Government floats option of handing income tax to states or extending payroll tax in bid to “fix the federation”

Australian states and territories could raise different levels of income tax if a proposal being considered by the federal government is adopted.

However, the Council of Small Business of Australia says the proposal would only add more complexity to the country’s tax system.

A discussion paper for Prime Minister Tony Abbott’s bid to “fix the federation”, released yesterday, said giving states back some power to levy income tax may be one method of addressing the growing concern of vertical fiscal imbalance between the two levels of government.

According to the paper, Australia’s level of vertical fiscal imbalance is high compared to other economies.

The Commonwealth raises 82% of total tax revenue, while the states and territories raise 15% and local governments raise 3%. This compares to Canada, where the central government raises 45% of total tax revenue.

State governments raise only around $130 billion of the total $230 billion in revenue they spend each year. The other $100 billion is raised by the federal government and transferred to the states.

The Commonwealth government has had responsibility for income tax since World War II. However, the proposal in the federation discussion paper, suggested changing these arrangements is one of three options for helping state governments raise more revenue.

Under the proposal, the level of income tax levied by the federal government would be reduced and state governments would have the ability to impose income tax above that level. However, there would be minimum and maximum limits applied.

Speaking to SmartCompany this morning, COSBOA executive director Peter Strong said varying the levels of income tax between Australian states and territories would create incentives for individuals and businesses to operate in some states over others.

While Strong says he welcomes the discussion and says “everything should be on the table”, he is also concerned that different taxation regimes between regions could entice businesses to “move money around to where tax is lowest”.

“We’re trying to reduce complexity, not add it,” Strong says.

The government’s discussion paper also suggests that state-based taxes, including land tax and payroll tax, could be broadened to give states greater capacity to raise revenue.

This option would be in exchange for a reduction in Commonwealth-tied grants.

However, as state governments have used recent budgets to either cut their rates of payroll tax or lift the thresholds at which it kicks in, Strong says extending the tax would seemingly fly in the face of these reforms.

“Payroll tax inhibits business growth,” Strong says.

“It’s a no brainer.”

Strong says the states already impose different arrangements for payroll tax, which is a source of confusion for many growing businesses.

Instead, Strong says a “proper, broad-based consumption tax” is the way to go, referring to goods and services tax reform.

The discussion paper canvasses a number of options for GST reform, including imposing a minimum floor for GST revenue that a state could not fall below or calculating the amount of GST revenue a state is eligible for based on its population.

“We need to fix GST,” Strong says.

“Simplicity is the way to go.”

Strong says there will be winners and losers from either broadening the base of the GST or increasing the rate of the tax and so it is important for the states and commonwealth to “come together to sort it out once and for all”.

“We’re still a federation and that means there are certain behaviours everyone has to follow,” he says.

The discussion paper is part of an ongoing review into the Australian federation. The process will also include a green paper, expected to be released by the end of the year, and ultimately a white paper.