Gavin R. Putland,  BE PhD

Friday, December 07, 2012 (Comment)

Draft Federal Budget Speech, 2013-14

By Gavin R. Putland.* (P.S.: See also Maximalist ‘fiscal devaluations’ for Greece and Australia.)

Madam Speaker: This Budget will eliminate unemployment in Australia. It will do this by eliminating four categories of taxes: first, and most importantly, taxes that cause the cost of hiring a worker to be greater than the worker's take-home pay; second, the quarter of a trillion dollars per annum of reverse tariffs that hold back Australian producers while lacking any non-fiscal rationale (such as pollution reduction); third, property taxes that penalize the construction of housing and business accommodation; and fourth, taxes with unnecessary compliance costs. Of course there is considerable overlap between the categories.

Under the last category, the existing GST will be abolished from 1 July 2013.

Of all the taxes that raise the cost of labour above the worker's take-home pay, the most obvious offender, and the biggest offender in terms of revenue, is PAYG personal income tax. If personal income tax were simply abolished, the biggest tax cuts, not only in dollar terms but also in percentage terms, would go to those on the highest incomes. Meanwhile, whatever replaced personal income tax would presumably cause a rise in prices, for which the elimination of personal income tax would overcompensate high-income earners and undercompensate low-income earners, widening the gap between rich and poor. That outcome is unacceptable to this Government.

Accordingly, from 1 July 2013, employers will keep the PAYG income tax that they withhold from employees and contractors; but the employees and contractors will still receive credit for the withheld tax as if it had been paid to the ATO on the grossed-up incomes.

Allowing employers to retain the tax that they withhold from employees and contractors is the most innovative component of this Budget. It reduces the cost of labour as seen by employers, without reducing the workers' take-home pay, and without widening after-tax wage relativities. Unlike the outright abolition of personal income tax, it gives employers an income from which they can pay any alternative tax without having to raise prices. If that alternative tax is levied on anything but labour, it will preserve the desired reduction in the cost of labour as seen by employers, without reducing the workers' take-home pay.

Regrettably, this arrangement fails to eliminate the compliance costs of PAYG personal income tax, making it more necessary to reduce compliance costs in other ways. This Budget takes up the challenge.

Income tax in all its forms, except capital gains tax and resource-rent taxes, is a tax on production and therefore raises prices. In the national accounts, income is synonymous with value added. Hence an income tax is a value-added tax. But because income tax penalises income earned in production of Australian products while sparing income earned in production of imported products, it amounts to a value-added tax without border-adjustment. In other words, it's a reverse tariff. At about $200 billion per annum, it's by far the biggest reverse tariff in the Australian tax system. But the true nature of the tax is disguised by labelling “value added” as “income”, separating the value added by labour from the value added by capital, and taxing the former under the guise of “personal income tax” and the latter under the guise of “company tax”.

In this Budget, as I have already implied, personal income tax will remain but employers will keep the PAYG component. Company tax, other than capital gains tax and resource-rent taxes, will be abolished from 1 July 2013.

The second-biggest reverse tariff, and the second-biggest reason why the cost of hiring a worker exceeds the worker's take-home pay, is the Superannuation Guarantee. A Federally mandated, employer-funded 9% super contribution is equivalent to a Federally funded 9% contribution paid for by a 9% Federal payroll tax. Of course that 9% is soon to become 9.25%. And a payroll tax is a reverse tariff because it taxes the labour content of Australian products but not imported products.

Accordingly, from 1 July 2013, employers will no longer have to make superannuation contributions or pay the Superannuation Guarantee Charge. Instead, each person's 9.25% superannuation contribution will calculated on the income that the person declares for tax purposes, and paid by the Government out of general revenue.

If the necessary contribution to “general revenue” is paid by employers instead of the Superannuation Guarantee, it will not require employers as a class to find any additional income, and will therefore not cause any overall rise in prices. Again, if that contribution is levied on anything but labour, it will preserve the desired reduction in the cost of labour as seen by employers, without reducing the workers' take-home pay.

The third-biggest reverse tariff, and the third-biggest reason why the cost of hiring a worker exceeds the worker's take-home pay, is payroll tax, which taxes the labour content of Australian products but not imported products.

Accordingly, under this Budget, the Commonwealth will use its conditional grants power to compel the abolition of State payroll taxes from 1 July 2013. The States will be compensated by increased grants from the Commonwealth, funded out of general revenue.

(And tonight, Madam Speaker, when I say “the States”, I obviously mean the States and the Territories.)

If the necessary contribution to “general revenue” is paid by employers instead of payroll tax, it will not require employers as a class to find any additional income, and will therefore not cause any overall rise in prices. Again, if that contribution is levied on anything but labour, it will preserve the desired reduction in the cost of labour as seen by employers, without reducing the workers' take-home pay.

Madam Speaker, under Australia's constitutional arrangements, the primary responsibility for public investment in infrastructure rests with the States, which delegate some of that responsibility to local councils. The benefit of a public infrastructure project is manifested in higher property values in locations served by the project. More precisely, it is manifested as uplifts in site values, which are also loosely called land values or unimproved values. So, if the tax system captures a sufficient percentage of each uplift, the project will pay for itself by expanding the revenue base, without increasing tax rates, and without burdening taxpayers who don't share in the benefit. Accordingly, from 1 July 2014, Commonwealth grants to the States will be subject to the following conditions:

  • First, the States will require local councils to raise at least 80% of their own-source revenue from general rates on site values, and the rest from service charges, with effect from 1 July 2014. Because site values don't include values of buildings, the new rating system won't penalize construction. To ease the transition, year-on-year percentage increases in general rate bills, including any increases that coincide with the change in the rating system, will be capped in real terms. The caps will be determined by local councils — not imposed from above. In addition, councils will be given the unfettered right — if they don't already have it — to defer rate payments from property owners who are asset-rich but income-poor, until their properties are sold in the normal course of events. No home owner should be forced to sell in order to pay rates.
  • Second, insurance taxes, emergency service levies, conveyancing stamp duties, betterment levies, infrastructure levies on developers, and the existing land tax (not to be confused with local rates) will be abolished.
  • Third, in lieu of the abolished taxes, the States will levy a “vendor duty” on all capital gains on property realized after 1 July 2014. Property owners who have paid the old stamp duty more recently will be automatically compensated because their capital gains will be smaller. As buildings don't appreciate in value, except by way of capital expenditure which is deductible against capital gains, the vendor duty will automatically avoid penalizing construction of housing and business accommodation. The rate of the vendor duty, and whether that rate is applied to real or nominal capital gains, and whether there are any concessions for the family home or any further transitional arrangements for properties purchased before tonight, will be matters for the individual States.
  • Fourth, the owner of any property bought after 1 July 2014 will be allowed to pre-pay the vendor duty in the form of an annual charge equal to a percentage of the current site value. Further details — including the percentage, and whether the pre-payment will be compulsory for certain classes of properties or owners — will be matters for the individual States.

Madam Speaker, just as no home owner should be forced to move because of council rates, no home owner should be forced not to move because of stamp duty. The existing stamp duty tends to lock home owners into their current addresses, and discriminates against home owners who move frequently. The new vendor duty will reduce the lock-in effect, because a property sale will not create a tax liability, but will realize an existing liability. It will reduce the discrimination, because home owners who move more frequently will no longer pay a proportionally higher amount of stamp duty over their lifetimes, but will pay their vendor duty in a larger number of smaller steps. Property owners will be better off, because the new vendor duty, unlike the old stamp duty, will be guaranteed not to turn a capital gain into a capital loss or to magnify a loss, and because the vendor duty on the capital gain will give the States an incentive to invest in infrastructure that raises property values. Expectations of new infrastructure, together with the restoration of full employment, will revive property markets and thereby restore State Budgets to surplus.

To make room for the vendor duty, the Federal capital gains tax on real property will be abolished for properties sold after 1 July 2014. In other words, the opportunity to tax capital gains on real property will be surrendered to the States, in return for the abolition of all existing State property taxes.

The replacement of a stamp duty on the purchase price by a vendor duty on the capital gain will obviously improve the competitive position of first home buyers, who by definition have no capital gains to tax. Indeed, the advantage conferred on first-time buyers by this change will be several times larger than that conferred by the First Home Owners' Grant. Accordingly, the First Home Owners' Grant will be abolished from 1 July 2014.

Madam Speaker, it remains to announce what new tax will replace the revenue from PAYG personal income tax, company tax, the GST, the Superannuation Guarantee, and payroll tax. All else being equal, the aggregate revenue that enterprises save — in PAYG personal income tax, company tax, GST, superannuation and payroll tax — would balance the aggregate revenue that they pay out under the new tax, so that the overall price level would be unchanged. But of course all else is not equal, for three reasons.

  • First, the restoration of full employment will obviously reduce expenditure on welfare, so that not all of the revenue from the old taxes will need to be replaced by the new one.
  • Second, the restoration of full employment will expand the economy and therefore expand the base of the new tax. So, for any required amount of revenue, the required rate of the new tax — and therefore its effect on prices — will be less than it would be at the current size of the economy.
  • Third, replacing several taxes by one tax will reduce compliance costs, which feed into prices as surely as any tax.

For all these reasons, replacing the five old taxes by one new tax will reduce the overall cost of living — provided, as always, that the new tax base is not labour income. To satisfy this requirement with the least possible disruption, the Government has chosen a border-adjusted “cash-flow tax” (or “CFT”), as suggested in Chapter D1 of the Henry Report, with exemptions for financial services, residential rents, and all entities small enough to qualify for input-taxed status under the old GST. Treasury estimates that such a CFT would balance the Budget, while causing a one-off 3% fall in the CPI, if the rate were 25% on the tax-inclusive base [1].

Accordingly, from 1 July 2013, Australia will impose a border-adjusted CFT on at a rate of 25% on the broadest possible base, except that whatever is input-taxed under the old GST will be exempt under the CFT. In other words, if you are registered for CFT, you will subtract your domestic purchases from your domestic sales and send 25% of the difference to the ATO. The restriction to “domestic” purchases and sales is the “border-adjustment” which will make the CFT a consumption tax rather than a production tax. There will be no tax invoices. Hence you will be able to claim credit for all purchases from domestic suppliers even if they are exempt.

Thus we will end the present ridiculous situation in which enterprises that are small enough to be input-taxed are forced to register for GST, just because their prospective customers want tax invoices. It will also put an end to “sticky GST” — that is, GST which is hidden in prices charged by input-taxed entities but can't be claimed back by their GST-registered customers. In consequence of this mechanism, we now have GST on GST. But we won't have CFT on CFT.

By doing away with tax invoices, and by leaving PAYG personal income tax in the hands of employers, this Budget will end the iniquitous practice of compelling small business operators to work as unpaid tax collectors. In future, businesses will be payers of CFT, not collectors of GST and personal income tax.

The abolition of company tax and of the associated deductions for interest will reduce the present bias in favour of debt finance over equity finance, offsetting the advantage caused by the CFT-exemption of financial services.

In the unlikely event that border-adjustment of a CFT is found to contravene WTO rules, the enabling legislation will provide for the CFT to be turned into a retail tax at the same rate on the same base, measured by final consumption rather than value added. Consequently, no country will have anything to gain by questioning the legality of the CFT. The Government concedes that in the long term, the retail-tax option would further reduce the cost of living by further reducing compliance costs. However, the Government believes that the CFT, being based on natural accounting practices, would allow a smoother transition from present arrangements.

Madam Speaker, the Members opposite will be quick to point out that a rate of 25% on the tax-inclusive base is equivalent to 33⅓ % on the tax-exclusive base. The existing GST rate is quoted on the tax-exclusive base because the tax is collected by the invoice-credit method and coexists with company taxes calculated on GST-exclusive incomes. However, the CFT works more easily with the tax-inclusive base and doesn't need to coexist with company tax, because that's being abolished! Moreover, because most of the revenue to be replaced comes from income tax, which is on an income-tax-inclusive base, it is appropriate to quote the tax-inclusive CFT rate for purposes of comparison.

While the Members opposite are free to play numerical games with the rate of the new CFT, the bottom line is that the replacement of five existing taxes by the new CFT will reduce the cost of living.

While the Members opposite are free to describe the CFT as a great big new tax, the bottom line is that one great big new tax is better than five great big old ones, which together raised more revenue and had a greater effect on prices. That is especially the case when the CFT will not add to the cost of labour as seen by employers and will not act as a reverse tariff.

While the Members opposite define full employment as enough unemployment to force enough wage restraint to give stable inflation, this Government would rather reduce inflationary pressures by reducing on-costs than by throwing people out of work. While the Members opposite want to reduce the Non-Accelerating-Inflation Rate of Unemployment by attacking workers' wages and conditions, this Government will do it by removing taxes that impose costs on employers over and above workers' wages and conditions. While the Members opposite see full employment through the prism of class warfare, this Government sees it through the open door of tax reform.

A CFT is a value-added tax assessed by the subtraction method. While the Members opposite may claim that a VAT is a Tory policy, no Tory party in Australia or elsewhere has ever proposed to introduce a VAT in a way that would avoid a one-off rise in the cost of living or a one-off widening of after-tax wage relativities. Under this Budget, the cost of living will fall, jobs will be easier to get, and working families will consequently find it easier to get ahead.

The CFT will have a consumption base. If it seems contrary to conventional wisdom that a consumption tax replacing income tax would not cause a one-off rise in prices, that's because the conventional wisdom assumes that the income presently remitted by employers as PAYG tax would instead be paid out in gross wages and salaries, so that an equal amount of income remitted as consumption tax would need to come from elsewhere, namely higher prices. Under this Budget, however, the aggregate income presently withheld as PAYG tax will be made available to pay the CFT and will therefore not need to come from higher prices [2].

When we further allow for the growth dividend and the fact that not all of the old revenue needs to be replaced, we must conclude that the one-off change in the CPI will be negative.

Madam Speaker, apart from political inertia, there is nothing to stop other countries from following the example that Australia is now setting through this Budget. Consequently, some of the advantages obtained through this Budget are first-mover advantages. But that makes it all the more necessary that Australia moves first. If other countries subsequently imitate Australia, they will presumably claw back some of the global market share that Australia gains through this Budget, so that Australian producers must rely more on domestic markets. That may be an issue to be tackled in a future Budget.

Because personal income tax is to be retained in the hands of employers rather than completely abolished, this Budget preserves revenue from tax on income from assets, and preserves after-tax income relativities between high-paid workers and low-paid workers, between full-time workers and part-time workers, and between workers and those who receive income through assets. If the same result could be achieved by reforming workplace relations and registering the said assets as CFT collection points, one could abolish personal income tax altogether, along with its compliance costs. That too may be a challenge for a future Budget.

But in the present Budget, Madam Speaker, the urgent necessities are to restore full employment and raise Australia's market share — by removing taxes on labour, removing the Big Three reverse tariffs, and cutting taxes on buildings. To those ends, I commend this Budget to the House.


[1] Of course, as this document is a “draft”, these figures aren't really Treasury's estimates. They're Putland's back-of-envelope estimates. One hopes that Treasury, with all its resources, can produce more accurate figures. But whatever the correct rate is, it will indeed reduce the cost of living for the reasons stated in the text.

[2] What this Budget doesn't do with income tax:

Gross wages

What this Budget does with income tax:

Net wages

(Superannuation, GST & payroll tax are not shown.)

* The original version of this speech, posted on 10 June 2012, was written for delivery on 18 September 2012, which is about 8 months earlier than usual. The current version is written for delivery in May 2013 and assumes that the Labor government will still be in office at that time. I've also written a version with a Coalition spin (in which I forgot to change “8 months” to “6 months” to allow for the different delivery date).

P.S.: See also

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