Submission to the

South Australian Parliament’s Economic and Finance Committee

TAXATION REVIEW

February 2013

TABLE OF CONTENTS

1.Introduction - SA taxes in context

2.Why tax? To deliver services

3.Public goods versus private goods

4.Taxation, user charges, and related concepts

5.The fairness of the tax system

6.Local Governments’ financial performance

7.Local Governments’ financial capacity

8.Rates – restrictions on LG

9.The case against sharing rate revenue

10.A legislative cap on rates?

11.Targeted taxation – restrictions on LG

12.User charges – restrictions on LG

13.State taxation collected through Local Government

14.List of Recommendations

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Local Government Association of South Australia – February 2013

Submission to the SA Parliament’s Economic & Finance Committee Taxation Review

1.Introduction - SAtaxes in context

On 20 September 2012 the South Australian Parliament's Economic and Finance Committee resolved to inquire into and report on the South Australian taxation system.

The Committee is proposing to report on:

  • the fairness of the tax system;
  • the impact of the tax system on the cost of living in South Australia;
  • the impact of the tax system on the cost of business in South Australia, taking into account the ultimate incidence of State and local taxes;
  • the revenue neutrality of any tax reform:
  • where tax relief is proposed, the impact on the ability of the State or Local Government to collect revenue in order to provide services must be considered;
  • where tax relief is proposed, offsetting savings in the budget must be identified;
  • the compliance and administrative cost of State and local taxes including the transition to alternative tax revenue - the costs to both taxpayers and the Government's in generating tax revenue;
  • the sustainability of State and local taxes, the long term appropriateness of the level of State and local taxes in the light of long term demographic, social/ environment, economic and budgetary challenges faced by the State and Local Governments; and
  • any other related matter.

In the Committee’s terms of reference, “the tax system” is not defined. Presumably the Committee interprets its role as limited to examining taxes that are imposed under State legislation. However, the Committee is urged not to disregard the totality of the Australian taxation system. There is an “elephant in the room”that is responsible for the overwhelming proportion of total taxes raised:

As the Commonwealth’s Henry Tax Review put it:

“Improving the structure of the tax system should begin with recognising that the wellbeing of the Australian people is affected by the taxes of the entire federation. A tax affects people in the same way irrespective of which government is responsible for it. People also make choices in response to the totality of taxes and transfers they face.”[1]

The Henry Tax Review found that there are 125 different taxes in Australia, but 90% of taxation revenues are raised from the 10 major taxes, of which those with the biggest impact (by far) are the Commonwealth’s personal income tax, company tax, and the GST.[2]

The States’ major sources of revenue (apart from the GST which is received from the Commonwealth) are payroll tax and stamp duty on conveyancing, both characterised by the Henry Tax Review as inefficient (because they discourage job creation and asset transfers respectively[3]) and both of which the Henry Tax Review recommended for eventual abolition.

The multiplicity of other taxes raise relatively little of Australia’s overall tax receipts:

Ranking of Australian taxes by revenue in 2009–10[4]

As the Henry Tax Review put it:

“The States raise a significant proportion of their tax revenue from some of the least efficient taxes in our system. The more efficient of the taxes available to the States are poorly designed and, as a result, are currently limited in their capacity to generate revenue.

“The least efficient taxes undermine Australians’ living standards, reducing productivity and incomes by discouraging investment and workforce participation or by directing investment and resources to less valued activities.[5]

Therefore, the highest priority for the Economic and Finance Committee should be to recommend co-operation between all the States and the Commonwealth, so that over time the States can transition away from reliance on the existing, inefficient and poorly designed taxes, to alternative, more efficient sources of revenue. As the Henry Tax Review put it:

“The capacity to phase-out existing narrow-based taxes depends on the States having access to an alternative, more efficient revenue source. This could be a reformed land tax, revenue from a cash flow tax and/or a tax base sharing arrangement for personal income tax.

“Achieving many of the reforms listed in this report will require cooperation between the Australian government and the States. Changes are required to taxes, transfers and other types of expenditures across levels of government. Reforms would also need to be sequenced in a way that allows people to understand the reason for change and how they will be affected. One way to coordinate and implement reforms over time would be through an intergovernmental agreement between the Australian government and the States. Awellmanaged process would not only allow for poorly performing taxes to be replaced by more sustainable ones, it could also be a mechanism to deliver better policy outcomes across the federation on an enduring basis.”

The Henry Tax Review made a number of recommendations for improving the Australian taxation and payment transfer system. The first and arguably most important recommendation was that:

“Revenue raising should be concentrated on four robust and efficient broad-based taxes:

  • personal income, assessed on a more comprehensive basis;
  • business income, designed to support economic growth;
  • rents on natural resources and land; and
  • private consumption.

“Additional specific taxes should exist only where they improve social outcomes or market efficiency through better price signals. … Other existing taxes should have no place in the future tax system and over time should be abolished.

The LGA submits that this and other recommendations from the Henry Tax Review should be the starting point for the Committee’s deliberations.

The Local Government Association of South Australia has established a number of policy positions on matters related to taxation, including rates and other forms of revenueraising. Rather than simply cite the LGA’s policy, this submission endeavours to put these policies into context, explaining the background and the reasons for these policies.

The LGA submits that the Economic and Finance Committee will be better placed to appreciate the reasons for the LGA’s policy positions if it understands the context in which these policies have been developed.

To that end, this submission provides contextual background and proposes policy responses for South Australia, to address the identified issues.

Recommendations

Consistent with the Henry Review’s emphasis on co-operation between the spheres of Government, LGA Policy on Intergovernmental finances is:

6.5.1 Federal and State Governments should accept the principle of equitable revenue sharing with Local Government. Accordingly, Local Government is entitled to receive a guaranteed share of Federal taxation.
6.5.2 The vertical fiscal imbalance between the Federal, State and Local Governments must be addressed.
6.5.3Local Government supports the Australian Local Government Association's positive involvement in the negotiation of a tripartite Intergovernmental Agreement and ongoing Council of Australian Government (CoAG) processes to expose and minimise cost shifting and encourage good practice behaviour between governments.
6.5.4The Federal Government should not attempt to reduce tax sharing percentage levels or tie those funds derived from shared tax revenues to specific purposes.
6.5.5Local Government's revenue sharing entitlement must not be amalgamated with the State Government's revenue sharing entitlement.
6.5.6 Local Government's revenue sharing entitlement should be calculated as a fixed percentage of total Federal taxation. The distribution of revenue sharing entitlements for Local Government between States and Territories should be based on needs. Every Council should be guaranteed a per capita share of the funds allocated to South Australia at the level set by negotiation with the LGA. Allowance should be made for non-residential consumption of services i.e. where the per capita population funding does not reflect demands on services.
6.5.7 The Federal Government should determine revenue sharing with Local Government after consultation with the LGA and the State Government.
6.5.8 In moving to equitable sharing of revenue shares between States and Territories no State or Territory funding should be reduced in dollar terms with changes phased over time through increased funding.
6.5.9 The annual revenue sharing allocation should be guaranteed to be not less than if it were increased in accordance with the Consumer Price Index.[6]

2.Why tax? To deliver services

Governments exist to provide services to their citizens. Some services, such as Centrelink payments from the Commonwealth, or the police, teachers and nurses provided by the State, are easily recognisable by the public as Government-provided services. However, some of the main services provided by Local Government tend not to be recognised as such.

Local Government maintains a vast network of local roads, footpaths, bridges, drains, parks, recreation reserves and buildings. In South Australia, at 30 June 2011, these assets were valued in excess of $18 billion.

These assets are only a means to an end. They exist and are maintained only because they provide the community with particular services. At the risk of stating the obvious, roads are built and maintained to deliver the service of facilitating transport. Drains are provided and maintained to provide the service of minimising the risk of flood damage to property.

There are 68 Local Governments in South Australia. They are of widely varying size and scale.

At one end of the scale, the City of Onkaparinga serves an estimated resident population of 164,800 in an area of more than 51,000 hectares. As part of its services, the City of Onkaparinga maintains more than 1,400 kilometres of (mostly sealed) roads. Its portfolio of land, buildings and infrastructure in 2011 exceeded $1.4 billion. /
At the other end of the population scale, the District Council of OrrorooCarrieton serves an estimated 932 residents, albeit with an even longer network of (mostly unsealed) roads, spread out over an area more than six times the size of the City of Onkaparinga. In 2011 the comparable assets held by the District Council of Orroroo Carrieton were valued at only $27 million.[7] /

Roads, bridges, drains, footpaths and other infrastructure assets all have finite lives. To continue providing services through these assets, in a financially sustainable manner, Local Government must devote considerable resources towards routine preventive maintenance and periodic renewal expenditure.

This type of activity does not generate headlines, or present opportunities for ceremonial ribbon-cutting. Nevertheless, productivity would be lowered and therefore the entire community would be disadvantaged, if there was not a robust program of planned expenditure on items such as filling potholes, re-sheeting roads, re-roofing buildings, underpinning bridges that are no longer safe, and so on.

That is one of the reasons why each Council is required by law[8]to develop and adopt an infrastructure and asset management plancovering a period of at least 10 years.

Relative to annual operating revenue, the South Australian Local Government sector is threetimes more asset intensive (i.e. value of assets compared to operating revenue) than the StateGovernment and nine times more asset intensive than the Commonwealth Government.[9]

It follows that asset management is a more critical responsibility for Councils than it is for otherspheres of government. Sound asset management is the key to the financial sustainability ofevery Council.

Of course, Local Government also delivers many additional services, in ways other than directly through the provision of infrastructure. Local Government services such as waste collection, recycling, libraries, immunisation, and environmental health usually require the use of Council buildings and other assets, but the infrastructure itself does not directly provide the service to the community.

Many of these services are at least partly ‘private goods’rather than purely ‘public goods’. (See discussion in Section3 below.)

However, to continue delivering services of any type, Local Government must be financially sustainable. Given that services from infrastructure represent a large proportion of Local Government services, it follows that if any Local Government is not managing its infrastructure assets in a financially sustainable manner, it is likely to be both:

  • gradually reducing the standards of service provided by its infrastructure; and/or
  • leaving a financial burden for ratepayers in future years, to pay for the infrastructure services enjoyed by the present generation.

3.Public goods versus private goods

In the private sector, most goods and services generated by businesses are what economists call ‘private goods’ (i.e. their benefits are enjoyed predominantly by, or on behalf of, those who acquire them e.g. the purchase of household appliances or theatre tickets). Businesses price their goods and services according to market conditions and their own costs with a view to achieving a profit over time so that the business will survive and hopefully flourish.

Governments sometimes provide goods and services that have ‘private good’ characteristics but more often Government outputs and services are in the nature of ‘public goods’. Public goods and services are those whose use, enjoyment or benefit by some does not diminish the potential access, enjoyment or benefit by others.[10] Public parks or footpaths are examples of public goods - so are public health education campaigns. Public goods may be appreciated and valued even by people who do not make direct use of them.

It is usually efficient and equitable to charge users of private goods for the full cost of their consumption. However, charging people a fee to access public goods is more problematic.

Public goods are usually not supplied by the private sector, because it is often difficult to restrict their access to consumers who pay a charge. As a result, any revenue that might be raised would be insufficient to cover the cost of providing the goods, and private sector provision of these goods, therefore,would not be viable. Alternatively, where it is possible to restrict access to those who pay, society would be worse off. For example, restricting access to a public park by fencing it and charging admission would reduce the number of people who use the park and general community satisfaction would be reduced. Funding the provision of pure public goods from taxes overcomes this problem.

In practice, though, many goods and services have both ‘public good’ and ‘private good’ characteristics in varying proportions. Also, provision of some private goods may generate associated public ‘externalities’. These externalities may be described as ‘public goods’ (e.g. public views of attractive architecture/landscaping of a private building) or ‘public bads’ (e.g. air pollution from generation of electricity).

Because many government-supplied goods and services have both ‘public’ and ‘private’ characteristics it is common to see governments use two methods of funding: charging users for only part of the cost, and covering the balance from taxation revenues. For example:

  • the hire rate for a public hall might be set to recover marginal but not full long-term average total costs in order to encourage its use; and
  • dog registration fees might be set to recover less than full cost of a Council’s dog management responsibilities, recognising that non-dog owners also benefit from this service.

A large proportion of Local Government services – particularly the construction and maintenance of infrastructure – are predominantly ‘public goods’.

However, as noted above, many other Council services are either wholly or partly ‘private goods’. The provision of these services may be funded at least to some extent by a greater reliance upon targeted taxation, and/or user charges. See Sections4,11 and 12below.

4.Taxation, user charges, and related concepts

There is a clear distinction, in principle, between taxation and user charges. Taxation is compulsory, and there is no direct link between the tax raised, and the provision of any specific service. In contrast, user charges are paid voluntarily, in return for a specific “private good”.

However, there are also forms of revenue raising that have some of the characteristics of both a tax and a user charge. A number of Local Governments in South Australia impose “service charges” for one or more “prescribed services”. See Section 11 below.

These “service charges” are usually considered to be a form of targeted taxation, rather than user charges, because the prescribed services are made available to all land within a geographic area, and all land owners in the targeted locality[11] are required to pay the service charge. The charge may be adjusted according to estimated usage of the service[12] but land owners are not permitted to opt out of payment by refusing to use the service.

A related concept is the “separate rate” that Councils may impose to raise funds that are intended to benefit a specific locality.

In 2012, the Federal Government received a report from consultants Ernst & Young, 'Strong Foundations for Sustainable Local Infrastructure'[13] which recommended (among other things) “legislative change to permit Local Government to leverage future rates revenues to borrow for infrastructure investment.”

However, this recommendation was irrelevant to South Australia, where targeted rates for this and other purposes are already permitted:

A Council may declare a separate rate on rateable land within a part of the area of the Council for the purpose of planning, carrying out, making available, supporting, maintaining or improving an activity that is, or is intended to be, of particular benefit to the land, or the occupiers of the land, within that part of the area, or to visitors to that part of the area.[14]