Wednesday, March 25, 2009

Payroll tax reductions and employment generation?

Another contribution to the payroll tax debate, this time by Wayne Kayler-Thomson in today's The Age, Why tax the jobs we're trying to create?

IN THE flurry of a crisis, the blindingly obvious is often overlooked, and the current economic crisis is no exception. Everyone - employer groups, unions and governments - agrees that the mantra should be "jobs, jobs, jobs", but why do we tax the jobs we are seeking to create?Australia is a country with a $14 billion tax on jobs that impacts especially on labour-intensive industries.

For many years, payroll tax as rated as the No. 1 nuisance tax among members of the Victorian Employers'Chamber of Commerce and Industry (VECCI). It cuts in at a headcount of about 10-15 employees in Victoria. Even smaller employers regard it with dread, seeing it as a brake on future growth and a disincentive to hire. Some companies actually stop hiring so as not to incur payroll tax.....

A more competitive payroll tax rate is a headline indicator that states can point to when seeking local or overseas investment, and Victoria's relatively competitive payroll tax rate has been in no small part a factor in our superior investment and jobs performance against NSW over the past decade.
The funding of the reduction and eventual abolition of payroll tax should be a major priority for the Federal Government in light of the current economic crisis and should be the focus of any future stimulus measures, as well as the Henry review into taxation. One possible long-term solution is a lower payroll tax/higher GST scenario, with some economists estimating that a 12 per cent GST would enable this.....

The central problem with this analysis is that the author ignores something discussed in Economics 101, the distinction between the legal and economic incidence of taxation. In this article, the author makes no distinction between the legal and economic incidence of the payroll taxation, and his policy conclusions are therefore undermined.

Consider a world of flexible wages, where the demand for labour is downward sloping with respect to the real wage and the supply of labour is upward sloping. In such a world, employers do not bear the entire burden of payroll tax. So just as the current payroll tax is passed on in the form of higher prices, lower wages and lower returns to shareholders, any reduction in the payroll tax will result in lower prices, higher wages and higher returns. Higher wages and lower prices, coupled with the existing levels of excess capacity, will limit the employment generating impact of a payroll tax reduction. Of course, in order for a decrease in the payroll tax to have any significant effect on employment the decrease would have to be permanent, otherwise firms will not be willing to hire workers on a long-term basis. How much bang for the buck would such a payroll tax reduction generate?

A narrow focus on the legal incidence, as opposed to the economic incidence, of taxation leads to a further error in the discussion of a revenue-neutral tax mix change (reduction in payroll taxes accompanied by an increase in the consumption tax). A basic principle of the economic incidence of taxation is that any tax taxes the jobs we are trying to create! A GST-induced jump in the CPI will produce a corresponding jump in wage demands, which will have an adverse effect on employment.

While I don't have time to comment in detail on the tax-competition part of the article, it is clear that no consideration was given to economy wide implications for tax revenue, efficiency of resource allocation etc. Beggar-thy-neighbours policies are not what is needed to address the challenges faced by the Victorian economy.


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