Few today would disagree that Australia’s golden era of economic reform was from 1983 to 2007. This ‘longest decade of reform’, as described by George Megalogenis, saw privatisation, deregulation, tariff protection slashed, a new modern tax system, and a more flexible labour market. Productivity growth was the preeminent objective and free enterprise was celebrated rather than demonised. The Hawke-Keating Labor Government and the Howard-Costello Liberal Government that replaced it seemed to be more of a continuation of each other rather than a repudiation, at least in terms of economic policy. This reform nirvana, unfortunately, ended with the election of Rudd and the global financial crisis that hit early in his term. The subsequent period of 2007 to 2023 could be categorised as ‘the longest decade of inaction on economic reform’, from both sides of the political divide.

But why is it that we only ever view economic reform as the remit of the federal government? State governments after all have huge expenditures and balance sheets. They have vast state-owned enterprises and are primarily responsible for most of the services and infrastructure we rely upon. And Australia’s most inefficient taxes are levied at a state level, from payroll tax and stamp duty to insurance taxes and the emergency services levy. State economic reform is often the missing piece of the puzzle, and when done well - like has so frequently been the case in New South Wales since 2011 - goes mostly unnoticed. Of course, that is both a blessing, as state legislators can quietly go about reform without the heightened attention presented to our federal counterparts, and a curse, as important state economic reforms rarely get the credit they deserve.

The New South Wales economy is far more dynamic and successful today because of twelve years of Liberal Government reforms. Yet, there is still so much more that could be done at a state level, with four major reforms I believe are worthy of consideration.

Phasing out payroll tax

Any serious attempt at economic reform must consider the tax system, especially at the state level since that is where so many of Australia’s most inefficient taxes are levied. Particular attention must be paid to taxes placed upon private enterprise, as such taxes directly affect employment outcomes and wealth creation. It has long been understood that, although the legal incidence of a tax on business lies with employers, the real financial burden of poorly designed taxes eventually shifts along the market, either to employees or consumers. The most notorious example of this effect is observed in payroll tax.

Payroll tax is the largest state and territory-levied tax, providing governments with $24.7 billion in revenue in 2020-21, representing nearly a third of all tax revenue raised. Australia is one of the few countries within the OECD that levies a payroll tax. In theory, payroll tax is efficiently levied on the capital of medium and large-sized employers when the total taxable wages paid to their employees exceeds a threshold amount, in New South Wales that amount is $1.2 million (2022/23). However, in reality, the 2010 Henry Tax Review identified payroll tax as the third most inefficient tax country-wide, primarily stemming from each state or territory’s distortionary tax threshold, multi-category exemptions, and differing regulatory interpretations.

The payroll tax threshold creates a market distortion where, for small business owners with wages payable hovering around the threshold amount, it is more profitable to remain inefficiently small than to expand business operations to match the true market equilibrium. As a result, the potential deadweight loss is often counterbalanced by businesses passing on the cost of their payroll tax liability either to employees (through a reduction in labour costs, wages and/or headcount) or to consumers (through increased prices or lower quality). Payroll tax might not be a ‘tax on jobs’ by intention, but it certainly has become so by effect, most particularly for those small and medium businesses looking to expand beyond the threshold.

The New South Wales Productivity Commission has identified on multiple occasions that discordant rates, exemptions, and reporting obligations between jurisdictions also impede businesses attempting to expand inter-state. These differences serve as additional red tape, both for the government in managing revenue collection and for employers looking to hire across state boundaries. Increased costs to consumers created by payroll tax’s distortionary threshold, lower employee wages, and incongruence between jurisdictions, among other inefficiencies, are estimated to cause more than 40 cents of economic damage for each dollar of additional revenue raised.

Given payroll tax’s offence to market efficiency across Australia, the New South Wales Government should be commended for recently increasing the payroll tax threshold and reducing the payroll tax rate, especially during the pandemic budgets of 2020/21 and 2021/22. However, ultimately payroll tax must either be replaced or eliminated. Replacement would require a unified state-federal reform approach. The rationale is outlined in recommendation 57 of the Henry Tax Review affirming that “State payroll taxes should eventually be replaced with revenue from more efficient broad-based taxes that capture the value-add of labour”. A common proposal in this line of thought involves the federal government broadening the base of the Goods and Services Tax (GST) and increasing the rate, exchanging each state or territory’s payroll tax income for federal contributions from the new and expanded GST. This replacement approach no doubt seems like an elegant solution, however, getting such an agreement across nine state, federal and territory jurisdictions of all political persuasions and economic circumstances would be a formidable task.

In contrast to ‘replacement’, it is indeed possible to eliminate payroll tax without the need for federal cooperation. To do so would require a bold plan to gradually phase out payroll tax over time. The tax would be eliminated incrementally with slight reductions in the rate every year for 20 years. The small shortfalls in revenue each year would be covered by the natural annual increases in revenue of all other taxation sources. After 20 years, payroll tax would be eliminated, and overall revenue would still be higher in 2043 than in 2023. There would be no requirement to cut spending in each state or territory budget. The only caveat is that state and territory governments would be forced to restrain their expenditure to only modest increases, in line with Treasury forecasts.

Neither replacement nor elimination of payroll tax would be easy to achieve politically, but the economic benefits would be enormous. It’s not solely about removing deadweight loss in the tax system as a concept, but also about encouraging businesses to grow and the greater employment opportunities that follow. In particular, any state that moves first on the elimination approach would attract new business investment and employment from other higher-taxing state jurisdictions. New South Wales should act unilaterally and become the beneficiary.

Phasing out stamp duty

Like payroll tax, the 2010 Henry Tax Review identified state-based stamp duties on property (sometimes called transfer duty or conveyance stamp duty) as among the most inefficient taxes in Australia. Stamp duty is a significant source of state revenue despite being volatile, inequitable, inefficient, and inconsistent with the needs of a modern tax system. It is a volatile form of revenue because it is subject to Australia’s ever-changing property prices and, more particularly, the highly fluctuating quantum of property transactions. It is inequitable as people who move more frequently pay more tax, irrespective of their income or wealth. And it is inefficient and outdated because the tax’s high deadweight loss is created from discouraging transactions, meaning property misallocation away from its most valuable use.

As practical examples, this infamously productivity-stifling tax means that first home buyers face a huge barrier to entering the market; those aiming to upsize to suit their family needs are inhibited from moving; elderly Australians are remaining in their oversized homes for longer than is necessary; investors find their assets even more illiquid as they hang on to their properties longer to recoup the cost of stamp duty; and labour is inefficiently allocated to housing as people are less likely to move to change jobs or their location of employment.

The need for stamp duty reform is clear. What is ultimately required is the replacement of stamp duty in the form of a land tax, which is overall far less inefficient and more revenue stable. An annual land tax would consist of a fixed amount plus a rate applied to the (improved or unimproved) land value of a property. Crucially, state and territory governments would be required to commit to a locked indexation, ensuring land tax rates will not disproportionately increase over time. Treasury studies in New South Wales have indicated that a land tax model would result in a 3-4% reduction in home prices, whilst at the same time enabling a forecast 1.7% increase to gross state product from productivity increases.

The question then arises: how will state and territory governments account for the initial shortfall in revenue from the transition to land tax? One option is federal assistance in recouping losses through temporarily increasing other more efficient taxes, such as the GST. However, in much the same way as payroll tax, federation-wide tax reform is near impossible as it requires reaching an agreement across nine state, federal and territory jurisdictions of all political persuasions and economic circumstances. My preference is for New South Wakes to act unilaterally rather than wait impatiently for a federal solution.

Unilateral action is possible, and the Australian Capital Territory Labor Government should be congratulated for first initiating stamp duty reform more than a decade ago. Most first-home buyers in the Australian Capital Territory are today completely exempt from paying stamp duty if the property costs less than $1 million, and by 2032 there will be no duty on property transfers in the territory at all. Similarly, the New South Wales Liberal Government has started this reform by giving first-home buyers a choice between stamp duty and a small annual land tax on purchases under $1.5 million. The New South Wales Government should expand this scheme to include all owner-occupied properties on future purchases under $1.5 million, with the threshold increasing by $50,000 every year in perpetuity. In the long run, a transition to land tax is revenue neutral, however, expanding the scheme will mean budget gaps in the short term. Limiting the reform to only owner-occupied properties and including a threshold will ensure that those budget gaps are more manageable than under an immediate total abolition scenario. But also, by slowly increasing the threshold each year, more properties will become eligible, meaning eventually stamp duty is phased out entirely.

The New South Wales Government’s first tranche of the reforms, pertaining to first home buyers alone, simply absorbed the budget shortfalls out of consolidated revenue. An expanded or second tranche would ideally be funded by reducing government expenditure (as outlined in Part III). However, if the government was not inclined to reduce spending to fund the reforms, and federal assistance was not an option, then thought should be given to a temporary increase in council rates as a short-term replacement source of revenue collected by the state government. Council rates are outlined as one of the most efficient forms of taxation in the Henry Tax Review, due to the immobility of land. Nonetheless, a temporary rate increase should be considered as a last resort, with federal tax replacement like GST, consolidated revenue, and expenditure reductions all being preferable. Like all impactful reforms, phasing out stamp duty requires political willpower, and while New South Wales is on the right track with first-home buyers, it should be viewed as only the beginning of a much longer process of reform.

Refocusing and Restraining Expenditure

Accompanying bold plans to reform payroll tax and stamp duty, it is necessary to go ‘back to basics’ briefly to review government expenditure. Minimising unnecessary expenditure is an economic imperative for any government that seeks to manage taxpayer money responsibly. Sensible expenditure constraints lead to greater value per-dollar for taxpayers and a reduction in overall debt and deficit. I am principally advancing two approaches to managing expenditure: refocusing budget announcements to be outcomes-focused and ending the practice of pork barrelling.

There exists fundamentally flawed thinking that more and more government spending will lead to better outcomes in health, education, transport or other services. Most budget accomplishments are defined by volumes of expenditure – ‘record’ and ‘unprecedented’ funding – whose material outcomes are difficult to ascertain. Whilst volumes of spending aren’t inherently bad indicators of a government’s priorities, justification for new expenditure should instead be made based on foreseeable outcomes, as opposed to abstruse dollar figures. Ronald Reagan once remarked that the “government does not tax to get the money it needs; government always finds a need for the money it gets”, pointing to the large wastage associated with public spending.

A shift is therefore needed in our approach to government projects, from being input-focused (talking in dollar figures) to outcome-focused (talking in statistical outcomes and results). An idea that aligns with this concept of outcome-focused spending is to implement key performance indicators for how taxpayer money is spent by the government, tied to statistics from sources such as the ABS or the relevant state treasury. For example, what was once a “$300 million local hospital upgrade” now becomes “an initiative to cut local hospital waiting times by one hour”.

An even better solution would be to enable individuals themselves to choose how their taxpayer funds are spent through the delegation of responsibility for certain kinds of expenditure. One of the best, but most politically daring, examples is the idea of school vouchers, where parents issue a certificate of funding to the school that they decide is most appropriate for their child - public or private – thereby providing choice and competition in education. Choice in schooling then becomes available to everyone, not just the wealthy, through government funding and a competitive market. Where there is choice, greater efficiency is the result.

The second substantial treasury reform is the need to crack down on pork-barrelling, a practice at every level of government that should be offensive to all political persuasions. Pork-barrelling is both immoral and inefficient, creating scenarios where genuine community need is overlooked by the government in favour of funding more politically advantageous projects. Elected officials and not bureaucrats should determine how taxpayer funds are spent, but it should be transparent, and the funding should only be limited to core services. Transparency means that grants and funding proposals should have their business cases independently scrutinised and benefit-cost ratios determined. For major projects, above a certain threshold, credible independent organisations like the Productivity Commission could be used. Any Minister that deviates from the independent advice or ignores the benefit-cost ratios must publicly disclose their reasons for doing so.

Pork-barrelling can also be curbed by ensuring that the government only focuses on core services and infrastructure. At the 2022 federal election, we saw outrageous profligacy from the Morrison Government, with announcements such as $10 million for regional newspapers and $15 million for breweries. These grants are not the core function of government, as important as those businesses may be. Pork-barrelling in this manner could be avoided by reducing the amount of money the government has available for such projects. The government should be forced to adhere to prudent budget principles. For example, expenses growth should be capped at 2% and should not be allowed to exceed revenue growth. Furthermore, the government must always maintain a AAA credit rating from all rating agencies and should never hand down a deficit over 1% of GDP, with a surplus and no net debt always being the aim. This reduces the pool of funds available for new and unnecessary projects that are so often at the heart of pork-barrelling and heeds the advice of Peter Costello that “the easiest cut you will make is the stuff you never go into”.

Reducing the quantum of taxpayer money available for pork-barrelling by imposing an expenditure growth cap of 2% per year also fits well with the elimination of payroll tax policy detailed above. Governments cannot afford huge spending sprees if revenue growth is constrained due to gradual payroll tax reductions over two decades.

No doubt governments of all persuasion enjoy the benefits of new spending announcements for political gain. But I seriously question the political benefit of pork-barrelling in an increasingly well-informed and sceptical electorate that values integrity and could consider politicians brandishing novelty-size cheques as an attempt to buy their vote. Governments are the custodians of taxpayers' funds, and we should only spend their money with an abundance of caution and care.

Privatisation

Beyond structural reform, treasuries Australia-wide have options to privatise portions of their assets to raise funds for infrastructure projects, healthcare and schools. Privatised assets that exist within a competitive market or are properly regulated, such as QANTAS or 49% of the New South Wales electricity grid, have proven historically successful in raising capital for other significant investments. Privatisation also provides an incentive for innovation and greater efficiency in fields previously the sole domain of government.

New South Wales has been a huge beneficiary of privatisation over the last 12 years. We call it ‘asset recycling’ not for political branding but instead for accuracy, as the capital unlocked from selling or leasing one asset is then invested into building another, until that new asset is built and the capital once again unlocked to build another, and so the cycle continues. It allows governments to build new productive infrastructure like major road and rail projects without plunging into huge debt.

The 2016-17 electricity network transaction was the state’s most notable example of asset recycling. By leasing 49% of the state’s ‘poles and wires’ over a 99-year horizon, the state's coffers generated net proceeds of $23 billion, exceeding expectations by about $2 billion Profits raised from the transaction funded the Rebuilding v infrastructure program which included a budget for public transport, new roads, new schools, new health facilities, upgraded cultural attractions, and water security improvements.

The Productivity Commission in 2013 recommended that state-owned electricity networks be privatised as they are less efficient than their private sector peers. This is hardly surprising, as state-owned enterprises are not subject to the price mechanism and the forces of supply and demand. In many ways, privatisation is an easy version of economic reform. Instead of Treasury officials painstakingly trying to force inefficient government monopolies to become more dynamic, that job is outsourced to the private sector, led by shareholder and customer expectations.

The New South Wales Government should consider leasing its remaining 51% share of the state’s electricity network – 100% of Essential Energy and 49.6% of Ausgrid and Endeavour Energy – to drive efficiency and to receive a revenue boost akin to that of 2016-17. The ‘recycled’ revenue from the new lease would provide an opportunity to invest in even more infrastructure to boost the state’s productivity, supporting and expanding upon current plans such as the Western Harbour Tunnel and Beaches Link, Sydney Metro, Circular Quay Precinct Renewal, Parramatta Light Rail Stage 2, and new school and hospital upgrades. Other state and territory governments would benefit from simultaneously adopting analogous privatisation measures.

Whether it be privatisation, tax reform or expenditure restraint, there is no doubt that state governments are ripe for bold economic reform. Too often these important reforms are kicked down the road on the basis that federal assistance is needed or an inability to get an agreement among jurisdictions. This is mostly a cop-out and shows a complete lack of creative thinking and tenacity. Federation-wide economic reform is always preferable, but I have outlined that four major reforms could be achieved unilaterally, and of course, there would be many more. Increasing the housing supply and reforming the New South Wales planning system is a critical reform area to improve housing affordability and grow the state’s economy. Deregulation and reducing red tape on businesses, large and small, is often spoken about but rarely actioned. Competition policy, industrial relations, and the efficiency of the public service require critical reform. And of course, if tough conversations need to take place with the federation, they should start by addressing vertical fiscal imbalance and horizontal fiscal equalisation. New South Wales should be celebrated as a bastion of economic reform over the last 12 years. But further productivity-enhancing reforms are required for our continued prosperity, especially now during trying times. What is ultimately required is for us to seize the initiative and create our own longest decade of economic reform; such reforms require ingenuity and courage from our state’s political leaders if they are to succeed.

Chris Rath is a Member of the Legislative Council in the Parliament of New South Wales. Before that he worked in the insurance industry.