territories the labour demand largely would remain unchanged. As a result we would likely see each state either leaving the income tax level unchanged or funding decreases through more deficit spending.

This is where we have to begin looking at supply side solutions to these problems, especially when there are a number of economists that believe Australia is at the peak of our Laffer Curve on income tax. Of course there is never a wrong time for a tax cut, but when revenue is the key indicator you need to get more creative with your taxation strategies to not harm growth but to also to keep revenue levels up, especially in situations where our debt levels are by far beginning to exceed our ability to pay.

In the 2013-14 tax year company tax receipts were equal to $67.3billion[3], almost the same amount as raised by all state taxes combined. While there is no data on where company tax is collected we are able to make rough estimates from the statistics relating to entities incomes and profits by state for the 2013-14 income year. While this doesn’t give the exact figures of tax receipts aggregating the results to the profitable areas of industries gives us an estimated total tax receipts of $68.4billion, this variation could be for any number of reasons. Obviously aggregation has occurred with these statistics and they don’t account for tax credits and a range of other factors. From these numbers we can look at the state breakdowns; that is the estimated amount of tax revenue raised by each state.

 

Estimated Corporate Profits by State ($mil)[4]
ACT NSW NT QLD SA Tas Vic WA Unknown Total
$1,101.8 $79,591.4 $594.6 $23,490.2 $6,739.8 $1,279.0 $85,272.4 $28,078.1 $1,767.6 $227,915.0

 

 

Estimated Corporate Tax Receipts by State 2013-14 ($mil)
ACT NSW NT QLD SA Tas Vic WA Unknown Total
$330.5 $23,877.4 $178.4 $7,047.1 $2,021.9 $383.7 $25,581.7 $8,423.4 $530.3 $68,374.4

 

With these numbers we can compare how well off a state would be in relation to their current GST funding.

GST Distribution 2013-14 Budget ($mil)
ACT NSW NT QLD SA TAS VIC WA Total
$1,021.8 $15,557.9 $2,756.0 $10,740.9 $4,595.0 $1,800.5 $11,320.3 $2,457.5 $50,250.0

 

A quick analysis of these figures and you can see that the states with lower populations would be negatively affected if states were given corporate taxing powers in exchange for the federal government taking all of the GST revenue. While NSW, VIC, and WA are all significantly better off. This is all assuming that no tax rate changes are undertaken. What however is likely to occur is that to encourage business investment states would compete on the corporate tax rate, this would not only encourage foreign businesses to invest in Australia but incentivise companies to move interstate to help minimise their tax. A side result of this would hopefully make the decision of corporate tax cuts much easier to make as not only would we be competing globally but also locally as well. This local competition would move labour force demand to where companies are relocating and result in greater investment due to the likelihood of lower tax rates. This would be of greatest benefits to areas like Tasmania, and South Australia, which do not have the large population centres of other states so it makes it harder for them to compete for business investment.

As a result we would ideally see state governments taking on a greater role for their own fiscal security, without relying on the inefficient taxes such as payroll and stamp duty. Nor would the federal government be expected to foot the bill for state fiscal mismanagement and would result in a large reduction in costs associated with the federal government passing money to the states.

Moving towards a competitive corporate tax system would have greater benefit than that of a competitive income tax system. While income taxes aren’t likely to change supply all that much, they do change behaviour in terms of minimisation strategies and this would be the largest benefit to be achieved out of returning income taxing powers to the states. Corporate tax competition however would be more likely to act in the intended fashion, with states competing for corporate investment. As this would likely create a more friendly business environment this would result in labour demand being shifted to the more friendly business states, as they drop their corporate rates to try to capture a larger share of investment. As this occurs there would likely be greater overall investment, doing more to grow the overall economic pie and flowing on more to the everyday Australian in a much more unseen way than the in your face income tax restructure.

[1] ABS: Adjusted Measures of Government Revenue

[2] Federal Budget Papers 2014-15 Budget Paper 3: General Revenue Assistance

 

[3] Budget Papers 2015-16: Statement 4: Revenue

[4] Please note I’ve not subtracted the loss making parts of the industries from this as they don’t get given tax dollars in return to compensate for their loss

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