A TAX SHIFT FOR OUR FUTURE

People should be rewarded for effort, hard work, savings and entrepreneurship – but the way we tax income and deliver benefits fails that test.

Personal income tax and benefit withdrawal in combination creates a disincentive for many people to work additional hours, invest in education, or grow a small business. Because benefits are based on family income, secondary earners – usually women – can often lose the majority of each additional dollar of income in tax and foregone benefits. Their effective tax rates are often far higher than those faced by society’s richest individuals.

How do we justify leaving only a tiny fraction of the social value of working harder in the pocket of the worker? It’s unfair and counterproductive – it discourages the very thing we want more of. We need tax for revenue, but is this perverse arrangement the best we can do?

Another problem is that capital income – personal income from savings and investment – is often taxed preferentially, at lower rates than labour income. Tax-free capital gains on the family home and the concessional treatment of investor capital gains are prime examples. Superannuation tax concessions are another.

These problems mean our income tax and transfer system is a long way from treating all income equally, let alone from prioritising income from work over income from wealth. The system grossly favours people with accumulated wealth, including inherited wealth, over people with only their bodies and minds to earn from. This system may be familiar, and normalised, but in its fundamental design it is irrational and immoral.

We need a closer look at how we tax income from work and income from wealth. We need to reorient tax settings to reward effort and savings – not to further enrich those who chose their parents and tax advisor wisely. This would grow our economy, let us all earn a dignified income, empower women who choose to work, and sever the cycle of inherited privilege.

Why tax businesses for creating jobs? Why tax workers for filling them? Payroll tax is a regressive tax on wages and jobs. It’s a handbrake on the activity central to economic prosperity and human dignity: meaningful work.

The more an employer pays their staff, the more they pay in tax. That drives up the cost of workers and drives down the wage they receive. Workers suffer lower incomes, higher unemployment, and underemployment.

Payroll tax costs society some $0.25 to $0.33 in lost income (foregone production) for each dollar in revenue collected. [1] That means by discouraging hiring and work state governments are effectively destroying up to a third of the revenue they collect.

This is unfair, counterproductive, economically destructive – and barely remarked upon.

We say payroll tax must be abolished. There are many better alternatives. As long as landowners are rewarded for mere ownership of land, such as via untaxed windfall gains, there is no place in civilised society for a tax on hiring and work.

[1] Murphy (2016), Efficiency of the tax system: a marginal excess burden analysis, ANU TTPI, page 11.

When firms invest in innovation and productivity it improves our living standards, provides jobs, and creates goods and services. Why do we discourage this through taxation? We currently tax all company profits on a like basis.

A better approach would tax companies more heavily on superprofits – the rents extracted from land, resource rights, natural monopoly positions, or other exclusive advantages that yield outsized profits relative to the investment or risk taken on. It would tax companies less on the normal return to equity – the return that compensates the owners for deferring consumption and risking their own capital on an uncertain bet.

Taxing superprofits and untaxing normal profits will encourage more productive activity, making us wealthier. To appreciate how, consider two firms: one engaged in productive activity and the other extracting economic rents.

The first is a digital design company providing services to clients around the world. The firm’s employees, which account for most of its production costs, are talented designers creating new ideas, designs, systems and technologies. Unless this firm has some special advantage, competition from similar firms will reduce the owners’ profit down to a normal return to capital. Taxing this profit, which is barely enough to induce investment and production, discourages those activities. That has flow-on effects on the number of employees hired, the wages offered, and the extent of innovation and productivity growth in the firm and elsewhere (via spillovers). Ultimately, it may lead to the firm’s operations moving abroad.

The second firm is a mining company generating profits by extracting a natural resource. The company didn’t produce this resource. Some part of its profit recoups the investment in extraction, but since the firm has exclusive rights to the mining lease, and the overall resource is limited, competition from similar firms will not necessarily limit the firm’s profit to this amount. The firm may gain a superprofit or economic rent – a profit in excess of that necessary to induce investment. We describe that part as ‘unearned’. Taxing it means shifting money from the shareholders to the public, without discouraging investment. It’s a pure transfer.

Currently, both firms pay tax on profits at the same rate. Under a better system, the first firm would pay less tax, stimulating further investment and production, and the second would pay more tax, yet without discouraging investment or production. This would create economic benefits without imposing economic costs.

There are various ways of recalibrating company tax to achieve this, such as by converting it to a cash flow tax along the lines of the Henry Review recommendation or the proposals advanced by Ross Garnaut and others. Such a system would reward companies that profit from investing in our living standards, without enriching those in monopoly positions.

Stamp duty on property transfers is unfair: it places a higher burden on those who move house or business premises more often. This is arbitrary, because the act of transacting land is generally unrelated to any cost incurred by the state or any special benefit derived by the seller. And land transfers are socially valuable: they improve productivity by better matching households to houses and businesses to premises. Stamp duty stands in the way of this. Stamp duty likely affects worker commute times, business distances to suppliers, customers, and employees, and traffic congestion, as well as misallocating housing, which results in overcrowding in some houses, empty bedrooms in others, too many costly renovations, and not enough efficient new builds.

Although stamp duty is a de facto tax on land income – it eats into the vendor’s sale proceeds – it is a crudely targeted one. It doesn’t distinguish between sellers who bought long ago and are making large capital gains and sellers who bought recently and may be making capital losses. And because it applies to the total property value, not the land component, it discourages investment in improvements. There are better (fairer) ways to tap the land income base. We don’t want to abolish stamp duty, because that would create large (and largely untaxed) capital gains for the current owners. We want to replace it with a fairer, more efficient tax on land. One option is a new land value tax. But switching from a transaction tax to a recurrent tax has pitfalls. Another option might be to convert stamp duty into a ‘value capture’ tax paid on sale, with the tax calculated as a share of the uplift in land value since the previous sale. Replacing stamp duty will let us make the most of our land, housing and transport networks, through smarter patterns of occupation and land use. More importantly, it will replace an arbitrary penalty on moving with a fairer sharing of unearned income from passive ownership of land.

Unlike wages and the normal profit of business, income from land is unearned.

That means no effort or sacrifice created it. The landowner received this income simply by virtue of owning a resource in limited supply: land, or more precisely, valuable locations. A fixed supply of land in desirable locations is the essential feature distinguishing land from capital (i.e. buildings and machines). It is key to the economic and ethical case for land tax. Mark Twain’s quip – “buy land, they’re not making any more of it” – truly hits the point.

Land income takes several forms. One is a portion of the cash rent landlords get when leasing their premises. Some part of this recoups the cost of investment in structures, but the portion above this is pure economic rent, reflecting location value alone.

Location value can’t be competed away: land can’t be ‘imported’ from elsewhere to drive down the price of housing to the construction cost. Each site is a tiny monopoly, and is priced accordingly.

Another type of land income is the land portion of the ‘imputed’ rent homeowners get from their own house, referring to what they could receive were they to lease it out instead of occupying it. Another is the so-called ‘capital’ gain (actually a land value gain) when a property grows in value. (Paper gains are income too; whether it’s smart to tax them before they’re converted to cash is another matter.) We often don’t see land income directly – it’s bundled with returns to capital, or it isn’t received in cash. But it’s a distinct type of income, and can be taxed distinctly.

Land has value because it generates this income. But land income, and land value, doesn’t emerge from any action of the landowners. It is created by the rest of us.

The value of land measures the benefit society at large provides to each location by virtue of what is collectively provided through the state, i.e. infrastructure, services, and regulation, and what that lets us access, i.e. markets, opportunity, amenity, culture, community – all the things we value.

Land value sums up what we, the collective, contributed to making a place desirable. The value of land has nothing to do with how the owner uses it.

In the Georgist tax ethic (and that of earlier thinkers) that makes land the proper object of taxation. What could be more intuitive than society socialising and sharing that which society created, while letting individuals keep the fruits of their own efforts? The principle is inarguable.

This ethic is one reason for land tax. The other is efficiency. Land can be taxed at no economic cost, with no discouragement to investment or production. Landowners can improve their capital value, but they must take their land value as given. And if nothing you do changes the value of your land, why change how you use it? This is why economists describe a tax on land value as a perfectly efficient tax.

In an ideal system, land rent would be heavily taxed, allowing for the abolition of taxes on wages and profits and distribution of any excess as a citizen’s dividend (i.e. a universal basic income). That’s the light on the hill. Of course, we can’t move there quickly. Land is a legitimate vehicle for savings under our current economic system. For many people the land under their house is their most valuable asset, the reward for a lifetime of work and saving. Fairness demands we not punish through rapid change those who bought property rather than shares, cash, bonds, or other assets. To some extent, those land rents are bought and paid for.

So how can we fairly transition to a better system? It must be at the point where land inheritance perpetuates privilege. We have the right to the fruits of our work and saving in this life, but do our own children have the right to benefit from that? Should our effort, luck or cunning in acquiring legal claim to a limited and valuable piece of our earth let us privilege our own family at the expense of others?

We already use land taxes – but not nearly enough. Council rates fall partly or entirely on land value, depending on the rating base, but capture only a small share of land income. State land taxes are levied on a narrow base of commercial and industrial property, and fail to prevent landowners acquiring large windfall gains from rezoning decisions and new infrastructure.

Land has become a great dividing factor. Many of us earning a wage struggle with the rent and bills, while those who inherited land or bought it long ago now, in the words of John Stuart Mill, “grow richer, as it were in their sleep, without working, risking or economising”.

Broadening land tax, along with other ways of capturing land income, would move us closer to an ethical and efficient tax system in which economic reward is proportionate to effort. This would grow our economy, and more: it could encourage faster housing supply, reduce incentives for corruption, stabilise housing markets by curtailing speculation, and restrict one channel by which wealth inequality grows within and between the generations.

Our system of rights over natural resources – minerals, oil and gas, forests, water and more – is often an elaborate version of ‘finders keepers’.

Some 60 years ago Lang Hancock ‘staked his claim’ to the world’s largest iron ore deposit, in the Pilbara. Wrangling legal rules, state politics, and media narratives, he finally secured exclusive ownership rights, recognising and speculating on the prospect that rising demand and falling costs might one day make the claim highly profitable. Today those rights are worth billions, and remain in private hands, their value tempered only by royalties introduced in the meantime.

Just as for land, the principle of first-in first-served for natural resources – referred to in mineral prospecting as the “first finder’s right” – is a fundamentally unfair basis for determining who benefits from the riches of the earth.

Why should Lang Hancock’s daughter be the richest person in Australia, largely by virtue of inheriting a chunk of the earth? Why should a taxi driver in Melbourne be living on the breadline? Both are Australians. We can (charitably) assume both work hard. Why does one live in luxury and the other in poverty?

The answer, which is not a justification, is the unfair way we allocate resource rights and share their value. Exclusive rights to our shared natural endowment without fair payment to society enriches some at the expense of the rest of us, an expense we bear through higher taxes and a lower quality of life.

There’s a simple principle we should not back away from: our natural resources are ours, collectively, and should be sold for no less than what they’re worth. That means we should capture the economic rents that extraction rights provide. If we do that, we can untax the taxi driver, every other worker, and indeed every productive business contributing to our economy.

Resources are an outsized share of Australia’s exports, but a far less significant contributor to job creation and demand for inputs from suppliers. With only a relatively minor benefit to our economy along the way, our resources are shipped offshore, with the vast profits that generates following shortly after. We can and should demand that the industries exploiting our common wealth give more back to our economy.

The way to do that is with better taxes. Designing better superprofit taxes, possibly as a replacement for crudely-calculated royalties which make resource investment a riskier bet than it need be, can do that.

And in the interim, royalties can simply be lifted and tweaked. Queensland in 2022 introduced three new tiers for coal royalties, with higher rates applying when coal prices are higher – a rough-and-ready proxy for superprofit taxation. This measure raised an extra $6 billion in 2022–23 as coal prices rose, which is over $1,000 per Queenslander, and is more than was raised by either payroll tax or stamp duty in that year. [1]

[1] Queensland Budget 2023–24, Strategy and Outlook, Revenue.

Much economic activity degrades our natural world as a by-product of production or consumption, such impacts being described as ‘negative externalities’.

A fairer economy would price negative externalities so that these social costs are internalised into business and individual decisions. Otherwise the community at large bears the burden, and polluters have inadequate incentive to clean up their processes. Environmental pricing can also raise revenue to replace other taxes.

This approach is underused. Numerous polluting activities could be priced in addition to or instead of being regulated in quantity (a common approach in state environmental regulation). Pricing can be more economically efficient than prescriptive regulation (sometimes described as ‘command and control’ regulation) because it allows firms to find the cheapest path to cleaning up their act.

Waste, air pollution, water pollution – the potential applications of this go beyond carbon pricing. Even congestion charging is based on the same approach.

The principle we’re pushing is the ‘polluter pays principle’. Those who take from the rest of us by degrading our natural world must compensate us for our collective loss. It is consistent with the philosophy behind land taxation: if you monopolise part of the earth we all have equal entitlement to, you should pay us for the privilege.

Where does pollution pricing sit within the tax system? There is another broad principle for a system that best supports economic growth and collective welfare: the principle of taxing “bads, neutrals, then goods”. That means we should raise revenue first by pricing the undesirables (pollution), turn next to non-distortionary taxes (such as on land and superprofits), and only then, if necessary, resort to taxing activities we want more of, such as work, investment, and production.

Our current tax system gets this entirely back-to-front.

Savvy property owners know how to extract unearned income from land. They listen closely to (and often influence) government planning and investment decisions. These owners – land speculators – know to buy low, wait, then sell high. Their profits are windfalls, unearned incomes they did nothing to produce.

The largest windfalls come from rezoning and new infrastructure.

Land is no more than a location with a bundle of rights attached. Laws and regulations determine that bundle. When additional use rights are added to the bundle, by way of rezoning or planning approval, its value rises in consequence. The simplest example is when farmland is rezoned to allow for residential development, boosting its value enormously. The same occurs when existing residential land is ‘upzoned’ to allow higher density, or when commercial land is upzoned for higher-value uses. By way of example, we estimated that the uncaptured uplift from the 2012 upzoning of Melbourne’s Fisherman’s Bend, a brownfields precinct adjacent to the CBD, was around $4 billion. Had that been captured it could likely have funded all necessary investment for the area. [1]

Infrastructure provision has the same effect on land values. When the government announces a new train station or train line, hundreds of thousands of dollars can be added to the value of an ordinary residential property overnight. And since new infrastructure is usually paired with rezoning for more intensive use, property owners gain a double dividend.

Such windfall gains are a ‘honeypot’ for corruption, an irresistible temptation for politicians and their backers.

It’s always been this way. Melbourne’s extensive railway system is in part a product of speculation, as 19th century parliamentarians judiciously bought land at the same time as voting for public investment in new train lines running through it. [2]

Rezoning favours and trading on inside information remain the norm today, with only the most egregious instances making it to the category of ‘scandal’. One study found that 60% of the value uplift from rezoning decisions in Queensland went to politically-connected property owners, for example. [3] This grey-gift corruption is so entrenched in our economic and social structures that we see it as normal. Taxing rezoning and infrastructure windfalls would allow us to cut taxes on work, investment and production, and would lead to valuable infrastructure effectively paying for itself. This approach – referred to as value capture – would not deter any valuable economic activity. But it would reduce the incentives for corruption and the distortion to public decision-making that results from it.

Capturing value is fundamentally fairer than giving it away. When the state builds a train line with taxpayer dollars, it should be taxpayers that benefit, not lucky or well-connected individuals. When the state grants additional land use rights, the recipients should be charged for the privilege; there should be no upzoning without value capture. To give these rights away for free instead of selling them is to privatise public assets without the public getting a cent.

There are many ways to enact value capture taxation: windfall gains taxation triggered upon rezoning, developer charges payable upon development, land value uplift taxes levied at the point of sale, and auctions for land use rights, amongst others. There are working models for many of these here and abroad.

[1] Prosper Australia (2021), The Rezoning ‘Honeypot’: Evidence from Fishermans Bend.

[2] Mares (2012), Can we afford to get our cities back on the rails? Grattan Institute.

[3] Pascoe (2015), In the zone: Insider trading rife in land rezoning racket, SMH, 29 September