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Appendix 3: Technical notes to Chapter 11

• Horizontal fiscal equalisation
• Rates of piggy-backing State personal income tax
• Flat rates of State income tax
• Endnotes

A3.0 This appendix explains the calculation of:

• the amount of Financial Assistance Grants required to preserve the current extent of horizontal fiscal equalisation;
  

• the rates of piggy-backing State personal income tax that would be needed to raise $10 billion or $21 billion; and
  

• the flat rates of State personal income tax that would be needed to raise $10 billion or $21 billion.

Horizontal fiscal equalisation

A3.2 The following table indicates the 1998-99 Financial Assistance Grants payable to each State, as well as that State’s population, the relativities for each State determined by the Grants Commission, and that State’s share of the unquarantined Health Care Grants. Each States share of Financial Assistance Grants equals the sum of the total Financial Assistance Grants and unquarantined Health Care Grants, multiplied by its population as a proportion of the total Australian population, multiplied by its Grants Commission relativity, less its share of unquarantined Health Care Grants.

State

Population (thousands)

1998 Commonwealth Grants Commission relativities

1998-99 Financial Assistance Grants ($millions)

1998-99 unquarantined Health Care Grants ($millions)

NSW

6371.1

0.87765

4757

1789.4

VIC

4670.4

0.88042

3545

1269.4

QLD

3489.0

1.02186

3206

968.4

WA

1840.0

0.98252

1616

500.4

SA

1489.7

1.22194

1678

452.8

TAS

470.8

1.54974

736

118.4

ACT

310.1

0.88435

282

63.6

NT

193.5

4.89353

1034

57.5

TOTAL

18834.6

16854

5219.9

A3.3 The equalisation impact of distribution according to this formula can be seen in the following table, which indicates the share of Financial Assistance Grants each State would receive according to two alternative formulas: the first uses unweighted population in place of population weighted by Grants Commission relativities; the second uses proportion of personal income tax collected in that State in place of population weighted by Grants Commission relativities.

A3.4 When considering the possibility of a State personal income tax, the distribution of Financial Assistance Grants according to personal income tax collected in each State is particularly pertinent. The table above makes it clear that it is the Australian Capital Territory which, if it were able to levy personal income tax on the same base as the Commonwealth, would be least in need of equalisation payments. The following table indicates the amount of revenue that would be raised in each State, if it were allowed to levy personal income tax at a rate sufficient to ensure that the Australian Capital Territory was able to replace all its Financial Assistance Grants with its own personal income tax receipts, without needing to alter the total amount of personal income tax collected in Australia. It also indicates the equalisation payment each State would have to receive, if it was to remain in the fiscal position it currently enjoys.

A3.5 The table thus indicates that if the approximately $17 billion of Financial Assistance Grants to be paid by the Commonwealth to the States in 1998-99 were to be replaced to the maximum extent possible with revenue raised by State personal income taxation, then:

• if the total amount of income taxation raised in Australia was to remain unchanged; and,
  

• if no State’s overall fiscal position was to be altered;

then

• approximately $7 billion would be required for Horizontal Fiscal Equalisation payments; and
  

• the remaining $10 billion could be replaced by a State personal income tax levied on the same base as the Commonwealth personal income tax.

Rates of piggy-backing State personal income tax

A3.7 If a State personal income tax raising either $10 billion or $21 billion was introduced, and there was to be no change in the tax mix from personal income to consumption taxation, Commonwealth tax rates would have to be reduced by an amount that would reduce Commonwealth personal income tax receipts to either $65 billion or $54 billion. The rate of piggy-backing State personal income tax required to raise $10 billion or $21 billion, given Commonwealth personal income tax receipts of $65 billion or $54 billion, is indicated in the following table:

Commonwealth personal income tax receipts	State personal income tax receipts	Piggy-backing rate of State personal income tax
$65 billion	$10 billion	15.4%
$54 billion	$21 billion	38.9%

A3.8 Calculating the change in Commonwealth marginal tax rates required to yield this result is more complicated. The following table indicates the current marginal rates of Commonwealth personal income tax, and modified rates which would ensure that each individual’s personal income tax liability remained unchanged, given the piggy-backing rate of State personal income tax:

Taxable income

Current marginal tax rate

Marginal tax rate creating room for a 15.4% piggy-backing State personal income tax

Marginal tax rate creating room for a 38.9% piggy-backing State personal income tax

0 - 5,400⁴

0

0

0

5,401 - 20,700

20

17.1

14.0

20,701 - 38,000

34

29.3

24.1

38,001 - 50,000

43

37.1

30.5

50,001 and up

47

40.5

33.2

A3.9 These rates assume that the Medicare levy would accrue entirely to the Commonwealth. However, there are a number of other factors that they do not take into account.

A3.10 Commonwealth personal income tax revenue includes not only revenue raised from the basic personal income tax and the Medicare levy, but also Higher Education Contribution Scheme repayments and the additional Medicare levy payable by high income earners with no private health insurance. If the rates of these taxes remained unchanged, then the rates indicated in the table above would have to be reduced if income tax liability was not to be increased by the payment of piggy-back tax on top of these additional tax imposts.

A3.11 Matters are further complicated by consideration of tax credits and tax rebates. Rebates and credits are reductions of the amount of tax payable and are applied to a gross tax liability arrived at by applying the marginal rates to taxable income (ie total income less allowable deductions). Any individual receiving a tax rebate or tax credit therefore pays tax at what are effectively lower marginal rates. The reduction in marginal rates for such an individual, necessary to ensure that that individual’s personal income tax liability remained unchanged, given the piggy-backing rate of State personal income tax, would therefore be less than the reduction indicated in the table above.

A3.12 These complicating factors therefore push the rates in the table above in opposite directions: consideration of sources of personal income tax revenue beyond the basic personal income tax rates and the Medicare levy suggests that the rates in the table should be reduced, while consideration of the impact of tax rebates and tax credits suggests that the rates should be increased.

A3.13 In 1996-97, total gross personal income tax assessments (including Higher Education Contribution Scheme repayments of $251 million) equalled $63.4 billion, total Medicare levy assessments equalled $4.0 billion, total rebate and credit entitlements equalled $7.6 billion, and total net personal income tax assessments equalled $60.3 billion.⁵ It can thus be seen that the impact of these complicating factors is comparatively marginal, and the following rounded marginal tax rates are put forward as indicative of the changes that would be necessary to ensure that each individual’s personal income tax liability remained unchanged, given the piggy-backing rate of State personal income tax:

Taxable income

Current marginal tax rate

Marginal tax rate creating room for a 15.4% piggy-backing State personal income tax

Marginal tax rate creating room for a 38.9% piggy-backing State personal income tax

0 - 5,400⁶

0

0

0

5,401 - 20,700

20

17

14

20,701 - 38,000

34

29

24

38,001 - 50,000

43

37

30

50,001 and up

47

40.5

33.5

Flat rates of State income tax

• the number of people with taxable incomes greater than the tax-free threshold;
  

• the total income earned by those people.

A3.15 Determining the total number of taxpayers, and their total income, for 1998-99, is an approximate process.

A3.16 In 1996-97, 8.2 million people paid tax on their income; the total of their taxable income was $258.3 billion.⁷ The total Australian population in 1996-97 was 18.4 million.⁸ The estimated population for 1998-99 is 18.8 million.⁹ The proportion of the population lodging tax returns has remained relatively stable,¹⁰ which suggests that the number of taxpayers in 1998-99 will be approximately 8.4 million.

A3.17 Average earnings are estimated to have grown by 4.75% in 1997-98, and are estimated to grow by 4.25% in 1998-99.¹¹ This suggests that total taxable income in 1998-99 will be approximately $282 billion.

A3.18 The revenue that would be earned by a State personal income tax levied at a flat rate on taxable income can be calculated by subtracting the product of the number of taxpayers and the tax-free threshold from total taxable income, and then multiplying this result by the rate of State tax. Assuming 8.4 million taxpayers with a total taxable income of $282 billion, a tax rate of 4.23% would raise $10 billion, while a tax rate of 8.87% would raise $21 billion:

Number of taxpayers

Taxable income less product of number of taxpayers and tax-free threshold ($5,400)

4.23% of taxable income less product of number of taxpayers and tax-free threshold

8.87% of taxable income less product of number of taxpayers and tax-free threshold

8.4 million

= $236.64 billion

$10.001 billion

$21.000 billion

A3.19 As with the calculations in relation to piggy-back taxation, there are complicating factors.

A3.20 The tax-free threshold for the unearned income of minors is $416 rather than $5,400.¹² In 1996-97 there were 31,890 individuals paying tax on income less than $5,400. These individuals would therefore increase by a small amount the revenue earned by a State personal income tax levied at a given flat rate of taxable income.

A3.21 The calculations above assume that all personal income tax credits and rebates would be paid by the Commonwealth. However, it would be reasonable to expect that at least some of these payments - particularly those relating to the averaging of taxable income across multiple years for certain categories of taxpayer - would be met by the States as well as the Commonwealth.

A3.22 As was the case in relation to piggy-back taxation, these complicating factors therefore push the rates in the table above in opposite directions: consideration of the reduced tax-free threshold for the unearned income of minors suggests that the rates in the table should be reduced, while consideration of the impact of tax rebates and tax credits suggests that the rates should be increased. However, the impact of these complicating factors is likely to be comparatively marginal. Given the approximate nature of the above calculations, the following rounded rates are put forward as indicative of the rates that would be necessary for a State personal income tax, levied at a flat rate on taxable income, to raise either $10 billion or $21 billion of revenue:

Endnotes

1Unquarantined Health Care Grants are the base Specific Purpose Payments made to each State under the Australian Health Care Agreements (Medicare Agreements), negotiated between each State and the Commonwealth. In 1998-99 these are to total approximately $5 billion.

2See Federal-State Relations Committee, Australian Federalism: The Role of the States, Second Report on The Inquiry into Overlap and Duplication, Parliament of Victoria, Melbourne, 1998, pp 41-2.

3Commonwealth of Australia, Budget Strategy and Outlook, Statement 5 - Revenue, 1998-99 Budget Paper No 1, Table 1, p 5-3.

4Minors must pay the top marginal tax rate (47%) on all unearned income over $416: Income Tax Assessment Act 1936, Part III, Division 6AA; Income Tax Rates Act 1986, s 13.

5Australian Taxation Office, Taxation Statistics 1996-97: a summary of taxation, superannuation and child support statistics, 1998, Chapter 3, Detailed table 11.

6Minors must pay the top marginal tax rate (47%) on all unearned income over $416 (see n 4 above). Under the proposal for a piggy-backing State personal income tax, this rate would reduce to 40.5% or 33.5%.

7Australian Taxation Office, Taxation Statistics 1996-97: a summary of taxation, superannuation and child support statistics, 1998, Chapter 3, Detailed table 11.

8Commonwealth of Australia, Federal Financial Relations, 1997-98 Budget Paper No 3, Table 1, p 1.

9Commonwealth of Australia, Federal Financial Relations, 1998-99 Budget Paper No 3, Table 1, p 1.

10Taxation Statistics 1996-97: a summary of taxation, superannuation and child support statistics, above n 7, Chapter 3, p 14.

11Commonwealth of Australia, Budget Strategy and Outlook, Statement 2 - Economic and Fiscal Outlook, 1998-99 Budget Paper No 1, Table 1, p 2-5.

12See n 4 above.