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The tax reform right under Turnbull’s nose

Posted by on April 5th, 2016 · Affordability, Government, Tax, Transport

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Three days was all it took for ‘the most fundamental reform to the Federation in generations‘ – Prime Minister Malcolm Turnbull’s proposal to allow each of the States to set its own income tax, at different rates, on top of the Federal income tax – to be consigned by State and Territory leaders to history (‘that proposal is not there. It is withdrawn. It is not acceptable to COAG‘). Midges live longer than that. Blog writers had barely enough time to start thinking of questions about the proposal (how would negative gearing work – would rental losses in Queensland be deductible against wages earned in New South Wales? If the both State and Federal income taxes were levied through the Australian Tax Office, would that offend the qualification at section 51(ii) of the Constitution?) when the whole thing was knocked off.

The Turnbull Government is once again without a tax reform agenda; instead, the Prime Minister is now working on media messaging about how ‘we have to live within our means‘.

Which is another misstep. ‘Living within our means’ is a principle familiar to households, whose spending depends on first getting money from somewhere – from selling labour, selling property or selling promises to pay it back with interest. Households’ abilities in all these regards – their ‘means’ – are finite, and so constrain their spending on life’s essentials and niceties; these constraints also induce households to save some money in anticipation of times when the getting of it may be harder. This way of thinking and acting makes sense for individual households, and firms too; it also makes sense for State Governments – though their ability to get money by levying taxes is an important additional ‘means’ that private sector entities don’t have.

But it doesn’t make sense to wish all entities in the economy would behave this way altogether (because as each saves, so they spend less, and reduce the getting of money by all: the paradox of thrift), and it doesn’t make sense for the Federal Government to think and act as if it is constrained like a household. The Federal Government doesn’t need to get money from somewhere else before it spends; in the Australian economy, it issues the national currency that underpins the payments system, and the notes and coins, through which all those other entities transact as they get and spend money. As such it can do things that households and other entities cannot – like spend without first getting money elsewhere – and it should operate according to different principles, like: ‘we have to maintain demand sufficient to engage all the labour that households are selling’, ‘we have to develop capital in our economy that makes labour as productive as can be’, and ‘we have to ensure that those who cannot work have incomes to buy a fair share of the products of labour.’

Thinking this way about the Federal Government entails thinking differently about tax. In particular, it means that the basic purpose of Federal Government taxation is not getting money for spending; instead, it is to ensure that all the other entities in the economy will use the national currency, and that some fiscal space is cleared for government spending without undue inflation. And rather than getting hung up on the absolute amount of taxation and whether it matches the amount of government spending, we should give more thought to questions of how taxation affects the shares of income and wealth that households end up with, and how it affects the economic choices and behaviour of individuals.

It is the equity and behaviour impacts of taxation that deserve greater attention in the current debate (and to the extent that the State income tax proposal would have obscured these aspects of taxation behind the State Governments’ household logic of ‘getting money to spend’, it is a good thing that the proposal was dispatched). And if the Prime Minister paid greater attention to these considerations, he might grasp hold of the really beneficial tax reform agenda that has recently been gaining ground in the public debate.

This agenda is land tax: a broad-based land tax, including on land used for owner-occupied housing and primary industry, levied at progressive rates according to per square metre land values. It ticks every equity and behaviour box:

  • land is in fixed supply so cannot be taxed out of existence;
  • land cannot be moved out of the jurisdiction so the tax is impossible to avoid (unpaid land tax mounts as a charge against the registered title);
  • land ownership promises gains (rents, price increases) that come not from any effort by the owner, but from the uses to which other persons could put the land, so taxing land values gets at unearned gains;
  • land tax, payable year in and year out, is a spur to owners to put their land to productive use, or sell it to someone else who will, so it taxes land out of speculative or unproductive holding and into the market, thereby improving affordability.

The States currently levy land tax – on a narrow base and with inadequate thresholds and rates – but there’s no reason why the Federal Government couldn’t do it (in fact, for the first half century of the Federation, it did).

Use it as an opportunity to remove other taxes that are inequitable or that badly affect individual decisions (like payroll tax, stamp duty for owner-occupiers (let’s keep stamp duty for landlords) or even income tax), add some transitional measures (for example, let the amount of stamp duty paid by an owner – whether that was $20 000 last year, or £20 fifty years ago – stand as a credit against their land tax liability) and enshrine some hardship provisions (for example, let any owner-occupier without the means to pay land tax other than by sale of their home defer the liability, so that it mounts as a charge against the property), and there’s your tax reform for greater housing affordability, productivity and equity.

More and more people are coming around to land tax reform. It was a key recommendation of the Henry Review; more recently, the McKell Institute has published a report in support of land tax/stamp duty reform, and today, the NSW Business Chamber, the NSW Council of Social Service and the NSW branch of the Australian Manufacturing Workers Union have jointly made a case for land tax/stamp duty reform. Each of these parties has framed their support for land tax reform as a matter of State Government finances, and so emphasises its role as a source of revenue (to get and spend money), and each puts forward different transitional and hardship measures, but the case on economic behaviour and equity grounds is also made.

And while the Prime Minister has cast about for a tax reform agenda, the Government’s own Minister for Major Projects, Paul Fletcher, has been talking up ‘value capture’ – a variation on the theme of land tax, by which the Government proposes to take, in the form of money, some of the increase in the value of land that comes from its being serviced by new transport infrastructure. The value capture discussion has a way to go, and we might question some of the directions that it is presently taking: in particular, the Minister frames value capture as a means of financing government spending; however, as the foregoing discussion suggests, the Federal Government shouldn’t feel that its spending for public purposes is constrained by the amount of value it may capture, nor that it needs private interests to drive infrastructure spending decisions. The Minister also indicates that the Federal Government is interested in value capture mechanisms that apply narrowly to designated areas that will benefit from infrastructure development; however, rather that relying on government officers to be able to identify and designate at the outset which are the areas that benefit, why not take a wider approach, and let the market show where the benefits are realised, and tax them wherever that is.

Here is the germ of a tax reform agenda, right under the Prime Minister’s nose.

2 Comments so far ↓

  • Chris Martin

    Hi Glen

    Land tax reform always gets twinned with stamp duty reform. There’s a strong case for linking the two (land tax taxes holding, stamp duty taxes getting go), but there are problems as well, as you point out.

    I wonder what might have been if a State Government had said in response to Turnbull, ‘fine, set our State income tax rate to zero, and we’ll make it up with a broad-based land tax’!

    cheers, Chris M

  • Glen Searle

    The main problem with introducing land tax for all properties is that the p.a. cost is very high, which makes it politically unacceptable. The stamp duty on an average Sydney dwelling is now about $40,000. With households moving on average every 7 years or so, this means stamp duty would have to be about $6,000 p.a. on average to make up for lost stamp duty. But land tax is a more efficient tax. It should be introduced in stages, starting at a low rate with high value properties in return for lowered stamp duty. The threshold could remain the same, so that land tax would be payable for more properties over time as dwelling prices increased. The rate per $ of property value could be slowly increased over time as well.

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