Gavin R. Putland,  BE PhD

Tuesday, April 17, 2012 (Comment)

Australia's payroll taxes are probably unconstitutional

Payroll tax is a tax on the value of labour, including the labour embodied in goods. Thus, in substance if not in form, it amounts to a duty of excise on the affected goods. In Australia, payroll taxes are imposed by the States and Territories. But under s.90 of the Australian Constitution, only the Federal Parliament may impose duties of excise.

In Ha v. NSW (1997), the High Court held by a 4-3 majority that an excise is "an inland tax on a step in production, manufacture, sale or distribution of goods". If paying the workers is such a "step", that definition would sink payroll tax.

The dissenting Justices preferred a narrower definition of excises, saying that the purpose of s.90 was to "prevent impairment by the States of the common external tariff," so that "A State tax which fell selectively upon goods manufactured or produced in that State would be an excise duty..." A domestic payroll tax on labour embodied in goods manifestly discriminates against locally produced goods because it is not levied on the corresponding labour embodied in competing imported goods.

So the contention that payroll tax is an excise would have found support on both sides of the Court. (But I'm not a lawyer and this article isn't advice!)

It is no defence to say that payroll tax is not levied on goods per se. As Sir Samuel Griffith wrote in Peterswald v. Bartley (1904), "In considering the validity of laws of this kind we must look at the substance and not the form." The majority in Ha v. NSW quoted this with approval and added: "In recent cases, this Court has insisted on an examination of the practical operation (or substance) of a law impugned for contravention of a constitutional limitation or restriction on power." The minority agreed, saying: "Whether a tax which falls upon locally produced goods discriminates against those goods in favour of imported goods is a question of substance, not form." Elsewhere in the judgments, one can find some support for the view that faulty form is enough to invalidate a law, but none for the view that faulty substance is not enough.

The emphasis on substance over form is interpreted as a repudiation of the "criterion of liability" test formulated by Kitto J. in the Dennis Hotels case (1960). But even if that test were revived, it would not necessarily salvage payroll tax. In Kitto's words, "a tax is not a duty of excise unless the criterion of liability is the taking of a step in a process of bringing goods into existence or to a consumable state, or passing them down the line which reaches from the earliest stage in production to the point of receipt by the consumer." Kitto held that the sale of similar goods in a previous accounting period was not such a step. He could hardly have said the same about paying the workers employed in bringing the present goods "into existence or to a consumable state, or passing them down the line..."

It is immaterial that payroll tax captures the labour content of services as well as goods. A constitutional prohibition on taxing goods (as in the majority definition) was surely not meant to be circumvented by taxing services as well; indeed, in WA v. Chamberlain Industries (1970), the High Court held that a tax on receipts of money was an excise although the tax made no distinction between payments for goods and payments for services. Similarly, a constitutional prohibition on a tax that discriminates against locally-produced goods (as in the minority definition) was surely not meant to be circumvented by discriminating against locally-provided services as well. If the purpose of s.90 is to let the Commonwealth decide between protection and free trade (as in the minority definition), that decision is no less relevant to services than to goods, especially in this age in which technology has lowered barriers to international trade in services. Moreover, if a tax affecting goods and services alike is not an excise, then the GST is not an excise! Yet it was never thought that the States had the power to impose the GST. That is why the Commonwealth imposes the GST and grants the revenue to the States, with the result that the Commonwealth and the States blame each other for underfunding of State services.

The payroll-tax threshold impedes economies of scale in two ways. First, it directly creates a diseconomy of scale: as soon as the total enterprise payroll exceeds the threshold, the tax adds to the marginal cost of labour and therefore the cost of its marginal product. Second, to the extent that payroll tax favours smaller enterprises, it deters them from growing and therefore protects established players from new competition. Both mechanisms tend to raise prices, including prices of goods.

Does the prohibition of State excises extend to the Territories? Yes, according to a 4-3 decision of the High Court in the case known as Capital Duplicators No.1 (1992). The precise question referred to the Full Court was: Does Ch.IV of the Commonwealth Constitution operate so as to preclude the Legislative Assembly of the Australian Capital Territory from exercising the power to impose duties of excise within the meaning of s.90 of the Constitution? The three Justices who answered in the negative (Mason C.J., Dawson and McHugh JJ.) held that the Federal Parliament's power to impose excises could be and had been delegated to the ACT Legislative Assembly. Of the four who answered in the affirmative, three (Brennan, Deane and Toohey JJ.) held that the Federal Parliament could delegate powers to subordinate legislatures but had not done so, while one (Gaudron J.) seemed to imply that no such delegation would be possible in the case of the exclusive power to impose excises.

That said, six of the seven Justices thought that the Federal Parliament either had authorized or could authorize the Territories to impose duties of excise. But it could not authorize the States to do the same.


Short of outright abolition, the only reform of payroll tax that might comply with s.90 is to replace the enterprise-level threshold with a threshold for each employee. If the new threshold were high enough to exempt most workers whose wages are accounted as production costs (as opposed to overheads), then the connection between the tax and prices of goods would become more tenuous.

But of course it would be safer to abolish payroll tax altogether. The difficulty of that task has been greatly exaggerated. Here's my most comprehensive and politically saleable proposal for getting rid of payroll tax and much else: Here's a more limited proposal that replaces payroll tax and GST and incorporates a novel solution to vertical fiscal imbalance: And here's one that can be implemented at State level, replacing not only payroll tax but also the existing State property taxes: Or if you prefer simplicity, the total revenue from payroll tax and the existing selective land tax could be replaced by an all-in land tax at a rate of about 0.8% per annum.

On past form, however, the High Court will probably have to pull the plug on payroll tax before any alternative is seriously considered. In the mean time, payments of payroll tax should be marked "PAID UNDER PROTEST" in order to maximize the chances of a refund in the event that the tax is found unconstitutional.

[Based on a letter submitted to the Age, Sep.4, 2009. Last modified May 22, 2013.]

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