Payroll Taxes: Thresholds, Firm Sizes, Dead‐weight Losses and Commonwealth Grants Commission Funding*

Abstract

Payroll‐tax thresholds make firms smaller than they would otherwise be and concentrate firms at just below threshold employment. We estimate the resulting dead‐weight losses under perfect and monopolistic competition. Under monopolistic competition, the threshold‐induced dead‐weight loss in Victoria is approximately 10 per cent of payroll‐tax collections over a wide range of threshold levels. Because payroll‐tax design affects the size distribution of firms, it also affects the Commonwealth Grants Commission's assessment of a State's capacity to generate payroll taxes. This violates a principle of the Commonwealth Grants Commission that its grant to a State be independent of the State's policies.