Property levy the most efficient tax for states

by John Daley and Brendan Coates

Published by The Australian, Monday 20 July

When premiers sit down with the Prime Minister to discuss state funding at the special Council of Australian Governments retreat on Wednesday, they should take a lead from the cyclists slogging it out in the Alps in the Tour de France. With the commonwealth and states facing acute and worsening budget pressures, all governments are going to have to work a lot harder.

Introducing a GST nearly cost John Howard an election, but the pay-off was significant. The GST gave the states a stable revenue source, even if it hasn’t grown quite as fast as the economy. It allowed some states to abolish some of their most inefficient taxes.

Yet since the introduction of the GST, no state has undertaken major tax reform. Instead, the states have sat in the slipstream behind the commonwealth, hoping it would do all the hard work. But slower economic growth, stagnant wages and falling commodity prices mean that states’ own source tax revenues will grow more slowly in future.

The commonwealth has clearly had enough of leading from the front. To deal with its own budget problems, the commonwealth cut promised funding to the states for hospital and schools in last year’s budget, leaving them with a projected budget shortfall of $16 billion by 2024-25. Despite their size, these cuts caused relatively little public outcry, and some of the suggestions in the federalism white paper suggest the commonwealth may cut grants to the states ­further. So, what can states do?

Unless substantial functions are transferred from the states to the commonwealth — and no one seems to be agitating hard for this — the states will need more revenues to meet their spending responsibilities. The working draft of the discussion paper on federalism examines three options: increasing the rate or broadening the base of the GST; sharing the personal income tax base with the states; or having the states collect more taxes directly.

The first and second options would effectively allow the states to stay tucked in the peloton as the commonwealth collects more revenues on their behalf. While premiers inevitably prefer these options, they are unlikely. Treasurer Joe Hockey has ruled out reforms to the GST without unanimous support from all states and both major parties federally — a tough ask. Western Australia would rather bring down the whole peloton than have the commonwealth raise more GST revenues, unless the other states agree to WA ­taking a much bigger share.

While less politically toxic than increasing the GST, providing the states with a share of income tax revenues would again involve the commonwealth doing the work while the states reap the gains. Hockey signalled last week that he expects the states to raise more of the revenues they spend.

This wouldn’t hurt Australia’s federation. Almost half of the states’ revenues come from commonwealth grants, much more than in other federations such as Canada, Germany and the US. If revenue and expenditure were aligned better, state governments would be less likely to blame the commonwealth — and vice versa — for policy failures. But the states would have to do their time at the front of the peloton, by undertaking their own serious tax reforms. The good news is that they can.

Property Taxes, a new Grattan Institute paper, finds that a modest property levy of just $2 for every $1000 of unimproved land value would raise $7 billion a year for the states and territories. The annual charge on the median-priced Sydney home would be $772 and in Melbourne $560, with lower ­average rates in other cities and the regions.

A broadbased property levy could help plug the funding gap for schools and hospitals left by the commonwealth. Based on historical price trends over the past two decades, revenues from a levy on unimproved land values could double to as much as $14bn by 2024-25, offsetting much of the projected shortfall from cuts to state hospital and schools funding.

A levy would raise somewhat more per person in NSW, Victoria, and WA, where property values are higher, but the Commonwealth Grants Commission’s redistributions of GST funds would lead to similar outcomes in all states.

A property levy based on the value of property holdings would be the most efficient tax available to states.

Well-designed property taxes generate less drag on the economy for each dollar of revenue raised than any other tax on offer. Unlike capital, property is immobile — it cannot shift offshore to avoid higher taxes. Concerns about the risks of multinational tax avoidance, the increasing mobility of global ­capital and the increasing value of residential property relative to ­incomes should make property taxes a priority in any tax reform.

Higher property taxes could also be used to fund the reduction and eventual abolition of state stamp duties on property. Stamp duties are among the most inefficient taxes because they discourage people from moving to better jobs, or to housing that suits their needs better. Their revenues are inherently volatile. Shifting from stamp duty to a broadbased property tax would provide a more stable tax base, spread the tax burden more fairly, and add up to $9bn annually to GDP.

State property tax reform isn’t the only improvement needed to Australia’s tax system and federation. But it should be part of the solution to balancing budgets, ­improving the efficiency of our tax base, and aligning federal responsibilities.

Like any worthwhile change, state property tax reform will face plenty of political headwinds.

But no one wins the Tour de France unless at some point they get out of the pack and make their own luck.