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Payroll Taxes in Australia, Part I: Background and Theoretical Analysis*
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PAYROLL TAXES IN AUSTRALIA, PART I: BACKGROUND AND THEORETICAL ANALYSIS· R. Chapman, Centre for Applied Economic Research, University oj New South Wales, P.O. Box J, Kensington, NS W 2033 and D. Vincent,
Industries Assistance Commission, P.O. Box 80,
Be/col/nen, ACT 2616. This paper provides an account of the struct ure of payroll taxes in Australia and, having OUllined the nature of the lax, canvasses some of the possible theoretical implications of the tax for the individual firm in a partial equilibrium setting. Implications of the structure of the lax for labour inten sity, firm size and growth are dealt with and different tax-shifting scenarios are introduced. The sequel to this paper then provides estimates of the actual payroll tax burden in more than onc hundred Australian industries and explores the implications of its removal for macro economic aggregates and for individual industry performance in Australia. A ranking of industries according to the apparent burden of the tax is compared with the distribution of employment gains resulting from tax abolition.
Introduclion
.1 Rationale For The Study 'ayroll tax (PRT) occupies an important and contentious place in the stru cture f Australian taxation. It has both been the object of considerable cr iticism nd has had its suggested abolition questioned by an Economic Planning and dvisory Council (EPAC) publication. [Economic Planning and Advisory :ouncil (1985)] Unfortunately, neither those advocating its abolition at the recent ax summit nor the submissions forming the basis of the EPAC summary paper !.g. Bureau of Industry Economics (1985), provided estimates of the individual ndustry burdens of PRT. Without such estimates it is difficult to
t
t
The views expressed in this paper do not necessarily reflect the opinions of the Industries Issistance Commission . .dit.ors' Note: This paper is the first in a two part series of papers dealing with payroll IX III Australia. Part II will appear in a future issue of the journal.
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offer any thing but a partial equilibrium ana lysis of the likely effects of its removal. It is a tax which is uneven in its industrial and geographical incidence. It would seem therefore that the practice of si mply rega rd ing it as an x per cent economy-wide impost on wage costs for the purposes of calculating the likely effects of its removal and repl acement should be approached with caution. It is possible that important inter-industry effects will be overlooked . This paper focuses on first, the history and stru cture of payro ll taxes in Australia, second their theoretical imp lications for factor use and firm size in the long run and th ird the relationship between labour supply elasticities and incidence questions. Its sequ el estimates the impact of PRT abolition under a variety of different assu mptions about compensatory fisca l measures. The implications for both the macro-economy and individual industries are measured and discussed . Quantification of the effects of PRT removal on such varia bles as aggregate and industry emp loyment demand, inflat ion rates and government revenue requires a framework capable of taking into account not on ly th e first round, or direct effects, of a reduction in an industry's costs of employing labour but also the indirect effects work ing through changts in the composition of economic activ ity , the overall tax base and the demand for each industry's products. A suitable basis for such work is the ORAN I model [D ixon et aJ. (t982)] which is used in Part II of this study. As a precursor to the model 's use, information is required on the importance of PRT in the total wage costs of more than one hundred Australian industries. The construction of this data base from various diverse sources forms a significant part o f this two part study and is published as an appendix to a preliminary version of this paper [Cha pman and Vincent (198 5)], along with details of the methods employed in its cons truction .
1.2 History And Current Importance OJ The Tax In 1972 the Com monwealt h handed over to the states the right to levy PRT which it had previously administered since 1941 when it was introduced to contribute to the funding of child endowment. From a standard rate of 2.5 per cent the states rapidly increased the impost, the revenue at hand-over being accompanied by an equivalent reduct ion in payments to the states. The experience of New South Wales (NSW), shown in Table 1, will serve as an illu stration.
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TABLE 1 CHANGE IN PAYROLL TAX RATE: NEW SOUTH WALES, 1971 TO PRESENT
Period
Standard Rate of Payroll Tax
I Sep tember 197 1 to 31 August 1973
3.5 per cent
1 September t 973 to 3 1 August 1974
4.5 per cent
I September 1971 to 31 August 1981
5.0 per cent
Post·) September 1981
5.0 per cent, and 6.0 per cen t on payrolls exceeding $ 1 million
While only Victoria (the other state which, along with NSW, has been deemed recently by the Grants Commission 10 have fared rather badly under the past formula for distributing grants to the states) has followed NSW into the imposition of a supe r tax of 6 per cent on "large" payrolls, other states have
also raised the tax rate to a standard 5 per cent, the Northern Territory being the exception at 4.5 per cent. Revenue collected from PRT in 1984-85 represented 5.5 per cenl of total revenue collected by all levels of government in Australia. In ter ms of total revenue yield , PRT ranks after corporate and personal income taxes, excise and sales taxes and property taxes. The states have made the most of their access to PRT as a "growth" tax. From comprising 1.26 per cen t of total Australian tax revenue in 197 1-72 it rose to 6.04 per cent in 1977-78 and 6.07 per cent in 1982-83. It is easily the most important single tax available to the states and comprises more than 30 per cent of their taxation revenue . The implications of its removal for states' revenues are such that major initiatives in the provision of access to alternative revenue would be ca lled for, possibly requiring interchange of state and Commonweailh powers. If compensation were arranged by way of access to income tax revenue this would deprive the states of fiscal independence unless the instrument of a state-levied income tax surchange were used .
2.
Nature of the Tax
Australia, unlike most other countries employing this tax instrument, levies PRT exclusively on the employer. Payroll taxes do no t have any employee-co ntributed component and are not "social-security contribu tion" taxes as in many ot her countries, and, as stale taxes, simp ly con tribute to the general revenue of the individual states.
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The tax is levied at an "enterprise group" level, roughly corresponding to the idea of the firm as a collection of related establishments rather than as a single legal entity. Since each state has (different) concessional rates for "smail" firms this has the effect of removing the incentive for owners to split, artifically. "ABC Enterprises Ltd" into "ABC Sydney Ltd" and "ABC Wollongong Ltd" thereby benefiting from a lower average rate of PRT. Furthermore the PRT base for a firm operating in anyone state is the wages and salaries paid to employees in that state but the rate of tax, from the point of view of any exempt ions relating to size, is determined by the Australia-wide payroll of thaI firm. The rates and exempt ion levels applicable in each state as at 1 January 1979 and 1 January 1984 are presented in Table 2 and a breakdown of each state's revenue into its components is given in Table 3, which highlights the dominant role of PRT in state revenu e raising. The 1979 data are prior to the introduction of the 1 per ce nt surcharge on la rge payrolls in NSW and Victoria. As a further complicating featu re, three states, NSW, Victoria and South Australia, operate decentralisation rebate schemes with rebates up to 100 per cent depending on location outside metropolitan areas, and NSW additionally offers some PRT relief based on employment of apprentices and for firms' additions to payroll incurred th rough the employment of persons under the age of 21 who are entering their first job. Economic Planning and Advisory Council (1985), however, indicates that perhaps one quarter of eligible employers are not applying for rebates in NSW and the scheme is being phased out in Victoria, To sustain the objective of protecting small firms from PRT in the face of innation that would bring an increasing number of such firms into taxable range each year, it has been the practice of the states to increase , periodically, the value of the threshold payroll for onset of the tax . In co ntrast the $1 million threshold of the one per cent surcharge has remained fixed and an ever increasing number of medium sized firms in states lik e NSW find themselves subject to a six teen per cent marginal rate of tax as their payrolls pass the $1 million mark.
Economic Analysis and Policy
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TABLE 2 PAYROLL TAX SCHEDULES 1978·79 AND 1983-84
Stale
Basic rate
Basic exemption
Exemption at upper end of taper
Surcharge on Payrolls over $1 million
(S)
(%)
0 0
157 ,000 325,000
1.0
63,000 200,000
37,800 37,800
11 4,085 443,300
1.0
l.O l.O
63,000 160,000
0 0
114,975 400,000
Queensland 1978-79 S983-84
l .O l.O
125 ,000 252,000
36,000 39,000
164,000 394,000
Western Australia 1978-79 1983-84
l.O l.O
60,000
37,800
160,000
0
Tasmania 1978-79 1983-84
l.O l.O
250,000
Northern Territory 1978-79 1983-84
l.O 4 .l
150,000
(%)
(S)
New South Wales 1978·79 1983-84
l.O l.O
63 ,000 130,000
VicCOrill 1978·79 1983·84
l.O l.O
South Australia 1978-79 1983-84
(5)
60,000 0
60,000 0
SOURCES: Business Review Weekly, June 2--8, 1984 and State Treasury Documents_
125
Payroll at upper end of taper
400,000
126
STATE AND LOCAL GOVERNMENT TAXES FEES AND FINES BY TYPE AND STATE. 1983-84
$m Victoria
Queensland
South Australia
Western Australia
Tasmania
Northern Territory
All States
Total Taxes, Fees and Fines
4718 .2
3556.9
1536. 1
877.1
985.0
245.1
66.3
11984.8
Payroll Taxes
1313.0
920.9
409.7
233.6
267.5
57.3
28.8
3230.9
--------------
1661.3
-----_1370.9 ....._-_.
651.5
340.8
362.6
89.7
21.0
4497.7 ...........__... -
188.9 800.7 549.9
143 .1 632 .7 459.2
26.8 336.0 288.3
28 .0 167 .6 132.7
42.4 166.8 129. 1
8.6 53.5 26.8
12.4 8.6
437 .9 2169.7 1594 .7
111.8
80 .9
-
Il.l
16 .5
0.4
-
220.7
137.4
91.4
97.4
24 .7
2.7
1472.6
Taxes on Properly including Land Taxes Rates Stamp Dmies Financial Institutions' Tax Taxes on Provision of Goods and Services including Taxes on Gambling Taxes on Insurance Taxes on Use of Goods and Performance of Activities including Motor Vehicle Taxes Franchise Taxes Fees and Fines
._---_ ...._----- ----------------- -------------_.- -------------- ---------_.__ .-
---------_._.
605 .7
513 .4 ---------_. __ ._-
451.6 143.0
250.4 120.2
87.2 43.6
44. 1 24.0
53.0 24.5
16.7 2.0
2.7
-
905.8 357.4
903.5
643.1
270.0
183.5
225.0
62.4
10.5
2297.9
521.9 375.6
321.2 308.2
209.5 46 .7
92.0 90.9
113.4 11 1.5
33. 1 29.3
4.4 6.1
1295.4 968.4
234.8
108.7
67.5
27.9
32.6
11.2
3.3
485.8
_._------------- ------------------ ------------------ --------------- ---------------- -----------------
---------------- ---------------- --------------- ------------------ ---------------- --------------- ---------------- -----------------
Source: Australian Bureau of Statistics (1985) Table 8.
Vol. 16 No. 02, September 1986
New South Wales
Economic Analysis and Policy
TABLE 3
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p tting aside for a moment the complicating factors of rebates and the I per unt surcharge, th e typical PRT scheme can be thought of as a "threshold and ce per " structure under which the firms with payrolls below the threshold pay ta tax and fo r successively larger firm s the concess ional ra tes (zero at the ~~reshold) are phased out. formally, such a tax function ca n be written as: Tj = 0 Tj = t [Wj - (a - b(W j - a))) T I- = t(Wi-cj
where
if Wi < a a-c
if a " Wi " a + -a-c b if Wi > a + b
Wi= payroll of the ith firm ; a = threshold below which no tax is paid; b = parameter determining the rate at which the concession eliminated; c = any res idu al concession; and t = the standard tax rate, e.g. 5 per cent.
IS
Thus lOa" determines the generosity of the scheme in te rm s of exemption levels for small firms and "b" determines how quickly the original rale is increased unt il the stand ard rate is reached. Only Victoria and Queensland had non-zero values for "c" according to Table 2, $37,830 and $39,000 respect ively in 1983. Diagrammaticall y, a variant of such a (ax scheme can be represented for NSW in 1983-84 by Figure 1, wi th the amendment that an extra taper zone has been incorporated in that diagram to accommodate th e phasing in of the one per cent surcharge for payrolls between $ 1,000,000 and $ 1,100,000.
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Vol. 16 No. 02, September 1986
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Economic Analysis and Policy
129
3.
Vol. 16 No. 02, September 1986
Some T heo relical Effects o f th e Ex isting Tax
3. 1 Firm Structure What literature th~rc is on PRT in Australia usually make~ some reference to the poss ible undesirable effects that PRT has at th e margm on employment. See, for example, Commit tee. of Inquiry into Revenue R~ising in Victo~ia (1.9?3) and Committee for Eco nomic Deve lo pment of Australia (1979). A sl mphfled model of the firm's choice may help to clarify this, bearing in mind th e tax structure discussed above. A profit maximising competi tive firm using homogenous capital and labour can be thought of as facing a PRT rate t which is a non-decreasing fun ct ion of it s labour inputs, L. It s total PRT bill will be t(L)wL where t(L) is the tax rate and w is the wage rate so W = wL is th e wage bill. The firm's costs are given by:
c
(I + I(L»wL + rK and revenue by R ~ pQ , Q ~ F(L,K) ~
and profits by v ~ pF - ( I + I(L))wL - rK Optimal choices of Land K satisfy
~ p 0 F _ ( I + ( (L»w _ wL 'l! _ 0 (I) oL
ilL .
of aK
~ P---r = O
(2)
Condition (I) ensures that the marginal revenue product o f labour is set equal to the tax-inclusive wage rate plus a proportion of the total wage bill, where the factor of proportionality is the marginal change in the rate. A ll this is given under the assumption tha t wand r are independent of I he lax, i.e. lhal the wage rale in the firms being consid ered is independent of the PRT structure. Payroll taxes in Austra lia have a "progressive clement" as shown in Figure 1 in thaI marginal rates increase with the reaching of th e threshold but then sell ie on to the standard rales once the taper zone is cleared. (In NSW and Victo ria th is increase in marginal rates is repeated again further up the wage bill ladder in the transition from 5 per ce nt to 6 per cent for large firms.) The Simplified model suggests tha t ca pita l intensity wi ll be higher with PRT than without, since the capital-labour choice wi ll be made where the re lative marginal products of the two factors equal their re lative marginal costs, i.e. OF I dF _ al d L d K - w (1 + I + L )/ r
at.
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The RHS represents the ratio of payroll tax·inclusive wage costs relative to capital costs per unit and is greater than ";' , the relative cost of labour and capital exclusive of PRT. It also suggests that the capital inten sive bias wi ll vary according to emp loyment size since the effective rale, t, does so. Rather than facing a fixed fa ctor price for labour, the firm experiences one that increases through the taper zone . In the short run when K is fixed, the marginal cost of output will shift upward s with each expansion in output wherever..£! > o . _ ill . This inhibits employment growth in response to any positive stimuli. It should be remembered that once the firm is large enough, however, this effect is absent si nce ~ = O. The kind of payroll tax structure we have in the Australian states ill may help to keep small firms small but it does not affect the sensitivity of large firms to a growth st imulus. Of course in compariso.n to a no·tax situation the PRT confers a relative advantage on small firms. Ju st how important this is for the preservation or evolution of the structure of a particular industry depends on the overall cost structure of that industry, including the possible cost disadvantages of small·scale producers in the absence of PRT.
3.2 Incidence On Industries And Economic Agents The existing PRT structure i mping~ differently on Australian incustries depending on first, the size distribution of firms, second the differing labour intensities as mea'!lured by the proportion of wages in total costs, third their geographical location, and their statutory exemption from tax. Virtually all fi rms in the basic iron and steel industry, for example, will be subject to tax at the maximum rate while an indu stry like textile finishing, with significant numbers of small firms and some degree of decentralisation in the two large manufacturing states, will experience a somewhat lower effective rate of PRT. In retailing, the industry average rate will be lower again, despite the few retailing giants, because of the relatively high proportion of employment in small firms. The farm sector, because of its essentially family-firm structure, is dominated by payrolls too small to incur the tax. Industries with large proportions of the workforce classified as " general government" such as non· residential construction and, more extremely, public administration and defence, will feel little direct effect from variations in PRT rates as a high proportion of the payrolls in these industries are exempt from the tax . Mention has already been made of th e effects on factor proportions and output of a non-uniform PRT. These effects on the firm omitleds the question of backward (onto employees) and forward (onto consumers) shifting of such a tax. Standard textbook models which postulate inelastic labour supplies give rise to full backward shifting onto labour in a partial equilibrium framework. This can be contrasted with Australian incidence studies where full forward shifting is assumed, e.g. Warren (l979) and with theoretical general equilibrium treatments such as Cornes (1977). With backward shifting the tax " causes the effective demand curve for labour to shift down ... [and] net wages are reduced." (Beach and Balfour (1983) p. 36) With full backward shifting, wages are redu ~ed
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bY the fu ll amount of the tax under assumptions of inelastic labour supplies. ut how much do firms' labour demand cu rves shift down and how elastic is bour supply'! These toget her determine the direct net effects on wages and ~ployment of a PRT in a partial equilibrium setting. The answer to the first ~uestion depends in part on the ability of firms to shift forward the extra impost on costs onto their custo mers. and thu s is ti ed up with quest ions of market ower. Attempts have been made to est imate the demand cu r ve shifl for the &ritiSh economy as a who le (Beac h and Balfour (1983)1 but such an estimate will necessarily miss th e importan t differences in market st ructure Ihat exist among industries. On the quest ion of labour supply elasticity. Hamermesh makes the point that "while evidence suggests that labour supply of adu lt ma les is relatively inse nsitive to changes in wages , th is is cerlai nly not true for secondary workers." (Hamermesh (1979) p. 12111 Beach and Balfour also drew a ttent ion to the differences in male and fe male supp ly elasticities. Putting as ide the differences in effective tax rates due to size. th e largest direct effect on emp loyment of the PRT burden would be in industries where there is little market power over the product and where the re are large female and "secondary" work components of the labour supply. In such industr ies there will be maximum downward shifting of the labour demand curve confronting an clastic labour supply curve. In contrast, industries which are male-e mployee domin ated and endowed with signi fi cant market power wou ld probably show the d irect effects o f payro ll tax increases o r decreases confined to wage changes rather than employment changes, if wages arc market-d etermined . All this presupposes clearing labo ur markets. The possible role that a minimum wage constraint can play in th is, with a given amount of downward shifting of the labour demand curve is shown in Figure 2. If labour mark ets are not clearing because of minimum wage constraints, even in the absence of PRT, then all of the direct effects of the tax will be on employmen t, with wages as a cost being reduced by the amount of the tax when it is removed and wages as a rate of pay left unchanged. See Figure 2.b. This complicates the implications fo r capital/ labour rat ios referred to above. In situation s whe re impositi on of the tax tends to drive wages down we a re relyi ng on the ultimate rati o o f tax· inclusive wage costs to capita l rentals being higher to bring abollt greater capital/labour ratios. In its appraisal of the Australian PRT effects EPAC (1985) claims that "traditional argum ents" presented by critics of th e tax assert t hat' 'payroll tax is a tax on labour incomes which discriminates against labour-intensive industries and employmelll and encourages capit al intensive indu st ries and employmenl." Readers of that Council paper are invited to draw the infe rence th ai alter native taxes, designed not to discrim inate against labour-intensive. wou ld be constructed on the assumption that "capital incomes are curren tly undertaxed relative to labour incomes", a notion which that paper quest ions. It is unfortunate that the EPAC report has chosen to juxtapose seve ral propos itions in thi s presentation of so-called "traditional arguments". Whi le it is trivially true that if labour inco mes' share of [he tax burden decreases, capital incomes' share must rise. it does not necessarily follow that havi ng advocated the lowerin g of payroll tax to remove "discrimination" agai nst employment.
r
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Economic Analysis and Policy
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its critics envisage or advocate a rise in the relative tax burden on capital incomes. Confusion arises through EPAC's presentation of discri mination against employment and discr imination against labo ur incomes as though they were so mehow mutually im plied in the arguments against the tax. This invites confusion between the effect of PRT on labour costs as opposed to labour incomes. Figure 211 Labour market effects of PRT in a market for Labour which would clear in the absence of the tax , minimum wages notwithstanding
Per Unit Labour Costs a- b employment e ffect
-- c
--
c - d wag e rate effect
e
e - f "downward s hifti ng" due to tax
Wmin rcdO-__________~_c~ / / /
f
/
Lt D
o
,
b
Quantity of Labour
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Vol. 16 No. 02, September 1986
Figure 2b Labour market effects of PRT in market for Labour which has a minimum wage above equilibrium In the absence of tax.
Per Unit L.abOur Costs
0
\Vmin
/ / /
/
" " "
"
"
r
LO L'
0
o
b
, Quantily of labour
Suppose the tax is removed and the cut in real wage costs induces expansion in economic activ ity and employment. Both labour and cap ita l incomes will rise. Further suppose the replacement of PRT wit h, say, a value added tax (V AT) suffi cient to recoup the lost revenue. The net effect may still be expansionary and it is not at all clear that the relative burden of taxes on ca pital income will have increased as a result. This would depend partly on the inciden ce of the VAT. However the discrimination against emp loymen t and against labourintensive industries will have been removed. Th e above points are chiefly relevant in a long term analysis and they hinge on supply elasticities of labour and capita l-labour substitution . In contrast, the tax experiments reported in Part 11 assume a short term environment in which wage rates deflated by the Consumer Price Index are exogenous. Capita l-labour substitution is however allowed for in th e analysis. For a discussio n of these
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and other relevant elasticities of substi tution see Bruce (1985). Furthermore th e interactive effects of red uced wage costs arc allowed full play through ~ gencral cquilibrium model. This fram ework allows recognition of two important features: (a) that differences in wages as a cost of labour inputs across industries are in part due to different industry PRT burdens; and (b) that any removal of such additional wage costs will have varied effects according to different labour cost shares and industry supply elasticities different import substitution elasticities and demand elasticities in product markets, and different growth rates of these markets. The quantification of these effects and accompanying effects on macro economic aggregates is the subj ect of Part II. REFERENCES Australian Bureau of Statistics (1985) Taxation Reyenue, Australia 1983-84, (ABS, Canberra). Beach, C.M. and Balfour, F.S. (1983) "Estimated Payroll Tax Incidence and Aggregate Demand for Labour in the United Kingdom", Economica, Vol. 50 No. 197, pp. 35-48 . Bruce, 1. (1985) " The ORANI Input-Output and Parameter Files for 1977-78", IMPACT Project Working Paper OP-51, University of Melbourne, February. Bureau of Industry Economics (1985) "Implications of Abolishing Payroll Tax", Report to the Economic Planning Advisory Council, June. Chapman, R. and Vin cent, D. (1985) "Payroll Taxes: An Investigation of the Macroeconomic and Industry Level Effects of Their Removal", Centre for Applied Economic Research (CAER) , Work ing Paper 75, University of New South Wales, August. Committee for Economic Development in Australia (1979), The Effects oj Payroll Tax on the Australian Economy, P . Series No. 21, (CEDA, Melbourne) . Committee of Inquiry into Revenue Raising in Victoria (1983) Report, Vol. I , (Government Printer, Melbourne). Comes, R. (1977) "The Incidence of Taxation on Factor Inputs: A General Equilibrium Approach and its Application to State-Local Taxation" in Mathews, R.L., (ed.) State and Local Taxation , (Austra lian National University Press. Canberra), pp . 10-38 .
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Dixon, P., Parmenter, 8., Sutton, J . a~d Vincent, D. (1982) ORANl: A Mu/tisectoral Model of the Auslralwn Economy, (North Holland, Amsterdam). Economic Planning Advisory Counci l ( 1985) The Economic Effects of Payroll Tax, (EPAC), Canberra). Hamermcsh, D. (1979) "New Estimates of the Incidence of Payroll Tax", southern Economic Journal, Vol. 45 No. 4, pp. 1208- 19. Warren, N. (1979) "Australian Tax Incidence in 1975·76: Some Preliminary Results", CAER Working Paper No.7, Un ivers ity of New SOllth Wales,
May.
Economic Analysis and Policy
Vol. 16 No. 02, September 1986
PAYROLL TAXES IN AUSTRALIA, PART I: BACKGROUND AND THEORETICAL ANALYSIS· R. Chapman, Centre for Applied Economic Research, University oj New South Wales, P.O. Box J, Kensington, NS W 2033 and D. Vincent,
Industries Assistance Commission, P.O. Box 80,
Be/col/nen, ACT 2616. This paper provides an account of the struct ure of payroll taxes in Australia and, having OUllined the nature of the lax, canvasses some of the possible theoretical implications of the tax for the individual firm in a partial equilibrium setting. Implications of the structure of the lax for labour inten sity, firm size and growth are dealt with and different tax-shifting scenarios are introduced. The sequel to this paper then provides estimates of the actual payroll tax burden in more than onc hundred Australian industries and explores the implications of its removal for macro economic aggregates and for individual industry performance in Australia. A ranking of industries according to the apparent burden of the tax is compared with the distribution of employment gains resulting from tax abolition.
Introduclion
.1 Rationale For The Study 'ayroll tax (PRT) occupies an important and contentious place in the stru cture f Australian taxation. It has both been the object of considerable cr iticism nd has had its suggested abolition questioned by an Economic Planning and dvisory Council (EPAC) publication. [Economic Planning and Advisory :ouncil (1985)] Unfortunately, neither those advocating its abolition at the recent ax summit nor the submissions forming the basis of the EPAC summary paper !.g. Bureau of Industry Economics (1985), provided estimates of the individual ndustry burdens of PRT. Without such estimates it is difficult to
t
t
The views expressed in this paper do not necessarily reflect the opinions of the Industries Issistance Commission . .dit.ors' Note: This paper is the first in a two part series of papers dealing with payroll IX III Australia. Part II will appear in a future issue of the journal.
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offer any thing but a partial equilibrium ana lysis of the likely effects of its removal. It is a tax which is uneven in its industrial and geographical incidence. It would seem therefore that the practice of si mply rega rd ing it as an x per cent economy-wide impost on wage costs for the purposes of calculating the likely effects of its removal and repl acement should be approached with caution. It is possible that important inter-industry effects will be overlooked . This paper focuses on first, the history and stru cture of payro ll taxes in Australia, second their theoretical imp lications for factor use and firm size in the long run and th ird the relationship between labour supply elasticities and incidence questions. Its sequ el estimates the impact of PRT abolition under a variety of different assu mptions about compensatory fisca l measures. The implications for both the macro-economy and individual industries are measured and discussed . Quantification of the effects of PRT removal on such varia bles as aggregate and industry emp loyment demand, inflat ion rates and government revenue requires a framework capable of taking into account not on ly th e first round, or direct effects, of a reduction in an industry's costs of employing labour but also the indirect effects work ing through changts in the composition of economic activ ity , the overall tax base and the demand for each industry's products. A suitable basis for such work is the ORAN I model [D ixon et aJ. (t982)] which is used in Part II of this study. As a precursor to the model 's use, information is required on the importance of PRT in the total wage costs of more than one hundred Australian industries. The construction of this data base from various diverse sources forms a significant part o f this two part study and is published as an appendix to a preliminary version of this paper [Cha pman and Vincent (198 5)], along with details of the methods employed in its cons truction .
1.2 History And Current Importance OJ The Tax In 1972 the Com monwealt h handed over to the states the right to levy PRT which it had previously administered since 1941 when it was introduced to contribute to the funding of child endowment. From a standard rate of 2.5 per cent the states rapidly increased the impost, the revenue at hand-over being accompanied by an equivalent reduct ion in payments to the states. The experience of New South Wales (NSW), shown in Table 1, will serve as an illu stration.
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TABLE 1 CHANGE IN PAYROLL TAX RATE: NEW SOUTH WALES, 1971 TO PRESENT
Period
Standard Rate of Payroll Tax
I Sep tember 197 1 to 31 August 1973
3.5 per cent
1 September t 973 to 3 1 August 1974
4.5 per cent
I September 1971 to 31 August 1981
5.0 per cent
Post·) September 1981
5.0 per cent, and 6.0 per cen t on payrolls exceeding $ 1 million
While only Victoria (the other state which, along with NSW, has been deemed recently by the Grants Commission 10 have fared rather badly under the past formula for distributing grants to the states) has followed NSW into the imposition of a supe r tax of 6 per cent on "large" payrolls, other states have
also raised the tax rate to a standard 5 per cent, the Northern Territory being the exception at 4.5 per cent. Revenue collected from PRT in 1984-85 represented 5.5 per cenl of total revenue collected by all levels of government in Australia. In ter ms of total revenue yield , PRT ranks after corporate and personal income taxes, excise and sales taxes and property taxes. The states have made the most of their access to PRT as a "growth" tax. From comprising 1.26 per cen t of total Australian tax revenue in 197 1-72 it rose to 6.04 per cent in 1977-78 and 6.07 per cent in 1982-83. It is easily the most important single tax available to the states and comprises more than 30 per cent of their taxation revenue . The implications of its removal for states' revenues are such that major initiatives in the provision of access to alternative revenue would be ca lled for, possibly requiring interchange of state and Commonweailh powers. If compensation were arranged by way of access to income tax revenue this would deprive the states of fiscal independence unless the instrument of a state-levied income tax surchange were used .
2.
Nature of the Tax
Australia, unlike most other countries employing this tax instrument, levies PRT exclusively on the employer. Payroll taxes do no t have any employee-co ntributed component and are not "social-security contribu tion" taxes as in many ot her countries, and, as stale taxes, simp ly con tribute to the general revenue of the individual states.
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The tax is levied at an "enterprise group" level, roughly corresponding to the idea of the firm as a collection of related establishments rather than as a single legal entity. Since each state has (different) concessional rates for "smail" firms this has the effect of removing the incentive for owners to split, artifically. "ABC Enterprises Ltd" into "ABC Sydney Ltd" and "ABC Wollongong Ltd" thereby benefiting from a lower average rate of PRT. Furthermore the PRT base for a firm operating in anyone state is the wages and salaries paid to employees in that state but the rate of tax, from the point of view of any exempt ions relating to size, is determined by the Australia-wide payroll of thaI firm. The rates and exempt ion levels applicable in each state as at 1 January 1979 and 1 January 1984 are presented in Table 2 and a breakdown of each state's revenue into its components is given in Table 3, which highlights the dominant role of PRT in state revenu e raising. The 1979 data are prior to the introduction of the 1 per ce nt surcharge on la rge payrolls in NSW and Victoria. As a further complicating featu re, three states, NSW, Victoria and South Australia, operate decentralisation rebate schemes with rebates up to 100 per cent depending on location outside metropolitan areas, and NSW additionally offers some PRT relief based on employment of apprentices and for firms' additions to payroll incurred th rough the employment of persons under the age of 21 who are entering their first job. Economic Planning and Advisory Council (1985), however, indicates that perhaps one quarter of eligible employers are not applying for rebates in NSW and the scheme is being phased out in Victoria, To sustain the objective of protecting small firms from PRT in the face of innation that would bring an increasing number of such firms into taxable range each year, it has been the practice of the states to increase , periodically, the value of the threshold payroll for onset of the tax . In co ntrast the $1 million threshold of the one per cent surcharge has remained fixed and an ever increasing number of medium sized firms in states lik e NSW find themselves subject to a six teen per cent marginal rate of tax as their payrolls pass the $1 million mark.
Economic Analysis and Policy
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TABLE 2 PAYROLL TAX SCHEDULES 1978·79 AND 1983-84
Stale
Basic rate
Basic exemption
Exemption at upper end of taper
Surcharge on Payrolls over $1 million
(S)
(%)
0 0
157 ,000 325,000
1.0
63,000 200,000
37,800 37,800
11 4,085 443,300
1.0
l.O l.O
63,000 160,000
0 0
114,975 400,000
Queensland 1978-79 S983-84
l .O l.O
125 ,000 252,000
36,000 39,000
164,000 394,000
Western Australia 1978-79 1983-84
l.O l.O
60,000
37,800
160,000
0
Tasmania 1978-79 1983-84
l.O l.O
250,000
Northern Territory 1978-79 1983-84
l.O 4 .l
150,000
(%)
(S)
New South Wales 1978·79 1983-84
l.O l.O
63 ,000 130,000
VicCOrill 1978·79 1983·84
l.O l.O
South Australia 1978-79 1983-84
(5)
60,000 0
60,000 0
SOURCES: Business Review Weekly, June 2--8, 1984 and State Treasury Documents_
125
Payroll at upper end of taper
400,000
126
STATE AND LOCAL GOVERNMENT TAXES FEES AND FINES BY TYPE AND STATE. 1983-84
$m Victoria
Queensland
South Australia
Western Australia
Tasmania
Northern Territory
All States
Total Taxes, Fees and Fines
4718 .2
3556.9
1536. 1
877.1
985.0
245.1
66.3
11984.8
Payroll Taxes
1313.0
920.9
409.7
233.6
267.5
57.3
28.8
3230.9
--------------
1661.3
-----_1370.9 ....._-_.
651.5
340.8
362.6
89.7
21.0
4497.7 ...........__... -
188.9 800.7 549.9
143 .1 632 .7 459.2
26.8 336.0 288.3
28 .0 167 .6 132.7
42.4 166.8 129. 1
8.6 53.5 26.8
12.4 8.6
437 .9 2169.7 1594 .7
111.8
80 .9
-
Il.l
16 .5
0.4
-
220.7
137.4
91.4
97.4
24 .7
2.7
1472.6
Taxes on Properly including Land Taxes Rates Stamp Dmies Financial Institutions' Tax Taxes on Provision of Goods and Services including Taxes on Gambling Taxes on Insurance Taxes on Use of Goods and Performance of Activities including Motor Vehicle Taxes Franchise Taxes Fees and Fines
._---_ ...._----- ----------------- -------------_.- -------------- ---------_.__ .-
---------_._.
605 .7
513 .4 ---------_. __ ._-
451.6 143.0
250.4 120.2
87.2 43.6
44. 1 24.0
53.0 24.5
16.7 2.0
2.7
-
905.8 357.4
903.5
643.1
270.0
183.5
225.0
62.4
10.5
2297.9
521.9 375.6
321.2 308.2
209.5 46 .7
92.0 90.9
113.4 11 1.5
33. 1 29.3
4.4 6.1
1295.4 968.4
234.8
108.7
67.5
27.9
32.6
11.2
3.3
485.8
_._------------- ------------------ ------------------ --------------- ---------------- -----------------
---------------- ---------------- --------------- ------------------ ---------------- --------------- ---------------- -----------------
Source: Australian Bureau of Statistics (1985) Table 8.
Vol. 16 No. 02, September 1986
New South Wales
Economic Analysis and Policy
TABLE 3
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p tting aside for a moment the complicating factors of rebates and the I per unt surcharge, th e typical PRT scheme can be thought of as a "threshold and ce per " structure under which the firms with payrolls below the threshold pay ta tax and fo r successively larger firm s the concess ional ra tes (zero at the ~~reshold) are phased out. formally, such a tax function ca n be written as: Tj = 0 Tj = t [Wj - (a - b(W j - a))) T I- = t(Wi-cj
where
if Wi < a a-c
if a " Wi " a + -a-c b if Wi > a + b
Wi= payroll of the ith firm ; a = threshold below which no tax is paid; b = parameter determining the rate at which the concession eliminated; c = any res idu al concession; and t = the standard tax rate, e.g. 5 per cent.
IS
Thus lOa" determines the generosity of the scheme in te rm s of exemption levels for small firms and "b" determines how quickly the original rale is increased unt il the stand ard rate is reached. Only Victoria and Queensland had non-zero values for "c" according to Table 2, $37,830 and $39,000 respect ively in 1983. Diagrammaticall y, a variant of such a (ax scheme can be represented for NSW in 1983-84 by Figure 1, wi th the amendment that an extra taper zone has been incorporated in that diagram to accommodate th e phasing in of the one per cent surcharge for payrolls between $ 1,000,000 and $ 1,100,000.
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Vol. 16 No. 02, September 1986
Margi nal T ax Rate 0 N
~
It) 0
~
0 0 0 N
0 0
• •
~
U
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:0
.•
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0 0
'"x
~
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• •
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."-• C
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"
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0 0 ~
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,,
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r- - - -
1. - - _ _ _ _
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o
o
~
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(5 00 0$ ) xel.
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• 0 0 0
•
1 ,•>
Economic Analysis and Policy
129
3.
Vol. 16 No. 02, September 1986
Some T heo relical Effects o f th e Ex isting Tax
3. 1 Firm Structure What literature th~rc is on PRT in Australia usually make~ some reference to the poss ible undesirable effects that PRT has at th e margm on employment. See, for example, Commit tee. of Inquiry into Revenue R~ising in Victo~ia (1.9?3) and Committee for Eco nomic Deve lo pment of Australia (1979). A sl mphfled model of the firm's choice may help to clarify this, bearing in mind th e tax structure discussed above. A profit maximising competi tive firm using homogenous capital and labour can be thought of as facing a PRT rate t which is a non-decreasing fun ct ion of it s labour inputs, L. It s total PRT bill will be t(L)wL where t(L) is the tax rate and w is the wage rate so W = wL is th e wage bill. The firm's costs are given by:
c
(I + I(L»wL + rK and revenue by R ~ pQ , Q ~ F(L,K) ~
and profits by v ~ pF - ( I + I(L))wL - rK Optimal choices of Land K satisfy
~ p 0 F _ ( I + ( (L»w _ wL 'l! _ 0 (I) oL
ilL .
of aK
~ P---r = O
(2)
Condition (I) ensures that the marginal revenue product o f labour is set equal to the tax-inclusive wage rate plus a proportion of the total wage bill, where the factor of proportionality is the marginal change in the rate. A ll this is given under the assumption tha t wand r are independent of I he lax, i.e. lhal the wage rale in the firms being consid ered is independent of the PRT structure. Payroll taxes in Austra lia have a "progressive clement" as shown in Figure 1 in thaI marginal rates increase with the reaching of th e threshold but then sell ie on to the standard rales once the taper zone is cleared. (In NSW and Victo ria th is increase in marginal rates is repeated again further up the wage bill ladder in the transition from 5 per ce nt to 6 per cent for large firms.) The Simplified model suggests tha t ca pita l intensity wi ll be higher with PRT than without, since the capital-labour choice wi ll be made where the re lative marginal products of the two factors equal their re lative marginal costs, i.e. OF I dF _ al d L d K - w (1 + I + L )/ r
at.
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The RHS represents the ratio of payroll tax·inclusive wage costs relative to capital costs per unit and is greater than ";' , the relative cost of labour and capital exclusive of PRT. It also suggests that the capital inten sive bias wi ll vary according to emp loyment size since the effective rale, t, does so. Rather than facing a fixed fa ctor price for labour, the firm experiences one that increases through the taper zone . In the short run when K is fixed, the marginal cost of output will shift upward s with each expansion in output wherever..£! > o . _ ill . This inhibits employment growth in response to any positive stimuli. It should be remembered that once the firm is large enough, however, this effect is absent si nce ~ = O. The kind of payroll tax structure we have in the Australian states ill may help to keep small firms small but it does not affect the sensitivity of large firms to a growth st imulus. Of course in compariso.n to a no·tax situation the PRT confers a relative advantage on small firms. Ju st how important this is for the preservation or evolution of the structure of a particular industry depends on the overall cost structure of that industry, including the possible cost disadvantages of small·scale producers in the absence of PRT.
3.2 Incidence On Industries And Economic Agents The existing PRT structure i mping~ differently on Australian incustries depending on first, the size distribution of firms, second the differing labour intensities as mea'!lured by the proportion of wages in total costs, third their geographical location, and their statutory exemption from tax. Virtually all fi rms in the basic iron and steel industry, for example, will be subject to tax at the maximum rate while an indu stry like textile finishing, with significant numbers of small firms and some degree of decentralisation in the two large manufacturing states, will experience a somewhat lower effective rate of PRT. In retailing, the industry average rate will be lower again, despite the few retailing giants, because of the relatively high proportion of employment in small firms. The farm sector, because of its essentially family-firm structure, is dominated by payrolls too small to incur the tax. Industries with large proportions of the workforce classified as " general government" such as non· residential construction and, more extremely, public administration and defence, will feel little direct effect from variations in PRT rates as a high proportion of the payrolls in these industries are exempt from the tax . Mention has already been made of th e effects on factor proportions and output of a non-uniform PRT. These effects on the firm omitleds the question of backward (onto employees) and forward (onto consumers) shifting of such a tax. Standard textbook models which postulate inelastic labour supplies give rise to full backward shifting onto labour in a partial equilibrium framework. This can be contrasted with Australian incidence studies where full forward shifting is assumed, e.g. Warren (l979) and with theoretical general equilibrium treatments such as Cornes (1977). With backward shifting the tax " causes the effective demand curve for labour to shift down ... [and] net wages are reduced." (Beach and Balfour (1983) p. 36) With full backward shifting, wages are redu ~ed
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bY the fu ll amount of the tax under assumptions of inelastic labour supplies. ut how much do firms' labour demand cu rves shift down and how elastic is bour supply'! These toget her determine the direct net effects on wages and ~ployment of a PRT in a partial equilibrium setting. The answer to the first ~uestion depends in part on the ability of firms to shift forward the extra impost on costs onto their custo mers. and thu s is ti ed up with quest ions of market ower. Attempts have been made to est imate the demand cu r ve shifl for the &ritiSh economy as a who le (Beac h and Balfour (1983)1 but such an estimate will necessarily miss th e importan t differences in market st ructure Ihat exist among industries. On the quest ion of labour supply elasticity. Hamermesh makes the point that "while evidence suggests that labour supply of adu lt ma les is relatively inse nsitive to changes in wages , th is is cerlai nly not true for secondary workers." (Hamermesh (1979) p. 12111 Beach and Balfour also drew a ttent ion to the differences in male and fe male supp ly elasticities. Putting as ide the differences in effective tax rates due to size. th e largest direct effect on emp loyment of the PRT burden would be in industries where there is little market power over the product and where the re are large female and "secondary" work components of the labour supply. In such industr ies there will be maximum downward shifting of the labour demand curve confronting an clastic labour supply curve. In contrast, industries which are male-e mployee domin ated and endowed with signi fi cant market power wou ld probably show the d irect effects o f payro ll tax increases o r decreases confined to wage changes rather than employment changes, if wages arc market-d etermined . All this presupposes clearing labo ur markets. The possible role that a minimum wage constraint can play in th is, with a given amount of downward shifting of the labour demand curve is shown in Figure 2. If labour mark ets are not clearing because of minimum wage constraints, even in the absence of PRT, then all of the direct effects of the tax will be on employmen t, with wages as a cost being reduced by the amount of the tax when it is removed and wages as a rate of pay left unchanged. See Figure 2.b. This complicates the implications fo r capital/ labour rat ios referred to above. In situation s whe re impositi on of the tax tends to drive wages down we a re relyi ng on the ultimate rati o o f tax· inclusive wage costs to capita l rentals being higher to bring abollt greater capital/labour ratios. In its appraisal of the Australian PRT effects EPAC (1985) claims that "traditional argum ents" presented by critics of th e tax assert t hat' 'payroll tax is a tax on labour incomes which discriminates against labour-intensive industries and employmelll and encourages capit al intensive indu st ries and employmenl." Readers of that Council paper are invited to draw the infe rence th ai alter native taxes, designed not to discrim inate against labour-intensive. wou ld be constructed on the assumption that "capital incomes are curren tly undertaxed relative to labour incomes", a notion which that paper quest ions. It is unfortunate that the EPAC report has chosen to juxtapose seve ral propos itions in thi s presentation of so-called "traditional arguments". Whi le it is trivially true that if labour inco mes' share of [he tax burden decreases, capital incomes' share must rise. it does not necessarily follow that havi ng advocated the lowerin g of payroll tax to remove "discrimination" agai nst employment.
r
132
Economic Analysis and Policy
Vol. 16 No. 02, September 1986
its critics envisage or advocate a rise in the relative tax burden on capital incomes. Confusion arises through EPAC's presentation of discri mination against employment and discr imination against labo ur incomes as though they were so mehow mutually im plied in the arguments against the tax. This invites confusion between the effect of PRT on labour costs as opposed to labour incomes. Figure 211 Labour market effects of PRT in a market for Labour which would clear in the absence of the tax , minimum wages notwithstanding
Per Unit Labour Costs a- b employment e ffect
-- c
--
c - d wag e rate effect
e
e - f "downward s hifti ng" due to tax
Wmin rcdO-__________~_c~ / / /
f
/
Lt D
o
,
b
Quantity of Labour
133
Economic Analysis and Policy
Vol. 16 No. 02, September 1986
Figure 2b Labour market effects of PRT in market for Labour which has a minimum wage above equilibrium In the absence of tax.
Per Unit L.abOur Costs
0
\Vmin
/ / /
/
" " "
"
"
r
LO L'
0
o
b
, Quantily of labour
Suppose the tax is removed and the cut in real wage costs induces expansion in economic activ ity and employment. Both labour and cap ita l incomes will rise. Further suppose the replacement of PRT wit h, say, a value added tax (V AT) suffi cient to recoup the lost revenue. The net effect may still be expansionary and it is not at all clear that the relative burden of taxes on ca pital income will have increased as a result. This would depend partly on the inciden ce of the VAT. However the discrimination against emp loymen t and against labourintensive industries will have been removed. Th e above points are chiefly relevant in a long term analysis and they hinge on supply elasticities of labour and capita l-labour substitution . In contrast, the tax experiments reported in Part 11 assume a short term environment in which wage rates deflated by the Consumer Price Index are exogenous. Capita l-labour substitution is however allowed for in th e analysis. For a discussio n of these
134
Economic Analysis and Policy
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and other relevant elasticities of substi tution see Bruce (1985). Furthermore th e interactive effects of red uced wage costs arc allowed full play through ~ gencral cquilibrium model. This fram ework allows recognition of two important features: (a) that differences in wages as a cost of labour inputs across industries are in part due to different industry PRT burdens; and (b) that any removal of such additional wage costs will have varied effects according to different labour cost shares and industry supply elasticities different import substitution elasticities and demand elasticities in product markets, and different growth rates of these markets. The quantification of these effects and accompanying effects on macro economic aggregates is the subj ect of Part II. REFERENCES Australian Bureau of Statistics (1985) Taxation Reyenue, Australia 1983-84, (ABS, Canberra). Beach, C.M. and Balfour, F.S. (1983) "Estimated Payroll Tax Incidence and Aggregate Demand for Labour in the United Kingdom", Economica, Vol. 50 No. 197, pp. 35-48 . Bruce, 1. (1985) " The ORANI Input-Output and Parameter Files for 1977-78", IMPACT Project Working Paper OP-51, University of Melbourne, February. Bureau of Industry Economics (1985) "Implications of Abolishing Payroll Tax", Report to the Economic Planning Advisory Council, June. Chapman, R. and Vin cent, D. (1985) "Payroll Taxes: An Investigation of the Macroeconomic and Industry Level Effects of Their Removal", Centre for Applied Economic Research (CAER) , Work ing Paper 75, University of New South Wales, August. Committee for Economic Development in Australia (1979), The Effects oj Payroll Tax on the Australian Economy, P . Series No. 21, (CEDA, Melbourne) . Committee of Inquiry into Revenue Raising in Victoria (1983) Report, Vol. I , (Government Printer, Melbourne). Comes, R. (1977) "The Incidence of Taxation on Factor Inputs: A General Equilibrium Approach and its Application to State-Local Taxation" in Mathews, R.L., (ed.) State and Local Taxation , (Austra lian National University Press. Canberra), pp . 10-38 .
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Dixon, P., Parmenter, 8., Sutton, J . a~d Vincent, D. (1982) ORANl: A Mu/tisectoral Model of the Auslralwn Economy, (North Holland, Amsterdam). Economic Planning Advisory Counci l ( 1985) The Economic Effects of Payroll Tax, (EPAC), Canberra). Hamermcsh, D. (1979) "New Estimates of the Incidence of Payroll Tax", southern Economic Journal, Vol. 45 No. 4, pp. 1208- 19. Warren, N. (1979) "Australian Tax Incidence in 1975·76: Some Preliminary Results", CAER Working Paper No.7, Un ivers ity of New SOllth Wales,
May.