Taxing Times: 'States' Responsibilities'

In the wake of the COVID-induced recession late last year, I brought ESSA readers an article on the most exigent suite of reforms at the Federal level. However, as we’ve entered the second quarter of the 2021 with the virus well and truly suppressed, there is a conversation to be had on how to harness and optimise our state of economic wellbeing. This is an especially important consideration given crises often act as a springboard for the implementation of beneficial and efficacious changes. To paraphrase the late, great Milton Friedman and Winston Churchill, ‘never let a good crisis go to waste’. Indeed, Friedman believed that it was ‘only’ a crisis which ‘produces real change’. It’s often tempting to valorise reforms of epochs past, but the only real reforms that have occurred in the Australian states in the last two decades were the taxes abolished which the GST replaced. Given the Federal Government’s penchant for claiming that various duties are ‘states’ responsibilities’, a situation has presented itself to discuss changing some of those highly distortionary taxes which are, indeed, ‘state responsibilities’.

Amongst the most pernicious of those fiscal responsibilities operated by states is stamp duty, a tax decried by public policy doyen Dr Ken Henry as ‘diabolical’ [1]. Successive economic reviews have recommended the phasing out of stamp duty to be replaced with an annual land tax.

Why is it so bad?

Well, the answer’s not that simple, because basically all of the aspects of stamp duty are bad. The most galling critiques are begat by something in tax economics referred to as ‘marginal excess burden’. This is simply a way of measuring how much economic value is destroyed for every dollar that a tax raises. In the case of stamp duty, it has the highest marginal excess burden of any tax in the Commonwealth [2]. To put this in perspective, the renowned econometrician Chris Murphy estimates stamp duty’s marginal excess burden at 87cents for residential property and 196 cents for commercial property [3]. Treasury analysis estimates a similar figure to the Murphy’s research at 72 cents destroyed for every dollar raised [4].  

Similarly, Ken Henry reiterated its demerits, initially outlined by him in his eponymous review published over a decade ago, in a column earlier this year [4]. Those being, that it causes a large upfront tax imposition on first homebuyers, many of whom have to save for many years for a deposit and often also have small deposits. Likewise, it creates disincentives for individuals and families to move to better, more appealing jobs as they would have to outlay additional stamp duty costs on another property. Additionally, concerns around equity or ‘fairness’ are raised as higher taxes are imposed on people who have to move more often for work. Dr Henry underscores that stamp duties are not simply problematic to individuals and families, but it also causes a suite of funding problems for government. That being, stamp duty is a highly volatile source of funding given it’s affected by both dwelling prices and the rate of turnover of housing stock.

The problems with stamp duty should be of greater interest than merely to policy wonks, academics, economists and public sector employees. Its tax liability bedevils first homeowners and all individuals at large, who hope that the state will make provisions of basic services from their hard-earned tax dollars. Moreover, this becomes vexatious for policymakers and politicians, as stamp duties make up a large share of state government tax revenue. In Victoria – Australia’s second most populous state – the proportion of state revenues that are generated by the most economically distortionary or ‘bad taxes’ is the highest in the country [5]. Most of these so-called ‘bad taxes’ Victoria raises come from stamp duty, as the graph below demonstrates.

Source: Saul Eslake ‘Reforming Tasmania’s Taxation System: Some Options’ and ABS.

In the nascent COVID-normal world, it will be more important than ever to calibrate a coherent, state-based economic framework to incentivise free movement of people to undertake the most productive, interesting and highly paid work. Stamp duty, as previously noted, inhibits this. It would also help Australia at large leverage its comparative advantage, given our response to the economic and health crises is perhaps second only to New Zealand. By removing this ‘diabolical’ tax, not only would it incentivise current Australian residents and citizens to move more freely, were the opportunity to present itself, but it would help bring in critical skilled migrants on which Australia’s economy is in part dependent.

What, then, are the solutions?

Stamp duties have their genesis in colonial Australia, where they were employed due to their ease of administration. If stamp duties have any redeeming features, their administrative ease is its first and last. There are of course no solutions in economics, only trade-offs wherein cost-benefit analyses show benefit flows. The best candidate for reforming such a large portion of states’ own revenue base would be a replacement with a broad-based, annual land tax with no exemptions or different rates. Henry’s tax review recommends this, and Eslake’s Tasmanian Tax Review identifies the candidacy of land taxes. The tax, then, should be levied on all land and not distinguish between its uses so as not to create distortions, nor to discourage commercial operations. Land taxes yield considerable advantages over taxes on individuals, capital gains and profits as the quantity of land is finite and taxing it doesn’t reduce work or investment, respectively.

What are the equity concerns for new homeowners?

There are some concerns regarding how fair or otherwise this proposition is for new homeowners, as they will have paid stamp duty and yet also be expected to bear the burden of land tax. For this, a credit could be given to recent payers of stamp duty for the future sale of their home so as to offset these concerns.

Political considerations

Unlike almost all tax changes, the land tax has almost universal political support. However, Australia’s endemic sense of complacency remains writ large in the political economy with regards to any stamp duty changes. The only change agent on the issue is NSW, which committed to the change in the wake of its report into Federal-State Financial Relations last year. Subsequently, Dominic Perottet has taken on the sole responsibility for political salesmanship of the changes. Notwithstanding, there have been a panoply of criticisms of his proposals. The most notable came from the head of ANU’s Tax and Transfer Policy Institute, Robert Breunig [6]. The problems he sees are Perottet’s ‘opt-in period’, which would allow prospective owners to choose either land tax or stamp duty. His criticism is that its unspecified opt-in period is ‘politically hard, administratively complex, inefficient and unfair’. The lack of compulsion in the proposal to participate in a better system may lead to individuals making the wrong choice without knowledge of what future circumstances may arise. He also criticises its inequity, as infrequently traded homes in wealthy areas contribute no revenue to state services whilst homes in more frequently traded areas pay for the services being used by those tax exempt. Lastly, Breunig is of the view that the proposal may create perverse incentives to remain in their homes, so as not to have to pay any future taxes. This ‘lock-in’ effect would ameliorate the positive benefits of a tax switch that the proposal seeks to make.

Rather, Breunig is of the view that the tax should be applied universally, with no exemptions. He suggests that a fixed opt-in period would be second best to compulsion.

All of these critiques are reform ideals, especially given NSW does not hold the balance of power in both of its houses. This would be a much easier reform in other states, i.e. Victoria or Western Australia. However, given the largely non-partisan support of the proposal, there is a case for a ‘bolder’ set of reforms.

Finally, this will not be a costless exercise as the large upfront cost of stamp duty would be forgone were the best instantiation of land tax to be implemented. The corollary of this would be a short-medium term hit to state budgets. Given the advantages that a tax switch would yield, the Grattan Institute estimates that it would increase GDP by $17 billion or nearly 1% of GDP [7], governments should take advantage of the ultra-low cost of borrowing environment. And there is certainly a case for the Federal Government to offer incentives for states to do this, much like the Keating Government in the 1990s. Alternatively, there could be a cost-sharing arrangement between Federal and State Governments to incur some debt to fill the revenue hole created.

[1] Henry, K., “Extended Interview with Ken Henry”, ABC, 2019. Online. https://www.abc.net.au/news/programs/the-business/2019-12-05/extended-interview-with-ken-henry/11771938

[2] Eslake, S., “Reforming Tasmania’s Taxation System: Some Options”, The Australia Institute Tasmania. 2020. Online. https://taxpolicy.crawford.anu.edu.au/sites/default/files/uploads/taxstudies_crawford_anu_edu_au/2020-09/complete_saul_eslake_tax_reform_tasmania_sep_2020.pdf

[3] Murphy, C., “Efficiency of the tax system: a marginal excess burden analysis”, Tax and Transfer Policy Institute. 2016. Online. ,https://taxpolicy.crawford.anu.edu.au/sites/default/files/publication/taxstudies_crawford_anu_edu_au/2016-06/complete_final_chris_murphy_efficiency_tax_system.pdf

[4] Cao, L., “Understanding the Economy-Wide Efficiency and Incidence of Major Australian Taxes”, Commonwealth Treasury,

[5] Henry K., “Time’s up fort Taxation System”, Australian Financial Review, 2021. Online. https://www.afr.com/policy/tax-and-super/time-s-up-for-taxation-system-20210204-p56zoo

[6] Breunig, R., “NSW’s brave stamp duty switch should be even bolder”, Australian Financial Review, 2020. Online. https://www.afr.com/policy/tax-and-super/nsw-s-brave-stamp-duty-switch-should-be-even-bolder-20201118-p56fkh

[7] Coates, B., “Housing Affordability: re-imagining the Australian Dream”, The Grattan Institute, 2018. Online. https://grattan.edu.au/wp-content/uploads/2018/03/901-Housing-affordability.pdf