NSW State Budget 2014: part 2 – where is the money coming from?

In his Budget speech, NSW State Treasurer Andrew Constance said:

0. The money to rebuild New South Wales must come from somewhere. Our best option is to recycle capital from our existing infrastructure. It doesn't place a debt burden on our children, or a tax burden on enterprise.
   

 
Does the NSW State Government need to get its money from somewhere? From the perspective of Modern Monetary Theory, Treasurer Constance is... quite correct.

Unlike the Australian Government, which issues the national currency and so can never run out of it, the NSW State Government does not issue currency. This is a fundamental difference between the Australian Government and each of the State and Territory Governments. The NSW State Government is a currency user, and like other currency users, such as households and firms, the NSW State Government must finance its spending. It does indeed have to get money from somewhere.

Treasurer Constance indicates some of the ways in which the NSW State Government can finance its spending. Like other currency users, the NSW State Government can sell things it owns (the Treasurer's preferred method); it can also borrow money from financial institutions (which the Treasurer does not like doing). However, the NSW State Government has another means of getting money that's not available to households and firms: it can tax.

The NSW State Government uses money it collects through State taxes to finance its spending (unlike the Australian Government). This includes what it spends on interest on the money it has borrowed. It must be kept in mind, however, that the ability to raise money by taxation – that is, taking money from citizens by force of law – makes the State Government, in the eyes of lenders, a very safe prospect (AAA credited rated), and so it can borrow at lower rates than other currency users.

Which is why we find it baffling that the State Government should be so averse to debt that it won't borrow money to grow the stock of social housing... but is happy for community housing organisations to borrow for the same purpose, and will engineer intricate regulatory regimes and private sector consortia to try to make this happen, even though the State Government is innately better able to get cheap debt.  

Now let's look more closely at how the NSW State Government taxes.

The NSW State Budget predicts that for the coming year, 38 per cent of the NSW State Government's revenues will come from States taxes. (By contrast, 43 per cent will come from payments from the Australian Government; and the remaining 19 per cent will come from sales of goods and services, royalties, fines and other incomes.)

(NSW State Budget 2014, Budget Paper 2, Chapter 6)

And here's how NSW State tax revenue breaks down. The big three are: payroll tax (comprising 30 per cent of total State tax revenues), followed closely by transfer duty (AKA stamp duty – 24 per cent), then land tax (10 per cent).

(NSW State Budget 2014, Budget Paper 2, Chapter 6)

As well as raising revenue for the State Government, these taxes affect the behaviour of economic agents – in troubling ways.

Payroll tax is levied on firms at the rate of 5.45 per cent of the wages they pay to New South Wales employees above a threshold of $750 000 pa. Firms pay the tax, but because it increases the cost of putting employees on, it will cause some firms to choose not to put additional employees on, thus reducing demand for labour and hence labour's price – ie higher unemployment and lower wages. Not a happy result.

Transfer duty is levied on purchasers of property at rates applied to the value of the property bought; the rates apply progressively from 1.25 per cent up to 7 per cent on 'premium' properties above $3 million. Purchasers pay the duty, but because it otherwise increases the cost of purchasing a property, it will cause some would-be purchasers to bid less. Insofar as it discourages some would-be speculative buyers, that's a good result, but this effect also applies to other would-be purchasers, with unhappy results. In particular, people who just want to move house – to downsize, or to be closer to work, or to take up a job opportunity elsewhere – get punished by transfer duty, and as a result may not move. This makes the uses of property generally less efficient, contributes to long trips to work, and holds back economic opportunity. On balance, not a happy result.

Finally, there's land tax. Land tax is levied on owners of land at the rate of 1.6 per cent of total assessable land value above a threshold of $412 000 (increasing to two per cent on total values above $2 519 000). Land tax is levied annually, regardless of the amount of income – if any – the owner has derived from the land. This means the burden of land tax cannot be passed on by owners to the users of land (ie tenants), because owners cannot defer the liability while holding out for a higher price to cover it (contrast, say, a sales tax, which is payable only when the sale is made, thus allowing the vendor to hold out).

It also means that owners are encouraged to put land to productive use – or sell it to someone who will. This tends to discourage speculative hoarding and reduce the cost of land, making housing more affordable.

And, by its nature, land cannot be taken out of the jurisdiction or hidden – making land tax hard to avoid – and its supply cannot be reduced.

Finally, keep in mind that the increases in value that land tax gets at are increases that come from the economic development of the community generally (such as developments in transport infrastructure, and developments in uses of adjoining sites). Taxing these increases allows them to be 'recycled' for community use, rather than leaving them to accumulate, unearned, to the land owner.

These are the numerous happy results of land tax... the trouble is that we don't get anywhere near the full benefit of them, because of the defective way in which land tax is applied in New South Wales. Far too much land has been made exempt from land tax: in particular, land used for owner-occupied housing, which accounts for about 60 per cent (by dollar value) of the potential tax base. This undermines the discouragement of speculation in land and makes housing more expensive.

There's other problems too: the threshold is too high ($412 000 cannot be justified as an exemption for low-cost housing) and the increasing marginal rates discourage large institutions, such as super funds, from owning residential rental properties.

The NSW State Government should be making much greater use of land tax, both for the revenue it the Government needs, and the encouragement land tax – properly applied – gives to productive economic activity and housing affordability. The NSW State Government should broaden the land tax base to include owner-occupied housing, reform the structure of the rates, and replace other taxes that burden work and enterprise.

Read the TU's land tax policy here.