Two taxes, no distortions, no losers

As an association specializing on tax reform, writing a submission to a Review of State Taxation, Prosper Australia (www.prosper.org.au) has two options:

We have chosen the latter. We present our proposals in the following Summary (which should be read in sequence).

2. Summary

The equity, economic efficiency, administrative efficiency, and political acceptability of the NSW tax system (including local taxes) could be improved, without disadvantage to any vested interests, as follows:

On completion, the above reforms would eliminate State and local taxes on productive activities or the results thereof. The remaining ILT and SWT would not penalize productive efforts by the payers (site owners), and transfers of sites would at most realize — not create — liability for the taxes. Whereas most existing taxes inhibit production, hence raise prices, hence feed inflation, hence raise the natural rate of unemployment (the minimum rate consistent with stable inflation), and hence cause the Reserve Bank to raise interest rates in pursuit of that artificially created "natural" unemployment rate, the ILT and SWT would have none of these effects.

Provided that the two SWT rates and the two fractional caps on deferred ILT add up to less than 100%, no property owner would be harmed in any sense (cash or accrual, annualized or capitalized, short-term or long-term) in consequence of subsequent increases in site values. Moreover, because the State and local governments would receive fractions of all uplifts in site values, they would have a fiscal incentive to induce such uplifts by providing infrastructure. Thus property owners would receive windfall capital gains from infrastructure projects that would not otherwise proceed. But because the ILT would impose a holding cost on sites, and because the SWT and the deferred component of ILT would reduce the attractiveness of capital gains relative to current income, absentee site owners would be encouraged to use their sites productively — e.g. by building accommodation and offering it to tenants — or sell the sites. This would improve the bargaining position of renters and buyers relative to landlords and sellers, ensuring that renters and first-time buyers also benefit from the overall increase in GSP — that is, ensuring that accommodation becomes more affordable when measured against the spending power of the tenants and the amenity of the accommodation, even if prices and rents do not fall in dollar terms.

3. Myths and facts about State taxation

3.1 Myth: that the States' taxing powers are narrow

That the States cannot impose duties of customs or excise (under s.90 of the Constitution) or income taxes or various "nuisance taxes" (under revenue-sharing arrangements imposed by the Commonwealth under s.96 of the Constitution) diverts attention from a far more significant fact: The States have an unfettered power to impose holding taxes and transfer taxes on property (except property owned by the Commonwealth; this exception applies to all subsequent discussion). In particular, the States have an unfettered power to impose holding taxes and transfer taxes on sites — a site being a piece of ground or airspace, including any attached building rights, but excluding actual buildings and other improvements.

Land, being a natural resource, is in fixed supply. Rezoning land and increasing permitted building heights may effectively create sites, but such decisions are reserved for governments. Hence, from the viewpoint of private entities (taxpayers), the supply of sites is fixed. This is true of the overall supply of sites, the supply of sites zoned for any particular purpose, and, most importantly, the supply of sites within acceptable distance of any particular services, infrastructure, or markets. Yet access to suitably located sites is essential to life and livelihood. Therefore the rents and prices of sites are competed upward until they absorb the economy's capacity to pay; this is the all-devouring rent effect. It follows that all taxes, being deductions from that capacity to pay, are deductions from the total rental value of sites, hence (when converted to present values) from the total capitalized value of sites; that is, all taxes are ultimately borne by site owners. A holding tax imposed directly on a site is merely a special case in which the deduction is made directly from the realized or imputed rent received by the owner of that site, while the present value of the tax is deducted from the price that a rational buyer will pay for that site.

That all taxes ultimately fall on site values was an early conclusion of political economy. It was known to John Locke [1] and Benjamin Franklin [2], and was reaffirmed by Henry George [3] as a corollary of the "all-devouring rent" theory, which itself has been emphatically vindicated by the modern observation that growth in per-capita GDP does not improve the affordability of housing.

If all taxes fall on site values, then the capacity of site values as a tax base is automatically sufficient to replace the revenue from any other taxes that one might wish to abolish, because those other taxes are indirect site-value taxes. The only remaining problem is how to move those indirect site-value taxes directly onto sites in an equitable and politically acceptable manner. In this submission we simplify the problem by proposing to move only property taxes, which by definition are already paid by site owners (see items 1, 2, 6, 7 & 8 of the Summary). In the case of recurrent property taxes, which are already attached to particular sites (e.g. because they are imposed on buildings or other improvements on, or services delivered to, the respective sites), we further simplify the problem by attaching the new direct site-value taxes to the same sites, hence the same taxpayers (see items 1 and 2 of the Summary).

If the thesis that all taxes fall on site values were not true in general, it would be true of property taxes, which by definition are borne by site owners. And if it were not true of property taxes in general, it would be true of property taxes attached to particular sites, which by definition are borne by the owners of the same sites. And if it were not true of all property taxes attached to particular sites, the taxable capacity of site values would still be considerable; for example, if the rental value of the average address were 20% of the net income of the occupant, and if the site accounted for 30% of that rental value, then site rents (realized or imputed) would account for about 6% of GSP — which, according to Figure 2.2 in the Issues Paper, is more than the current tax revenue of any State, and enough to replace all Federal grants and subsidies to NSW!

Consequently, any reader who rejects the thesis that all taxes fall on site values does not thereby obtain a reason for discounting the rest of this submission. If the thesis is entirely false (except for direct site-value taxes), the States have a substantial tax base in site values. If the thesis is even partly true, the capacity of that tax base is greater.

3.2 Myth: that the tax base available to the States is a shrinking fraction of GSP

As noted in the Issues Paper, the States have been and will be required to abolish various taxes as a condition of receiving GST revenue, which itself may decline as a fraction of GDP because of disproportionate growth in GST-free consumption. But this says nothing about the taxable capacity of site values.

If, as we argue above, the price of access to sites absorbs the economy's capacity to pay, we should expect it to absorb a greater fraction of GDP in response to economic growth. Rising housing costs relative to household income tend to confirm that prediction. A sophisticated study by T. Dwyer [4] confirms it more comprehensively. For example, apart from the "popping" of short-term "bubbles", the total value of land in Australia rose relative to GDP for half a century, from 49% of GDP in 1954/5 to 159% of GDP in 1994/5. By 2004 it was about 250% of GDP [5].

3.3 Myth: that the need for infrastructure is a fiscal liability

The market cannot value the benefit of infrastructure except through the price of access to the infrastructure; market value equals price of access. But the price of access has two components: the obvious one, namely the charges payable for actual use of the infrastructure (e.g. fares, tolls, waste-discharge tariffs); and the hidden one, namely the price of living or working in a location where the service provided by the infrastructure is available, as opposed to a location where it is not.

The value of a location is reflected in rents or prices of real estate in that location. More precisely, it is reflected in the rents or prices of sites, not buildings. The value of a building in any location is limited by construction costs, whereas a site has a unique location, hence a locational value, even if no buildings yet occupy it.

So the "hidden" component of the price of access to infrastructure is the uplift in site values caused by provision of the infrastructure. Moreover, the benefit of the infrastructure to the public (as distinct from the provider, which we assume to be the government) is net of charges for actual use, and is therefore equal to the "hidden" component of the price of access. That is, the net benefit of infrastructure to the public is the total uplift in site values caused by the infrastructure.

Hence the economic cost/benefit ratio of an infrastructure project is simply the cost/uplift ratio. If the "cost" is understood as the cost to the provider, this is also net of charges for actual use, so that the cost/uplift ratio is the fraction of the uplift that must be recovered through the tax system in order to pay for the project. And if the project passes a cost-benefit test, this fraction is less than 100%.

(Note: Obviously costs and benefits may have lump-sum and annualized components, while uplifts may be expressed in terms of sale prices or rents. For the purpose of the foregoing argument, all terms must be converted to the same basis, e.g. present value or annuity.)

It follows that any infrastructure that passes an economic cost/benefit test can be financed by a tax collecting less than 100% of the uplift in site values caused by the infrastructure. The rest of the uplift is a net windfall for the site owners.

Alternatively, if a certain fraction of every uplift is reclaimed through the tax system, infrastructure projects whose cost/benefit ratios are equal to that fraction will be self-funding, while projects with lower cost/benefit ratios will be more than self-funding, yielding net contributions to revenue. These contributions may be spent on infrastructure projects with slightly higher cost/benefit ratios, or other services, or cuts in other taxes, or some combination thereof.

To solve the infrastructure problem, it is not necessary to find additional revenue in order to spend it on infrastructure. It suffices to redesign the tax system so that investment in infrastructure automatically results in additional revenue without further changes to the tax scales. The ILT and the SWT (described in the Summary, especially items 1, 2, 6 & 7) meet this requirement.

3.4 Myth: that land tax and CGT must be bad for property owners

If all taxes fall on site values, site owners might as well bear them in the form of direct site-value taxes as in any other form.

Every tax is a deduction from taxpayers' capacity to pay for access to sites. In the best case, in which the tax is only a deduction from that capacity, the tax will take as much from site owners as it delivers to the Treasury. But most taxes do more than that. By targeting productive transactions, causing otherwise viable transactions and hence otherwise viable enterprises to become unviable, most taxes cause a deadweight cost or excess burden; that is, they reduce the national income, which is the fund from which both taxes and site rents must come. Hence most taxes reduce the capacity to pay for sites — and therefore reduce the income of site owners — by more than the tax paid: the site owners are overcharged!

Direct taxation of site values avoids the overcharge because the taxable value is independent of, and therefore cannot deter, any productive activity of the taxpayer. Even if the tax causes the site to be sold, this does not destroy the taxable value or the incentive to use the asset productively, but merely transfers both to the buyer. As there is no loss of production, hence no loss of total capacity to pay for sites, the owners suffer no loss apart from the actual tax paid.

In other words, the principle that all taxes fall on site values applies not only to the taxes themselves, but also to their deadweight costs. Direct taxation of site values, by avoiding any deadweight cost, minimizes the cost to site owners of raising any given amount of revenue. Economically rational site owners should therefore prefer direct site-value taxation to any other form of taxation.

The same conclusion holds for an owner wishing to sell a site. Anticipated liability for site-value taxation reduces buyers' capacity to pay and therefore reduces the sale price. But so does anticipated liability for any other tax — with the usual overcharge due to deadweight. A rational seller will prefer the former scenario.

Taxes on site values (or, better still, on increases in site values) give governments an incentive to invest in infrastructure which increases site values, with the result that site owners receive windfalls that they would not otherwise receive, due to infrastructure projects that would not otherwise proceed. Other taxes dilute the incentive to provide infrastructure, but still ultimately fall — with the usual overcharge — on site owners.

The benefit to property owners from site-value taxation was emphasized by the Nobel-winning economist William Vickrey, who argued that charges for the actual use of infrastructure should be set at marginal cost (for optimal utilization) while the remainder of the cost should be financed by site-value taxation [6]:

Vickrey is extensively quoted by Don Riley [7], who is not only one of the leading advocates of site-value taxation in the United Kingdom, but also a successful property investor!

The proposed ILT and SWT (described in the Summary) indeed give governments an incentive to provide infrastructure. But they also ensure that site owners are still net winners from any uplifts in taxable site values. With the SWT and any deferred component of ILT, the total tax payable on transfer of a site is guaranteed to be less than the real uplift in the site value since the last transfer. Under the annual component of ILT, your tax bill does not increase unless your site value does, and your site value does not increase unless, in the judgment of the market, you are better off in spite of the tax implication.

It will be noticed that the SWT is somewhat reminiscent of the Federal capital gains tax (CGT), except that the SWT is computed on site values alone. If the Federal CGT is bad for property owners, that is because the Federal government is not primarily responsible for infrastructure. But even the Federal CGT, which largely falls on uplifts in values of non-replicable assets including sites, has a lower deadweight cost, and therefore does less harm to site owners, than an alternative tax on earned income or value added.

The clear implication is that the almost universal opposition of property owners to site-value taxation is suicidal madness. To the extent that such opposition is "successful", it forces the imposition of less efficient taxes which impose greater losses on property owners for the same revenue, and it blocks infrastructure projects that would increase site values for the benefit of property owners. Indeed, the attitude of property owners to infrastructure is far more ridiculous than that of a technology company that fails to invest in R&D. For the technology company, the expense of R&D is incurred up-front and may or may not be recovered. But for a property owner, the tax on the increase in the value of one's site is not payable unless and until the increase actually occurs.

3.5 Propaganda: that land tax closes businesses, destroys jobs, repels investment, closes caravan parks, throws tenants onto the streets...

In fact a holding tax on sites encourages the owners to use the sites productively in order to generate income to cover the tax. Thus it encourages owners to open businesses, create jobs, and invest in buildings, plant and equipment — or attract tenants who will. And one does not attract tenants by putting up the rent! As the tax encourages landlords to seek tenants, it does not drive away investors who wish to lease sites. As the tax is taken into account in market prices of sites, it does not drive away investors who wish to buy sites. And however heavily the land of NSW may be taxed, not one square metre of it will flee across the border into Victoria, South Australia, or Queensland. The same cannot be said for most other targets of taxation.

The need to use sites productively in order to pay the holding tax is an example of the wealth effect of taxation — that is, working harder to compensate for the tax. For most taxes, the wealth effect is outweighed by a substitution effect: avoidance of the taxed activity. Because the supply of sites is fixed, a holding tax on sites cannot produce a substitution effect on the macroeconomic scale unless it forces sites out of use, which it does only if it takes more than rational users would pay for the use of the sites — that is, if it takes more than the rental values of the sites. But if a tax is apportioned to the capitalized value of a site, it cannot take more than the rental value; if it did, no rational buyer would pay anything for the site and there would be no capitalized value to tax. The proposed ILT, like the land tax that it is meant to replace, is indeed based on capitalized site values. Thus it produces only a wealth effect.

However, because of that similarity between ILT and land tax, we need to consider some of the spurious objections to land tax and how the ILT might be immunized against them.

Spin: The venerable D&J Evans Hardware store was unable to pay its $120,000 land tax bill. So it would be forced to close and 32 employees would lose their jobs [Russell Skelton, “Soaring Land Tax Costs Jobs, Investment”, Sunday Age, Nov.21, 2004].

Reality: The big news was buried in a subordinate clause further down the page: “Although the site was sold to Woolworths for a record $15.25 million... the preferred option for the owners of Evans Hardware was to stay where they were.” Oh. So the land tax was so onerous that Woolworths volunteered to pay $15,250,000 up front for the privilege of paying the land tax in perpetuity! The article said nothing of the number of jobs that would be created by Woolworths, or re-created by Evans Hardware when it reinvested the $15,250,000. Concerning Evans Hardware's preference to stay put, an efficient tax system does not indulge commercial site owners who want to make locational decisions on non-commercial criteria, while an equitable tax system does not help a site owner sitting on an obscene capital gain to sit there even longer while the capital gain grows even more obscene.

In view of the handsome sale price and the opportunity to reinvest, Evans Hardware gained from the increase in its site value on an accrual basis, a capitalized basis, and a long-term basis. It also gained on a cash basis and a short-term basis — by collecting $15.25 million. And it gained on an annualized basis because the interest on the sale price greatly exceeded the land tax bill, and because the site could have been let, rather than sold, to a more intensive user. That the media managed to portray all this as bad news for Evans Hardware tells us more about the media than about site-value taxation.

The most that we are prepared to concede on the Evans Hardware story is that if site owners need to use their sites more intensively (or sell them) in order to pay their recurrent taxes, then perhaps they should be given some time to adjust. That is one reason for capping increases in the non-deferred portion of the ILT (see item 3 of the Summary).

Horror story: John Ribbands of the Metung Hotel faced a land tax bill of almost $81,000, which had doubled in a year [according to Kirsty Simpson in The Age, Mar.6, 2005].

Reality: Actually the land tax bill was for the hotel site plus the adjacent vacant site, not just the hotel site. But because of this "usurious" tax, poor Mr Ribbands sold the hotel and the adjacent site to David Strange for more than $4 million [Christopher Webb, “Strange Metung spot is a real little boaty”, The Age, July 19, 2005]. Mr Strange's plans to develop the adjacent site [www.metunghotel.com.au/land.htm] are a textbook example of how site-value taxation encourages investment and creates jobs. The new owner acknowledged as much when he said that the income from the existing hotel alone “wouldn't support the land value” — that is, it wouldn't cover the tax on the combined land value.

We concede, however, that sudden increases in recurrent property taxes make bad headlines, helping the media to peddle the otherwise bizarre notion that property owners suffer when their assets increase in value. That is another reason for capping increases in the non-deferred component of the ILT.

Beat-up: Land tax forces closure of caravan parks that provide permanent accommodation to low-income residents.

Reality: As the wealth effect of a holding tax on sites forces caravan parks to be redeveloped for permanent housing, it also forces idle land to be developed for caravan parks. The overall effect is to add to the supply of accommodation and make it more affordable. If the tax were high enough, it might force the construction of so much new accommodation that nobody would need to live permanently in a caravan park!

Spin: The Whitehorse Inn of Hawthorn (Victoria) was forced to close because the lessee, Jim Ryan, was unable to pay the land tax bill which had increased from $1440 (in 1998) to $40,000. Some 15 staff would lose their jobs. Mr Ryan was liable for the land tax because he had signed a contract containing a tax-increment clause, whereby the owners could charge their land tax to the lessee [according to Farrah Tomazin in The Age, Feb.15, 2005].

Reality: Contracts requiring lessees to pay their landlords' land tax are about as respectable as contracts requiring workers to pay their employers' company tax; in each case, the weaker party is asked to pay a bill that arises from the stronger party's good fortune. By the time Mr Ryan got into trouble, tax-increment clauses in rental contracts had been banned in Victoria, but contracts signed or renewed before the ban were grandfathered. The Parliament could have capped land tax increases for lessors in grandfathered tax-increment contracts in order to protect the lessees, but failed to do so. So the fault lies not with land tax as such, but with the legislators, who botched the initial implementation and then botched the correction. Furthermore, the agenda of the City of Boroondara Urban Planning Special Committee reveals that the owners of the hotel site were planning to redevelop it as an office complex with restaurant, employing more people than the hotel, and with parking for more than five times as many cars as the hotel could accommodate — another example of how holding taxes on sites encourage investment and create jobs. Indeed, the lessee's inability to pay the land tax was fully explained by the fact that the site was not being used optimally.

No such problem would arise under the ILT, because tax-increment clauses would be banned from the beginning (item 1 of the Summary).

3.6 The Big Lie: that land tax is passed on in rents

It is quite true that a holding tax on buildings, by discouraging construction and preservation of buildings, restricts the supply of accommodation and raises rents. This is a substitution effect. No such argument applies to a holding tax on site values, which has no substitution effect, but only a wealth effect. That effect is to encourage development of sites and thereby increase the supply of accommodation, making rents more affordable, not less so. Moreover, the thesis that all taxes fall on site rents implies that taxes on tenants are shifted onto site owners, not vice versa.

Of course the same thesis applies to reductions in taxes, so that a tax cut for tenants would enable landlords to charge higher rents. Such a tax cut might well be accompanied by an increase in holding taxes on sites. But the rent rise would be due to the tax cut for the tenants, not the tax increase on the landlords.

Partial equilibrium analysis, in which a tax is shown as the height of a vertical line from the supply curve up to the demand curve, and in which the deadweight cost of the tax is shown as the area bounded by the tax line and the two curves, indicates that a tax is shared between sellers and buyers in inverse proportion to the elasticities of supply and demand, respectively. As the supply curve becomes steeper — that is, as supply becomes less elastic — the supplier bears more of the burden. In the limiting case in which the supply curve is vertical — that is, when supply is perfectly inelastic — the entire tax burden is borne by the supplier. Hence, as the supply of sites is perfectly inelastic, any tax on the rental value of sites is borne entirely by site owners.

The argument that land tax is passed on in rents, in its simplest form, assumes that the propagandee is ignorant of partial equilibrium analysis and of the other arguments offered above. In a more subtle and insidious form, it confuses the rent actually paid with the rental value of the land.

If a tax is levied on the rent actually paid, then the "price" is the rent, while the "demand" is the quantity of land that would be rented (as a function of price), and the "supply" is the quantity that would be offered "to let". In this case the supply curve is steep, but not vertical, because owners can respond to higher rents by offering a greater fraction of their land to let. And if the supply curve is not vertical, tenants bear some of the tax burden.

But if the tax is levied on the rental value of the land, it is levied on the potential rent, which is incurred either by tenants (by renting the land) or by owners (by not offering the land to let). So the relevant "supply" is not the quantity of land that would be actually offered to let (as a function of price), but rather the quantity potentially available for rent. This quantity is indeed fixed, so that the supply curve is indeed vertical. And the relevant "demand" is not the quantity that would be rented, but rather the quantity that would be rented or withheld by owners — both options being "demand" in the sense of excluding others from both occupying the land and paying the price. This quantity is obviously sensitive to price and would be variable if the "supply" were not fixed; that is, the demand curve is not vertical, although the supply curve is. Thus we have the extreme case in which suppliers bear the whole tax burden.

In general, if consumers bear some of the tax burden, they do so because suppliers can avoid some of the tax by restricting supply, forcing the price point up the demand curve. This is the manner in which sales taxes are shifted onto consumers. Hence a tax on rent actually paid can be partly shifted onto tenants, because landlords can avoid some of the tax by offering less of their land "to let". But a tax on potential rent cannot be avoided by withholding land from the rental market and therefore cannot be shifted onto tenants.

Caveat: If the holding tax depends on the actual use of the land, then it is not apportioned to potential rent, which by definition depends on potential use. This reopens the possibility of the tax being partly shifted onto tenants. For example, if a particular use is taxed more heavily than other uses, then landlords will be able to avoid the tax premium simply by letting their land for "other uses", so that tenants who demand the more heavily taxed use will have to compensate the landlords by paying more rent.

On this basis it is sometimes argued that the present land tax, which exempts owner-occupied sites, increases the rents of non-owner-occupied sites. But that argument runs into two obstacles. First, the exemption for owner-occupied sites does not alter the fact that unoccupied sites are fully taxable, so that their owners face the usual pressure to cover the tax by finding tenants, or avoid it by finding buyers. This pressure, as usual, tends to reduce both rents and prices. Second, if the exemption persuades people to become owner-occupants, it removes them from the rental market and tends to reduce rents. As some house-seekers have a choice between renting and buying, the supply of sites for rent cannot be considered in isolation from the supply of sites for purchase; any change in affordability in one market will spread to the other through arbitrage. For these reasons we do not believe that the land tax exemption for owner-occupants falls under the above "caveat".

The proposed ILT, like the existing land tax, is levied on the capitalized value of a site, which in turn is related to the potential rent, not necessarily the rent actually paid. And even if exemptions for owner-occupied sites were relevant, the ILT makes no such exemption. So indeed the ILT cannot be passed on in rents.

When we say that the supply of sites is fixed, the word "supply" refers to the stock of sites, not the rate of turnover of that stock. So the conclusion that site-value taxes cannot be shifted is true of holding taxes on sites, but not of turnover taxes on sites, let alone turnover taxes on sites plus improvements (such as the existing stamp duty on conveyances). The ILT is clearly a holding tax. The SWT is also a holding tax in the sense that the tax liability accumulates during the holding of the asset and is only realized on transfer of the asset. In particular, the SWT, unlike the present conveyancing stamp duty, would not discriminate against owner-occupants who move more often; they would simply pay their SWT in smaller and more frequent instalments.

3.7 Fallacy: post hoc, ergo propter hoc

When landlords raise rents after their land tax bills increase, they claim that they are doing so because of the land tax. But while a rise in land tax may give landlords the desire to raise rents, it does give them the ability to do so. That ability is caused by the same market movements that cause the higher valuations, hence the higher tax bills, and would exist even without the higher tax bills. As Adam Smith put it [8]:

Even if the tax bill first informs the landlord of the opportunity to raise the rent, it is only doing what any competent real-estate agent would do when a lease comes up for renewal.

3.8 Nuclear option: A tax on unoccupied sites

One way to stop site owners from pretending that a site-value tax is passed on to tenants is to make the tax payable only when there is no tenant. This arrangement would be equivalent to the sum of two components: a positive tax on the potential rent of the site, plus a negative tax on rent actually paid for the site. For the reasons explained above [subsection 3.6], the former component would fall entirely on the site owner, while the latter would be partly shifted onto the tenant in the form of lower rent — a double whammy for the owner.

Nor is this all. A vacant property tax would collect less revenue than our proposed ILT, leaving less scope for cuts in other taxes, hence less scope for increasing the spending power of renters and buyers of sites, whether by reducing their tax bills or by reducing deadweight costs. Moreover it would not reclaim a significant share of uplifts due to provision of infrastructure, and would therefore not greatly encourage such provision. But a vacant property tax would certainly force landlords to seek tenants — not merely to cover the tax, but to avoid the tax. Thus rents would be lower than at present — not merely "more affordable" when measured against the spending power of the tenants and the amenity of the accommodation, but actually lower in dollar terms.

Accordingly, while we do not advocate a vacant property tax, we would politely ask any incorrigible property investors who maintain that a holding tax on sites is shifted onto tenants, or who allege that it penalizes investors for "providing accommodation", whether they would be satisfied if the tax were confined to sites that don't have tenants and don't provide accommodation!

4. Addressing the guiding principles

4.1 Revenue adequacy

The per-site threshold for the ILT (item 1 of the Summary) and the grandfathering provision for the SWT (item 8) ensure that the transition to our proposed system would be revenue-neutral. Thereafter, adequacy of revenue would be protected by the natural growth in total site values as a fraction of GDP, and by the mechanism whereby infrastructure pays for itself by expanding the tax base [subsection 3.3].

Another aspect of revenue adequacy is the stability of revenue through economic cycles. In the case of the ILT and SWT, the relevant cycles are those of the land market, and the aim is not so much to protect revenue against cycles as to suppress the cycles.

Boom-bust cycles in the property market are better described as bubble-burst cycles. During the bubble phase, prices become decoupled from rents and are supported only by the assumption that someone else (the "greater fool") will pay an even more exorbitant price later. When that assumption loses credibility, the support for today's prices is taken away: the bubble bursts. Bubbles cannot occur in the market for buildings, because buyers know that the price of a building is limited by the production cost and declines with wear and tear; there is no expectation of capital gains and no "greater fool". So a "property bubble" is actually a land bubble.

The ILT and the SWT, by reducing the attractiveness of capital gains relative to current income, would reduce the speculative motive that leads to bubbles. To avoid bubbles is to avoid bursts. The ILT would further stabilize the market by negative feedback: rising prices would mean rising holding costs, which would tend to repel buyers and reduce prices, while falling prices would mean falling holding costs, which would tend to attract buyers and raise prices. Thus the growth in site values would tend to stabilize around the long-term trend.

4.2 Efficiency

Site-value taxes offer the highest possible economic efficiency. As the value of a site is not the result of any efforts of the site owner per se, but is determined by the effective demand for that site due to activities of the community on surrounding sites, a tax on that value does not deter any activity of the taxpayer. In general, a tax reduces the taxed activity; but with site-value taxation, there is no taxed activity.

This of course has further implications for revenue adequacy. All else being equal, a tax that erodes its own base cannot raise as much revenue as one that leaves its base intact.

It is sometimes objected that because the market value of a site is built up by developments on surrounding sites, taxing the said value deters the said developments. But of course the developments are generally done by parties other than the one paying the tax, who therefore cannot be discouraged by the tax. To this, the objector may triumphantly cite the following counterexample: If the same party develops a large cluster of sites, some of the uplift in the value of each site is due to work by the same party on the other sites in the cluster. Now remember that this argument is offered against site-value taxation and hence, by default, in favour of other taxes. So, because it is so iniquitous that site-value taxation sometimes falls partly and accidentally on productive activities, we are invited to conclude that we must impose other taxes that always fall entirely and deliberately on productive activities! To use a common fault of taxation as an argument against the one form of taxation that suffers least from that fault is mischievous in the extreme.

In this connection it is worth noting that the "nuclear" vacant property tax [subsection 3.8], which strikes preferentially at undeveloped or neglected properties, would be harder to portray as anti-development.

That our proposals would improve the affordability of accommodation has implications for efficiency. Jobs cannot be created unless:

Conversely, any policy that makes accommodation more affordable will tend to create employment. Hence the vacant property tax [subsection 3.8], which is especially effective in forcing down rents and prices of sites, is more efficient than one might first expect. One might call this a lowering of the nuclear threshold.

Administrative efficiency, like economic efficiency, is optimized by taxing nothing but site values. Unless one eliminates all property taxes, including municipal rates, one cannot do away with the need for a database of property transactions from which valuations are made for tax purposes. Even if one sacrifices economic efficiency by levying property taxes on capital-improved values (that is, combined values of sites and buildings), the need for separate valuation of sites is not eliminated, because accurate valuations must allow for locational values and take advantage of their spatial continuity; locational values are contained in site values, not building values. Even without property taxation, property valuations would be needed for other purposes such as insurance, divorce settlements, and compensation for compulsory acquisition. Again site values would be needed in the calculation of capital-improved values. Moreover, insurance assessors require separation of site values from building values, because only buildings need to be insured. Given the unavoidable need for site valuations, we might as well use them for tax purposes and avoid other tax-related administrative costs.

Assessment of ILT liability would be done by the OSR using the latest official site values. If the Valuer General revalued a site between acquisition and disposal, the initial and final valuations would be used to compute the SWT bill. Only if there had been no such revaluation would the SWT create any new computational problem, but this could be easily solved. For example, the taxable uplift could be the lower of (a) the uplift calculated by extrapolating recent valuations by a specified method, and (b) the capital gain according to the Federal formula.

Compliance costs (that is, administrative costs incurred by taxpayers) are also minimized by taxing nothing but site values. The recurrent component of ILT involves no compliance burden other than that of actually paying the bill. Because the liability for SWT would be realized only on transfer of a property, which is inevitably a paper-intensive process, the additional paperwork involved in calculating and remitting the SWT (and any deferred ILT) would not be unreasonable, and most of it would inevitably be done by the conveyancer.

In view of the foregoing, we must object to the following extraordinary statement in subsection 3.1.1 of the Issues Paper:

Payroll tax is a transaction-based tax, the "transaction" being the payment of a wage or salary. And while payroll tax may be more efficient than some other State taxes, it should not be mentioned in apposition with land tax in any statement about efficiency. To the extent that payroll tax is borne by employers, it artificially increases the cost of labour to employers and thereby increases unemployment. To the extent that it is passed on in prices, it is inflationary and therefore increases the "natural" rate of unemployment sought by the Reserve Bank. In short, payroll tax is exactly what it looks like: a tax on jobs. While it is not the only tax that deters employment, it is the only one with the ignoble distinction of being aimed solely at employment of labour, to the exclusion of other factors of production. Therefore while payroll tax, like all taxes, reduces site values, the mechanism by which it reduces site values is exceptionally destructive in terms of employment.

If payroll tax is indeed less inefficient than certain other State taxes, this fact can be taken into account when deciding the order in which existing taxes should be phased out as ILT revenue increases.

4.3 Equity

In Edinburgh on July 17, 1909, the implications of all-devouring rent for equity were starkly illustrated by Winston Churchill [9]:

The same logic applies to tax cuts in general [1,2,3]. Clearly it is futile to give a tax cut in the name of "equity" (whatever that means) if the benefit is competed away in the property market. And the only benefits that are guaranteed not to be competed away in the property market are those that are delivered through the property market, by strengthening the bargaining position of the intended beneficiaries relative to others.

Accordingly, we submit that the only reliable measure of the vertical equity of a proposed tax reform is the resulting redistribution of bargaining power in the property market from the rich to the poor. For the States, which for tax purposes are effectively barred from assessing income and consumption but free to assess asset values, the best proxies for the "rich" in the property market are landlords and sellers, in which case the corresponding proxies for the "poor" are renters and buyers. That distinction automatically gives preference to first-time buyers because they, by definition, are not simultaneously sellers.

The recurrent portion of the ILT would indeed enhance the bargaining position of renters and buyers by encouraging site owners to earn income from their sites, or let or sell them to others who will earn income from them. The SWT and the deferred portion of the ILT would add to this effect by increasing the attractiveness of current income relative to capital gains. And because first-time buyers would not have accumulated liabilities for ILT or SWT, their bargaining position would be strengthened relative to repeat buyers.

Our proposals are consistent with the capacity-to-pay principle, because the ILT payable on a newly purchased site is capitalized in the price, while the SWT and any increase in the ILT are only a partial repayment of an increase in the value of the site. The SWT and any increase in the ILT are also consistent with the "beneficiary pays" principle in that they reflect unearned increases in an asset's value due to the activities of parties other than the asset holder.

Notwithstanding any of the above, a government that robs Peter to pay Paul can always depend on the opposition of Peter, even if Paul's need is manifestly greater. However, a government that raises the incomes of both Peter and Paul may retain the support (or at least the tolerance) of both, even if Paul, on account of his greater need, gets a somewhat bigger raise. This of course requires the generation of additional income — that is, greater efficiency. In practice, then, those who wish to enhance equity in a politically sustainable manner must first seek efficiency, and must be content to distribute the additional income without redistributing the old income.

Accordingly, this submission does not ask property investors to accept lower rents or lower capital gains, even after tax. Rather, it proposes a tax system which would promote economic growth, including investment in infrastructure, but increase the bargaining power of renter and buyers so that they share in the gains.

4.4 Simplicity

Our proposals would result in an immediate simplification of taxes in NSW. At the local level, the SWT would replace lump-sum development levies, while the ILT would replace rates and all other recurrent levies on property owners, including annual service-connection charges (for water, sewerage and drainage), annual infrastructure levies, environmental levies, emergency service charges, and per-bin waste-collection charges. At the State level, the SWT would replace conveyancing stamp duty and mortgage duty, while the ILT would replace land tax and any other recurrent levies on property owners. In the case of NSW, the author is not aware of any “other recurrent levies” imposed directly on property owners by the State government. However, there is a fire levy imposed on property owners through their insurance premiums. This, we suggest, is effectively a holding tax on buildings and as such should be replaced by the ILT.

In the longer term, rising revenue from the ILT and SWT would allow the phasing out of all other State taxes, leading to even greater simplification.

As evidence of the simplicity of site values as a tax base, compared with various alternative tax bases, we note the sizes of the plain-text versions of various pieces of NSW consolidated tax legislation, as published by the Australasian Legal Information Institute:

For comparison we also list the sizes (as plain text) of two pieces of Federal legislation and one other notable document:

Of all the Acts on the above lists, the only one that uses site values is the Land Tax Act. That Act, although the second-shortest, is unnecessarily complicated in that it consists mainly of grandfathering provisions and the associated schedules, all of which would be subsumed by the per-site threshold and deferral provisions of the ILT. So an ILT Act would be shorter still.

4.5 Transparency

Everything written under the previous heading remains relevant here: there can be no transparency without simplicity.

Of course the Land Tax Act does not spell out the process by which sites are valued for purposes of taxation. Opponents of site-value taxation often allege that the process lacks transparency. To this we have three responses:

We further note that the calculation of site values (or changes in site values) does not require the recording of any transactions other than those which must be recorded for other purposes, such as the enforcement of property rights and tenancy rights. Site-value taxation is therefore optimal in terms of privacy.

4.6 Interstate competitiveness

Holding taxes on site values, by definition, cannot reduce the return on investment in anything but sites. For example, they cannot return the return on investment in buildings, plant and equipment, R&D, or training. They cannot even increase the rent bill for a tenant who wishes to invest in such things. For the purpose of attracting productive investment, any reduction in returns for buyers of sites does not matter, because sites continue to exist whether anyone buys them or not, and because a holding tax on sites, by encouraging owners to put their sites to use, increases the availability of sites to productive users. Even the "reduction" in returns on sites is mitigated by the capitalization of the tax in prices of sites, and countered by increased investment in infrastructure.

Hence, with site-value taxation, there is no need to cut taxes below that of competing States in order to attract investment; that is, there is no "race to the bottom". To finance government entirely out of site-value taxation is to take a shortcut to the bottom without sacrificing services or infrastructure.

The only "investment" that is driven away by site-value taxation is the holding of land in pursuit of speculative gains. Such "investment", by itself, does not serve any purpose except to squeeze more productive investors out of the market. In particular, it is not justified by any enterprise that the speculator may conduct while holding the land, because that enterprise, if economically desirable in itself, could be profitably conducted by a tenant, and therefore could be profitably conducted by an owner-occupant as occupant even if the tax completely obliterated the returns received as owner. Hence the opposition to site-value taxation is led by speculators of various sorts, who pretend that the tax drives away "investment", when in fact the only thing it drives away is parasitic speculation.

5. Constitutional threats to existing taxes

5.1 Are compliance costs unconstitutional?

Governments have a moral duty to collect revenue in order to defray the essential costs of government. In so doing, they do not need to waste the people's time or impose incidental costs on the people. Uncompensated tax-related compliance burdens, over and above the taxes themselves, are in our view immoral, and few things would please us more than to discover that they are also illegal.

We are therefore greatly encouraged by s.40 of the NSW Constitution, which states:

At face value, this would seem to imply that tax-related compliance costs are recoverable from the State. The implication is especially clear in respect of any tax which one private entity is required to collect from another.

The compliance costs of Federal taxes are similarly problematic in view of s.82 of the Commonwealth Constitution. This is especially the case for GST, which sellers collect from buyers, and personal income tax, which employers remit on behalf of employees.

5.2 Are new-vehicle duties unconstitutional?

The currently prevailing definition of duties of excise was given by a 4-3 decision of the High Court in Ha v. NSW (1997), hereinafter called Ha. The majority (Brennan C.J., McHugh, Gummow and Kirby JJ.) found that:

The minority (Dawson, Toohey and Gaudron JJ.) drew a different distinction between customs and excise duties, namely that customs duties discriminate against imported goods in favour of locally produced goods, while excise duties do the opposite:

In the majority view, the Constitution gives the Commonwealth exclusive control of the taxation of goods and therefore prevents the States from taxing goods. In the minority view, the Constitution gives the Commonwealth exclusive control of tariff policy (be it protection or free trade) and therefore only prevents the States from taxing goods in ways that discriminate between local and non-local goods.

The stamp duty on the sale or registration of a new vehicle, especially if collected and remitted by the dealer, would appear to be a "tax" on the "sale" of a "good" (the vehicle), or at least on "some step taken in dealing with" the good, in which case it is an excise according to the majority view. But because it does not discriminate between imported and locally-produced vehicles, it would not be a duty of customs or excise according to the minority view. In either case, it is sufficiently clear that taxes on second-hand goods, including stamp duties on second-hand vehicles, are not excises [10].

The majority and minority definitions in Ha essentially agreed with the majority and minority definitions, respectively, in the 3-2 decision of the High Court in Parton (1949), in which the majority ruled that a tax of 1/8 of a penny per gallon of milk sold or distributed in Melbourne was an excise.

Paradoxically, the minorities in Ha and Parton could claim support from the unanimous judgment in the first case in which the scope of "excises" came before the High Court, namely Peterswald (1904). In this case, however, the "discriminatory" definition of excises was not critical to the outcome, because the disputed tax, as applied to the case in question, was a "fee" for a licence to brew beer, and as such discriminated against local brewers. It was held not to be an excise because it was only loosely connected with goods; in particular, it was not apportioned to the quantity or value of goods sold.

5.3 Is payroll tax an excise?

Payroll tax falls on labour, including labour engaged in the “production, manufacture, sale or distribution of goods”, and feeds into prices, including prices of goods. Furthermore, because it applies to labour engaged in the “production, manufacture, sale or distribution of goods” only within the State imposing the tax, it taxes local goods more heavily than imported goods at the same stage of refinement, and has as much capacity to frustrate Federal tariff policy as any other tax on goods. Hence a constitutional challenge to payroll tax would attract sympathy from both the Peterswald and Parton factions of the High Court.

5.4 Disclaimer

6. Issues on which IPART seeks comment

6.1 Improvements to existing taxes

The ILT and the SWT may be understood as improvements to existing taxes, and in practice could be named accordingly, although for the sake of clarity we have used unique names in this submission.

At the local level, the ILT would replace rates and everything else on the "rates bill", and could be named accordingly. At the State level, it would replace land tax and could be named accordingly.

At the local level, the SWT would replace the present lump-sum "development levy" and could be known by that name. At the State level, it could replace the conveyancing "stamp duty" and could be known by that name or as a "vendor stamp duty". In each case, the improvement would consist in apportioning the tax to uplifts in site values.

6.2 Existing taxes that should be abolished

Taxes that should be phased out following the introduction of the ILT and SWT obviously include payroll tax and stamp duties (other than the SWT, if that is called a stamp duty).

While vehicles are not sites, annual vehicle registration fees can be understood as “moving land taxes” (or, equivalently, as compensation to the community for the road space taken by the vehicle) and as compensation for wear and tear on the roads. It is arguable that such aims are more accurately accomplished by fuel taxes, for which the liability automatically rises in proportion to use of the vehicle. But fuel taxes are excises and hence unavailable to the States. These arguments suggest that the elimination of vehicle registration fees should not be a high priority. To the contrary, one might argue that an exemption for one "basic" vehicle, with charges only for additional vehicles or larger vehicles, would be politically advantageous.

Gambling taxes could be defended if their primary purpose were to discourage gambling. However, the taxes are imposed at rates comparable with or lower than income and consumption taxes, indicating that their purpose is simply to raise revenue. In that case, gambling taxes should be phased out, so that the Government is free to deal with gambling as a social problem instead of a fiscal opportunity.

6.3 New taxes and their merits

While the ILT and SWT need not be construed as new taxes, their application could be extended in ways not mentioned above.

The essential economic property of sites is their fixed supply: private entities cannot create them or destroy them or move them into or out of the State. But this property is shared by other assets, which we might call site-like assets.

Consider taxi licences, commonly called plates, issued by State governments and usable only within their respective States (or specified parts thereof). These are clearly site-like. For a taxi operator per se, the one indispensable site-like asset is not a site, but a plate. Hence any tax advantage conferred on taxi operators would tend to be competed away, not in the rental values of sites, but rather in the rental values of plates. Similar comments apply to seaport time slots, easements, rights of way, pollution rights, water rights, fishing rights, and forestry rights, in so far as these things are separated from land titles.

It would therefore be reasonable to count such assets as sites for the purposes of the ILT and SWT. The usual deferral and grandfathering provisions would ensure that there were no losers in the transition to the new system.

Of course the foregoing observations have implications for the "all-devouring rent" theory and for the corollary that all taxes fall on site values: if these theories are to be accurate, "sites" must include all site-like assets.

6.4 Tax mix

In contrast to conventional "wisdom" which holds that a stable tax base requires a mixture of income taxes, consumption taxes and property taxes — a "three-legged stool" — the Lockean thesis that all taxes fall on site rents implies that the term "tax mix" is an oxymoron: the three legs are one, and all attempts by property owners to shorten the third leg while lengthening others are futile.

Observing, further, that taxes on site values give governments an incentive to do things that add value to sites, we see that the efforts of property owners to reduce their own burdens are not merely futile, but counterproductive.

6.5 Tax expenditures

Special favours delivered on the revenue side of the budget (tax concessions) tend to attract less scrutiny than equivalent favours delivered on the expenditure side (subsidies or grants), although their fiscal effects are the same. The renaming of "tax concessions" as "tax expenditures" is a laudable but not necessarily successful attempt to redress the imbalance and improve transparency. A more radical approach would be to forget about names and to insist that any special favours be actually delivered on the expenditure side of the budget.

The system proposed in this submission takes a more subtle approach, eliminating tax expenditures under the new system while preserving the essential effects of those granted under the old one. All sites and all site owners are subject to ILT and SWT. There are no exemptions, and no other concessions for particular classes of taxpayers or types of tenure except through deferrals, as specified in items 4 and 5 of the Summary. But exemptions from recurrent property taxes under the old system are automatically preserved by item 3, without specifying what those exemptions are. Item 5 is probably redundant, because any taxpayers to whom it might reasonably be applied are probably exempt under the old system. Item 4 is almost redundant at State level, because the affected taxpayers are exempt from the existing land tax and subject only to fire levies on insurance premiums; but it is a useful political sweetener at local level, because it offers ordinary home owners an advantage that they do not currently have. Meanwhile, SWT and the deferred component of ILT can be avoided simply by staying put. We see no need for any concessions or exemptions for any property owners who choose to realize capital gains, because they do so by choice (especially if they are not paying recurrent tax!) and, in so doing, gain an unearned capacity to pay. Neither do we see any need for concessions, other than deferrals, in respect of the ILT that they will pay on their new addresses in consequence of exercising their free choice, because that will be taken into account in the prices that they pay.

We do not regard items 3 and 8 as amounting to tax expenditures. Item 3 grants deferrals rather than outright exemptions. Item 8 is a transitional provision. Neither discriminates between classes of taxpayers or types of tenure.

That a site owner who sells a site under the new system might realize a tax liability from which the same owner would have been exempt under the old system is no cause for complaint, provided that the new tax liability accumulates only after the commencement of the new system (this is the purpose of item 8). If a tax reform is to have "no losers", it must ensure that taxpayers do not suffer losses due to circumstances beyond their control, including past decisions. But if taxpayers, knowing the new rules, subsequently make decisions that incur losses under those rules, they should blame themselves, not the rules.

The past/future distinction also has implications for efficiency. If a tax reform improves efficiency, it does so by changing incentives — that is, by changing the rewards and punishments for future decisions. In so doing, it can protect taxpayers against retrospective punishments for past decisions. But to extend the same protection to future decisions would defeat the purpose of the reform.

Note that while residential owner-occupants — that is, ordinary home owners — are currently exempt from land tax, they would not be exempt from ILT. Such an exemption would greatly reduce the effectiveness of the ILT in reclaiming uplifts in site values due to infrastructure, and would therefore greatly reduce investment in infrastructure. This would clearly not be in the interests of home owners, let alone anyone else. The deferral provisions (items 3 to 5 of the Summary) give more than adequate protection for home owners who are site-value-rich but income-poor. Or, to put it more pointedly, the deferral provisions give more than adequate protection for home owners who gladly borrow against rising equity in order to finance consumption, but who recoil in horror at any suggestion that they can do the same in order to pay tax.

6.6 Tax administration

Our proposals would streamline administration by minimizing the number of taxes and their collection costs and compliance costs. If the State did not waste resources on unnecessarily numerous and complex taxes, it could readily afford whatever resources are necessary to administer the remaining taxes fairly, transparently, and responsively.

Although it may seem otherwise, the requirement that the SWT be remitted by the seller rather than the purchaser is only an administrative arrangement. If the tax is payable by the seller, the seller will try to add it to the price. If it is payable by the buyer, the buyer will try to subtract it from the price. In the end, the cost will be shared between the seller and the buyer in inverse proportion to their bargaining power, regardless of who actually "pays" the tax to the OSR. That the SWT would replace a stamp duty formerly payable by buyers therefore does not mean that a tax burden would be shifted from buyers to sellers. But clearly it is more convenient to have the SWT payable by the seller, because the seller knows how the site value has changed and is therefore better able to calculate the tax in advance, and because the SWT will then be paid by the same person who pays the deferred ILT on the same property.

6.7 Non-tax revenue

Mining royalties are not taxes, because they are not unrequited; they are payments in return for the privilege of depleting resources owned by the people through the State. Because the royalties are not taxes, they are not excises (although they look like excises in all other respects, under any possible definition).

Mineral deposits are site-like except that their use involves depletion rather than mere occupation. In so far as they are site-like, they are a sound revenue base. But because their use involves depletion, it is logical that the compensation to the State is apportioned to the quantity or value of minerals extracted, not the time for which the right of extraction is held. Mining companies may complain that excessively high royalties make extraction or exploration uneconomic. This complaint conveniently forgets that a mineral deposit can be extracted only once and that its value will probably increase as the mineral in question becomes more scarce, in which case the real effect of an "excessive" royalty is to conserve the deposit until it will fetch a higher price. For these reasons we are not proposing that mining royalties be phased out.

While we have referred to the ILT and SWT as "taxes" in deference to convention, it can be convincingly argued that both of them — especially the ILT — are actually examples of non-tax revenue.

To buy a site subject to periodic payments of a holding "tax" is effectively to buy a share in the site and thereafter to pay rent on the remaining share. The holding "tax" depresses the market price of the site precisely as if the buyer were entering into such an arrangement.

The ILT and the SWT also reclaim shares of any subsequent increase in the value of the site. Because that increase is not the work of the owner, but rather the work of the surrounding community, it is arguable that the increase rightly belongs to the community, in which case the SWT and the increment in ILT are not taxes, but royalties. To the contrary, it is arguable that the owner is entitled to a share of the overall uplift in site values either as a member of the community (appealing to equity) or as a contributor to increases in values of other sites (appealing to both equity and efficiency). But any similarity between the increase in value of one's own site and one's efficient or equitable share of the overall increase is purely fortuitous, so that one's share of the common benefit might as well be received through infrastructure and services funded by the ILT and SWT.

Moreover, the distribution of subsequent increases in the value of a newly purchased site can also be understood as part of a shared-equity agreement, and affects the purchase price accordingly.

6.8 Tax harmonization

The State and local SWTs would be levied on the same base at different rates. The State and local ILTs would be levied on the same base with different rates and thresholds. Thus we have already proposed two examples of State-local tax harmonization. An example of interstate tax harmonization is proposed under the next heading.

6.9 Balance of State and Commonwealth taxes

Vertical fiscal imbalance is fundamentally incompatible with accountability. When one level of government raises revenue spent by another, each will blame the other for any shortfall in delivery of the associated services.

We have indicated that the rising revenue from ILT and SWT, given sufficient time, would eliminate the need for most existing State taxes. If the same reforms were made in all States, then, given even more time, they would also eliminate the need for Federal grants to the States. But one might prefer not to wait that long. Accordingly, we explain a method whereby the Federal Parliament could immediately eliminate vertical fiscal imbalance:

N.B.: If step (b) resulted in different GST rates in different States, this would not amount to (unconstitutional) discrimination between the States, because the Commonwealth would make exactly the same offer to each State. Any differences in outcomes would be the States' doing, not the Commonwealth's. (But these assertions are not legal advice.)

While step (c) would presumably result in an increase in GST rates, it would not cause an overall rise in prices, because the additional GST would replace other taxes that also feed into prices, and because overall compliance costs, which also feed into prices, would be reduced.

Step (a) would get rid of input credits. This would not only avoid new complications caused by inputs coming from different States (with different GST rates), but would also solve two existing problems, namely (i) tax evasion involving fake input credits, and (ii) entities whose turnover is below the GST-registration threshold being forced to register simply because potential customers want to claim input credits.

With these measures in place, the States would have effective control of the GST, and therefore would be able to phase it out in response to rising revenue from taxes on site values. Thus the immediate elimination of vertical fiscal imbalance would be followed by the eventual elimination of the GST.

Finally, notice that the Commonwealth could attach additional conditions to step (c). In particular, it could impose this entire submission on the States. It could even specify the bases of the SWT and ILT, leaving the States with control over the rates and thresholds. None of this would compromise the fiscal independence of the States. All of it would help to minimize compliance costs.

6.10 Commonwealth-State tax sharing

Subsection 3.3 implies that every State, however undeveloped, can bootstrap its development by taxing uplifts in site values. Subsection 3.4 shows that not all taxes have deadweight costs, so that the need to collect a higher fraction of GSP for the funding of essential services need not strangle economic growth. The whole concept of horizontal fiscal equalization (HFE) is based on a denial of these two basic truths. Admittedly, the Australian version of HFE includes an element of "mutual obligation" in that it rewards States for "tax effort". But the measure of "tax effort" fails to acknowledge that some taxes are more conducive to development and service-delivery than others. If we must have HFE, taxes on site values and uplifts in site values should count as "tax effort", while other taxes should not.

In the mean time, the fact that GST revenue is taken from NSW and given to other States makes it all the more necessary that NSW raise its own revenue as efficiently as possible. This submission addresses that need.

7. Epilogue

While our submission was in preparation, the submission by the Tenants Union of NSW was uploaded to the IPART website. That submission advocates the inclusion of owner-occupied residential sites in the land tax base, not because of any niceties concerning the taxation of actual uses instead of potential uses, but because a broader base would allow a lower rate, which allegedly would be passed on to tenants in lower rents. In short, the Tenants Union of NSW has swallowed The Big Lie. This, no doubt, will greatly please its members' landlords, who evidently have swallowed the myth that land tax is bad for property owners.

8. References

[1] “It is in vain in a country whose great fund is land to hope to lay the publick charge of the Government on anything else; there at last it will terminate. The merchant (do what you can) will not bear it, the labourer cannot, and therefore the landholder must: and whether he were best to do it by laying it directly where it will at last settle, or by letting it come to him by the sinking of his rents, ... let him consider.” — John Locke, Some Considerations of the Consequences of the Lowering of Interest and the Raising the Value of Money (1691).

[2] “Our Legislators are all Landholders; and they are not yet persuaded that all Taxes are finally paid by the Land... and therefore we have been forc'd into the Mode of indirect Taxes...” — Benjamin Franklin, Letter to Alexander Small, September 28, 1787.

[3] “A reduction in the amount taken from the aggregate produce of a community by taxation would be simply equivalent to an increase in the power of net production. It would in effect add to the productive power of labor just as do the increasing density of population and improvement in the arts. And as the advantage in the one case goes, and must go, to the owners of land, in increased rent, so would the advantage in the other.” — Henry George, Progress and Poverty (1879), Bk.VI, Ch.1.

[4] T. Dwyer, “The Taxable Capacity of Australian Land and Resources”, Australian Tax Forum, vol.18, no.1 (January 2003), pp. 21–68.

[5] B. Kavanagh, Unlocking the Riches of Oz: A case study of the social and economic costs of real estate bubbles (1972–2006) (Melbourne: Land Values Research Group, 2007), Figure 11 (p.16 of the print ed.).

[6] Contributions by William Vickrey in K.C. Wenzer (ed.), Land-Value Taxation: The Equitable and Efficient Source of Public Finance (New York: M.E. Sharpe, 1999), pp. 18, 23, 25.

[7] D. Riley, Taken for a Ride: Trains, Taxpayers and the Treasury (London: Centre for Land Policy Studies, 2001).

[8] An Inquiry into the Nature and Causes of the Wealth of Nations (1776), Bk.V, Ch.II, Pt.II, Art.I.

[9] Speech reported by The Times and reprinted in W.S. Churchill, Liberalism and the Social Problem (Hodder & Stoughton, 1909), and W.S. Churchill, The People's Rights (Hodder & Stoughton, 1910).

[10] P. Sampathy, "Section 90 of the Constitution and Victorian Stamp Duty on Dealings in Goods", Journal of Australian Taxation, vol.4, no.1 (2001), pp.133–155.