Gavin R. Putland,  BE PhD

Saturday, March 23, 2013 (Comment)

The only way to make payroll tax legal

Payroll tax is a cost of production, including production of goods. Therefore it's a duty of excise. Therefore it's unconstitutional because, under s.90 of the Australian Constitution, only the Federal Parliament has the power to impose duties of excise.

The existing payroll-tax threshold does not prevent payroll tax from raising prices, but merely changes the mechanism by which it raises prices. As the threshold is applied to the aggregate payroll of the enterprise, it impedes economies of scale: as soon as the total payroll exceeds the threshold, the tax adds to the marginal cost of labour and therefore the cost of its marginal product.

However, if the enterprise-level threshold were replaced by a threshold for each employee, and if the new threshold were high enough to exempt most workers whose wages are accounted as production costs (as opposed to overheads), one could argue that the connection between the modified tax and prices of goods is too tenuous to run afoul of s.90.

N.B.:  A threshold for each employee does not mean that employees would become liable for the tax. It means that the employer would have a tax liability for each employee whose earnings exceeded the threshold.

What sorts of rates and thresholds would replace current revenue from payroll tax? From ABS 6306.0, in Table 5 of the downloadable spreadsheet headed “ALL EMPLOYEES, Distribution of weekly total cash earnings”, we can obtain the number of employees in each of 25 weekly-income brackets, with thresholds from $200 to $2500 in $100 increments, for May 2012. The same spreadsheet shows the “average weekly total cash earnings” for all those employees. Hence we can compute their total earnings. For each income bracket except the top one (which has no upper bound), it is reasonable to assume that the average of earnings for employees in the bracket is the midpoint of the bracket. On that assumption, for each threshold, we can compute the total earnings of all employees earning less than the threshold, hence the total earnings of all employees earning more. From the latter, we subtract the sub-threshold component (obtained by multiplying the threshold by the number of employees earning more) to obtain the tax base. The total revenue required to replace current payroll taxes is obtainable from ABS 5206.0 Table 18 (payroll tax for the 2nd quarter of 2012, divided by 13 to obtain the weekly amount). Dividing the revenue by the base yields the rate, which is plotted in red in the following graph. The fraction of employees above the threshold is shown in black.

Disaggregating payroll tax

Caveats:  The tax base is underestimated, and the tax rate consequently overestimated, because (i) the base is assumed to consist solely of private-sector employees, whereas in fact it also includes contractors, and (ii) no allowance is made for an obvious anti-avoidance measure, namely the pro-rating of the threshold for part-time workers. For the latter reason, the graph underestimates the fraction of private-sector employees whose earnings would exceed the threshold.

As far as I can see, disaggregating the threshold is the only reform of payroll tax, short of outright abolition, that might make it compliant with s.90. As I have noted elsewhere, outright abolition is also eminently feasible. In the mean time, payments of payroll tax should be made “UNDER PROTEST” to maximize the chances of recovering the payments if the tax is subsequently found unconstitutional.

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