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Wednesday, May 14, 2014:

Budget reply: A tax policy for full employment and affordable housing

By Gavin R. Putland

To start participating in the economy, you need two things: a job, and a home within commuting distance of the job. The Australian Government (whichever party is in power) deliberately makes both hard to get.

Tax policies are designed not to help people find jobs and homes, but to help property owners get further ahead without having to create any jobs or supply any homes. That's why unearned “capital gains” on investment properties, including vacant lots, are taxed more lightly than hard-earned wages and salaries. That's why there's no “capital-gains tax” (CGT) on owner-occupied homes. That's why there's no Federal land tax. That's why, if the interest and other recurrent costs on an investment property exceeds the rent (“negative gearing”), the owner can claim the difference as a deduction against wage/salary income (although it isn't a cost of earning that income), while the cost of commuting to work can't be claimed against wage/salary income (although it is a cost of earning that income). That's why investors can claim negative gearing even if they don't build new homes, but simply buy existing homes (outbidding first home buyers in the process), and even if they don't actually get tenants (as long as their properties are supposedly “available” for rent). The lack of any obligation to build houses or get tenants shows that, contrary to the pretenses of the Government and the property lobby, the negative-gearing policy is not intended to encourage the supply of rental accommodation.

To compensate for all the concessions to property owners, the Commonwealth raises revenue from taxes that increase the cost of labour for employers above what the workers can take home and spend, and thereby cause unemployment — taxes price workers out of jobs.

The biggest offender is Pay-As-You-Go “personal” income tax, which employers “withhold” from wages and salaries. Although this component of income tax is credited to employees in their PAYG payment summaries (formerly known as group certificates), it is actually paid (“remitted”) to the ATO by employers, who are liable for it if it isn't paid. It's like a payroll tax on employees' net pay.

The second-biggest offender is the 9.25% employer-funded superannuation contribution. This impost, although not technically a tax, raises the cost of labour as if it were a 9.25% payroll tax — and indeed serves the same purpose as the payroll taxes in most other developed countries.

Like the GST, payroll taxes tax value added, except that payroll taxes focus on the value added by labour, whereas the GST doesn't care who or what adds the value (and doesn't tax exports). Hence payroll taxes, like the GST, are partly passed on in prices. Indeed, the effect of payroll taxes on prices should be more obvious than that of the GST: payroll taxes raise the cost of an input (labour) and therefore raise the price of the output. But the tendency to “pass on” the tax does not reduce the damage to employment; higher prices mean lower sales (including lower export sales), hence less employment in production.

Taxes and other imposts that raise prices — including PAYG “personal” income tax, employer-funded superannuation, and the GST — cause unemployment in yet another way: they cause upward pressure on inflation and therefore raise the so-called natural rate of unemployment, which is the minimum unemployment rate that causes enough downward pressure on wages to give stable inflation. In normal times, the Reserve Bank sets official interest rates so as to maintain unemployment at this so-called “natural” rate. It has not the faintest intention of allowing everybody who wants a job to get one.

The purpose of monetary policy in abnormal times is less clear, because abnormal times are not supposed to happen. They do happen because the pursuit of concessionally taxed “capital gains” causes debt-funded property bubbles, which burst, leaving borrowers owing more than their properties are worth.

The key to full employment is to get rid of taxes that feed into prices, especially those that add to the cost of labour. Because lower unemployment means less expenditure on welfare, only some of the forgone revenue needs to be replaced. But with what? If we tax the value of labour, there will be less labour employed. If we tax the value of (produced) capital, there will be less capital employed, hence less supply of its products, hence higher prices. But if we impose a holding charge on land, there will not be less land, and the available land will be more likely to be employed in order to generate income to cover the holding charge. Hence there will be more supply of housing and business accommodation, making both more affordable, and more supply of goods and services, reducing inflationary pressure.

If a holding charge on land, payable by land owners, replaces taxes that feed into prices, the owners will be compensated by a reduction in the cost of living. This is especially important for owners with limited income. For residential tenants, the benefits of more jobs and cheaper goods and services will be only partly competed away in higher rents, because the increased supply of housing will improve their bargaining position. Households will have more capacity to consume. Hence business will improve. The beneficiaries will include commercial tenants; and again, due to the increased supply of business accommodation, the benefit will only partly competed away in higher rents. For residential and commercial landlords, the benefit of tenants' higher capacity to pay rent will come in addition to the benefits of the reduction in the cost of living, further justifying the holding charge on their land.

Implementation can be in two stages. The first stage uses existing administrative machinery to achieve the desired price reductions as quickly as possible. The second simplifies the administration.

Stage 1: Stop taxes from feeding into prices

Part (a): Set the GST rate to zero. The compliance cost of the GST almost vanishes (because if the rate is zero, there's no need to calculate the base). Then let employers offset withheld PAYG “personal” income tax and compulsory superannuation contributions against the GST; that is, let them claim withheld PAYG tax and superannuation contributions as GST input credits. Consequently, GST revenue goes negative. Abolish Fringe Benefits Tax (because the offsets encourage employers to pay workers in money rather than in kind). Abolish personal income tax on rental income from property (because property is dealt with below).

(Note: Negative GST bills can already occur for some businesses in some or all accounting periods. A new business is likely to reclaim more GST on its set-up costs than it collects on its sales. An exporting business does not collect GST on its export sales but still reclaims GST on its domestic expenses.)

The most recent year for which we have all the necessary figures is 2011-12. In that year, according to ABS 5506.0, Australia collected $49 billion in GST, and $154 billion in personal income tax and FBT; and according to ABS 5204.0 (Table 6), wages and salaries amounted to $632 billion, on which a 9.25% superannuation contribution would have yielded about $58.5 billion. On those figures, part (a) causes a revenue loss of $261.5 billion — and a corresponding fall in the cost of living.

If the fall in the net cost of labour for employers eliminates $5 billion of unemployment benefits (out of $7.5 billion, according to the Budget Papers) and $6.5 billion of Disability Support Pension (out of $14.5 billion), the revenue to be replaced is reduced to $250 billion. This is still slightly pessimistic (too high) because it includes non-PAYG tax on non-rental income.

Part (b): Replace the revenue by a flat “Tax-Replacement Charge” (TRC) levied on land values. On a total base of $3.6 trillion (ABS 5204.0 Table 61, June 2011, excluding “Other”), the required rate is just under 7% p.a. Any unpaid portion of the TRC accumulates as a debt against the land and is capped to the value of the land (not including any buildings). In cases of obvious need (such as owner-occupants with limited income), there is an automatic right to let the debt accumulate until the land title is transferred in the normal course of events.

Anticipation of the TRC causes a burst of construction as land owners prepare to earn income to cover future holding costs. Anticipation of lower prices for goods and services causes a hiatus in consumption, freeing up capacity for the burst of construction.

Stage 2: Unscramble the egg

After Stage 1, we have a GST that raises no revenue because its rate is zero, and a PAYG tax and a superannuation contribution scheme that raise no net revenue because they are offset against GST. Clearly it would be simpler to get rid of all three. Conceptually, this requires three steps. In practice, the steps can be simultaneous.

Step (i):  Instead of reimbursing employers' superannuation contributions by a GST offset, cut out the employers and fund superannuation contributions out of general revenue. On paper, GST revenue becomes less negative but employers no longer incur super contributions to pass on in prices, and the effects on employers' cash flows cancel out. In reality, nothing changes except that employers no longer incur compliance costs for superannuation. That saving causes a slight fall in prices.

Step (ii):  Instead of reimbursing employers' PAYG remissions by a GST offset, exempt wages and salaries from income tax, and reinterpret employment agreements and awards so that workers continue to receive the same after-tax pay. On paper, GST revenue rises to zero while PAYG revenue falls to zero, and the effects on employers' cash flows cancel out. In reality, nothing changes except that employers no longer incur compliance costs for PAYG withholding. That saving causes another slight fall in prices.

Step (iii):  Formally scrap the GST.

The bottom line

After these reforms, employees' net wages and salaries will not be reduced. But the cost of labour for employers will be much lower, and much closer to what the employees can take home and spend. Consequently prices will be lower, exports will be more competitive, and there will be more jobs. The GST will be gone. Most individuals, including most individual property investors, will be outside the income-tax system. Superannuation contributions will be funded out of general revenue. Employers will forget about FBT, compulsory superannuation and PAYG withholding. The main source of Federal revenue will be an annual charge on land values, payable by the owners. Tenants will make their contribution because some of the benefit of more jobs and cheaper goods and services will be competed away in higher rents. The rest of the benefit will be a net gain for the tenants.

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