Home > Economics > Abolish the payroll tax

Abolish the payroll tax

March 27, 2010

Governments of all persuasion often claim that they support a strong private business sector, while at the same time burdening business with a range of taxes, regulations and obstacles. One such tax that has been a consistent thorn in the side of the private sector is the state payroll tax.

Payroll tax is paid by businesses based on the amount that they pay their staff. It is literally a tax on jobs.

In many ways, the payroll tax is similar to the income tax. Both drive up the cost of employing people. Both are paid by employers, based on wage payments. Both result in lower take-home pay for workers, higher prices for consumers, and lower profits for investors. The main difference is that while the Commonwealth income tax applies to everybody, the state payroll tax only applies to people working in a medium or large business.

Suffice to say, taxing businesses for hiring people will decrease their incentive to hire more people. By driving up labour costs, payroll tax leads to fewer businesses and more unemployment.

State governments that want to create a pro-business environment with high levels of employment should set a long-term goal of abolishing payroll tax. This isn’t as hard as it sounds. In Queensland, payroll tax contributes only 7 percent of total revenue. With prudent financial management and spending restraint, a reformist government could afford to remove the payroll tax in a few years.

Employment models suggest that removing the payroll tax could lead to 30,000 new jobs in Queensland, cutting the unemployment rate from 6 percent (the second highest in Australia) to under 5 percent.

In addition, a low-tax business environment would attract new business to Queensland, and contribute to stronger economic growth and higher wages.

In contrast to a reformist agenda, the latest Queensland state budget included a minor payroll tax rebate of only $0.015 billion, applicable for only one year. Looking around Australia, the WA government offered slightly more valuable payroll tax relief, with a one-year rebate of $0.1 billion. In the battle of moderate and meek reforms, the WA government wins this policy fight on points, but both states should do more.

Pursuing a reformist tax agenda would require real political leadership and a willingness to make tough decisions to hold down government spending. But given the benefits of tax reform and the questionable quality of some government programs, it is an agenda worth pursing.

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  1. March 27, 2010 at 10:55 pm

    The Henry Ergas and Ken Henry Tax Reviews both suggest keeping payroll taxes and if anything extending them by removing exemptions.

    • March 28, 2010 at 10:22 am

      Well then I disagree with them. Though to be fair to Henry & Ergas, I think they were limited by the terms of reference of their projects.

      I am not arguing that payroll tax is the worst tax. And I’m not arguing that we should cut payroll tax and increase an alternative tax. But I am saying that payroll tax (like many other taxes) is very costly to workers, consumers and investors… and that the benefits of removing payroll tax are higher than the benefits of the equivalent government spending.

  2. Tom N.
    March 29, 2010 at 7:28 am

    Two counterpoints, both of which I’m sure you’re aware but which are perhaps worth recording anyway.

    First, if payroll tax is indeed not the worst tax (as you accept in your reply to Sen) and if you also accept that, for the foreseeable future, governments will continue to meet electoral demands to spend and thus will continue to require taxation, then it does not follow that government should reduce payroll tax, at least until it has removed all worse taxes.

    Second, when you say that “By driving up labour costs, payroll tax leads to fewer businesses and more unemployment”, you of course does not address the impact of government spending on employment. Particularly if demand for labour is fairly price inelastic, payroll taxation and its subsequent expenditure could increase net employment. I know that you would realise that this is at least a theoretical possibility, so I wonder if your ommission of the point reflects some knowledge or literature on the matter that definitively settles the matter?

  3. March 30, 2010 at 6:27 am

    For all of your micro-economic brilliance Tom, I think you underestimate the importance of political dynamics & public choice theory. When Australia is run by a philosopher-king, I will be sure to suggest you as a key adviser. 🙂

    Geoff Brennan makes an interesting public choice argument for inefficient taxes. But in this case, my response is that I reject “2nd best” arguments. I agree there are other reforms which would give even higher benefits. But I do not agree that reforms must be ordered exactly, and given the difficulty of ever getting reform in the right direction I will gladly jump at any chance to push our country towards lower taxes.

    You are right that I didn’t do an analysis of the effectiveness of marginal government spending. A debate about whether tax & spending is too high/low is beyond the scope of this blog post. Suffice to say, I believe government tax and spending is too high, and the marginal benefit of much government spending is close to zero (or even negative).

  4. Tom N.
    March 31, 2010 at 11:53 pm

    Fair enough, although I hope your view that ‘the marginal benefit of much government spending is close to zero (or even negative)’ isn’t a reference to my salary! Anyhow, good to have found your new blogsite. I’ll read it with interest and try to keep my Clever Dick type narky responses to a minimum.
    T.

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