Economic effects of payroll tax

Calls to abolish or modify payroll tax are often heard. For example, the Australian Chamber of Commerce and Industry has called for the abolition of payroll tax as part of wider tax reform. While several reasons are cited for abolishing or modifying payroll tax, a common reason is that payroll tax reduces employment. It is important to distinguish between the legal incidence of a tax and its economic incidence. Legal incidence refers to the party legally responsible for paying the tax. In the case of payroll tax, legal incidence falls on the employer. The cost to the employer is, however, reduced by the fact that payroll tax is a deduction for company tax assessment purposes. Economic incidence refers to who finally bears the tax. As with other taxes—such as excise on alcohol—the economic incidence of payroll tax can shift along the production and distribution chain. Tax shifting occurs if the price of what is taxed increases when the tax is imposed. When tax shifting occurs, lower employment is only one of several possible effects of payroll tax. In general, the payroll tax base -- that is, the items to which the tax applies -- includes wages and salaries and other forms of employee benefit such as bonuses and fringe benefits. However, a feature is that the tax base differs from state to state. This increases compliance costs for businesses that operate in several jurisdictions. In March 2007, the states and territories agreed to harmonise their bases and administrative arrangements and there has been progress in this undertaking