PAYROLL TAX - A TAX ON ECONOMIC GROWTH & INCENTIVE

In a recent AFR article, 'Rudy's recipe for a thriving metropolis' (19th August 2003), Guiliani (former Mayor of New York) said:

"My general philosophy is as few taxes as possible. Lower taxes and put money in the economy and individuals will use the money in more creative ways than government will. That includes developing businesses which will employ people".

When Australian State payroll tax was explained to him, he was bemused.

"I don't understand that. We have about 20 forms of taxation in New York City, and some of them are strange, but nothing like that one!"

In a recent survey conducted by Australian Business Limited, the issue of payroll tax (PRT) was one of the issues top of mind to business.

Of all the businesses with more than 20 employees surveyed, 74% said that PRT was either an extremely or very important issue. Those businesses with 11-20 employees regard a reduction in PRT as being equally important as action to reduce or eliminate other State Government business taxes.

With rates ranging from 7.85% in the ACT to 4.75% in Queensland, State Governments are taxing business on the total wages paid or payable above varying thresholds. SA Government collects nearly $1 billion in payroll tax revenue. Whilst this sounds a lot, it is also filling its coffers with extra GST and stamp duty revenues, which have been largely unexpected.

Effective from 1st July 2003, in New South Wales the definition of wages for the purpose of payroll tax now includes share options and termination payments for non-executive directors. Both New South Wales and Victoria have removed the payroll tax exemption on wages paid to trainees and apprentices.

The changes continue to make it more expensive to employ people. Many businesses resist employing extra staff to avoid being pushed over the threshold or to reduce their payroll tax. This practice is keeping some businesses inefficiently small. This is bad for the business and bad for economic growth.

So, let's look at PRT in a bit more detail.

Payroll tax is an important component of state revenue (refer Table 1) and rivals property taxes as a leading source of State based revenue. The importance of payroll tax in funding a significant proportion of State Government activities and services should not be underestimated.

Table 1: Sources of State Taxation Revenue 2002/2003 - Estimated Result

Data Source: South Australian State Government Budget 2003/2004 - refers only to State taxation revenue, not including sales of goods and services, other revenue and Commonwealth Grants (see section 1.3 of budget).

Previous examination of payroll tax has highlighted that there exists within much of the business community a strong sentiment that the tax acts as a disincentive to employment as well as a brake on exporting. Export activity can, in fact, be hindered by the operation of a payroll tax. Predominantly, this is attributable to the inability to pass on the costs of a payroll tax to international consumers, given the usual price sensitivity to be found in export markets.

The impact of the payroll tax can also be seen to be somewhat uneven (beyond the somewhat arbitrary threshold level), given that firms subject to the payroll tax that are relatively labour-intensive in their structure will tend to be disproportionately disadvantaged in their operations compared to capital-intensive businesses where labour costs are a smaller proportion of overall expenses.

Table 2 below indicates (by firm size) the incidence of payroll taxation. The table clearly indicates that the burden of payroll tax falls almost exclusively on firms employing greater than 20 people but that the overall proportion of firms eligible to pay the tax is relatively small (less than 10%). South Australia is largely average by these measures, although the proportion of firms in the 20-99 employee range subject to the tax is relatively high - possibly explained by the threshold in South Australia being relatively low at the time.

Table 2: Proportion of Private Sector Firms Paying Payroll Tax by State/Territory

Data Source: Productivity Commission Report, "Directions for State Tax Reform", 1998. Updated figures not available at time of report writing.

The distribution of firm size within the local and national economy has an implication for any refinement of threshold levels. The vast bulk of firms are those that employ less than 20 people, which (notwithstanding wage differentials across individual firms and industries) generally means any threshold above a very low level will capture the same group of firms as the current threshold does. The inherent narrowness of the payroll tax is only offset to some extent by arguments about the relative costs of collection for smaller firms versus larger firms.

Of significant importance to the South Australian business community is the level of payroll tax faced in comparison with interstate competitors. Table 3 indicates the latest thresholds and tax rates for all Australian States and Territories. The table shows a consistent downward trend in payroll tax rates (and in many cases, increases in the threshold level) that has marked every jurisdiction in recent years. Payroll tax is one of the few ways in which a State can provide a competitive advantage to a firm and has, therefore, been a focus of recent taxation reform. If nothing else, the payroll tax rate has become a proxy for 'business friendly' positions of State Governments.

Table 3: Payroll Tax - Maximum Rates & Exemption Threshold for Australia, 1/7/2000 - 1/7/2003

* WA rates begin at 3.65% and phases up to 6% for wages beyond $675,000

Data Source:

(b) Individual State & Territory websites

As can be seen from Table 3 above, South Australia is very much a middle-ground State with respect to the rate of taxation, although it now has the lowest threshold of any jurisdiction in the country. Although South Australia is also a relatively low-wage State by national standards, the comparison with States such as Tasmania (which has an even lower average wage) is not (on the surface) flattering.

Businesses in South Australia that can no longer carry the burden of high payroll tax and workers' compensation premiums are packing up office and moving across our borders. Great for Queensland and Victoria, bad for South Australia.

One way to drive growth and the best way to improve welfare for people in SA or any State, for that matter, is to create and sustain as many jobs as possible. In general, Governments around the country must, therefore, look at reducing the levels of payroll tax in the long term.

However, given our growth prospects and ageing population in SA, we need to be bolder than other States. Why shouldn't SA lead the nation and take action to eliminate this hideous tax. If this is not politically acceptable, we should at least consider the following:

• Provide an amnesty for non-compliance for a period of 6 months (say) to bring more businesses into the net.
• Variance of threshold and rate approach (possibly via indexing). On the basis that any change would be revenue neutral, there is some scope to at least consider realignment of the applicable threshold (and any necessary change in the taxation rate to balance revenue). The difficulty with this approach is that the distribution of firms is such that a reasonably large movement in the threshold is unlikely to do more than exempt a relatively small number of firms from paying payroll tax whilst shifting a heavier burden onto an even smaller number of firms.

The 'kick-in' point of the tax will be shifted, but with more or less the same effect on the relevant marginal firms. Another possible approach to this problem might involve indexing the threshold to the CPI or other regular benchmark, to ensure the 'real' level of the threshold is not eroded over time. It should be borne in mind that South Australia now has the lowest threshold for payroll tax eligibility which, from a marketing perspective alone, is not favourable for the State.

• Adopt a multi-phase approach (as per WA). At present, in the marginal case, a firm faces an all or nothing transition into payroll tax. The hiring of a new employee may push a firm across the threshold, and then lead to the full rate of taxation levied on their entire wages bill. Perhaps a better or alternative approach involves phasing in the payroll tax at a lower rate than the current rate, then slowly increasing it in 'bands' of thresholds until the maximum rate is reached. Although a more complicated to administer scheme, it does provide some relief at the margin for a firm that is essentially on a knife-edge of paying either zero payroll tax or the full rate on their entire wages bill.
• SA is out of kilter with other States and is, therefore, uncompetitive. Consider increasing the payroll threshold to $1 million.
• Shift burden from small to large business.

If the SA Government were to implement any or a combination of the above successfully, it would not only attract SMEs from other States, it would more than likely, create additional revenue through their creativeness which would help invigorate the State and business sector.

Tony Martin - Director

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