Victorian State Budget

A changing landscape

Tuesday 1 May 2018

2018/19

CONTENTS

Victorian State Budget 2018-19 highlights 1

Budget overview 2

Payroll tax 4

Infrastructure 6

Property 8

Health and education 10

Rural and regional Victoria 12

Victorian State Budget 2018-19 Highlights

REGIONAL VICTORIA

$4.3BINVESTMENT IN

REGIONAL VICTORIA

3.65% 2.43% REGIONAL PAYROLL TAX RATE

$941MREGIONAL

ROADS

$704MREGIONAL PUBLIC

TRANSPORT

$11M IMPROVE MOBILE COVERAGE

& BLACKSPOT AREAS

INCREASED SPENDING

EDUCATION

$2.8B2018-19

HEALTH

$4.2B2018-19

INFRASTRUCTURE

$13.7B2018-19

$1.3B2017-18

$2.9B2017-18

$10.1B2017-18

EMPLOYMENT

WHERE DOES THE MONEY

COME FROM?

8.9% PROPERTY RELATED TAXES

16.6%PAYROLL TAX

2.7% GAMBLING TAXES

3.8% MOTOR VEHICLE TAXES

2% INSURANCE TAXES

0.7% MISC TAXES 1.2% INTEREST REVENUE

1.3% DIVIDENDS10.9%SALES OF GOODS AND SERVICES

48.2%GRANT REVENUE

3.7%MISC REVENUE

$7.5B $8.0B$9.2B $9.8B

PROPERTY RELATED TAX REVENUE$11.5B

2014-15 2015-16 2016-17 2017-18 2018-19

2017 2018

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2.2%POPULATION

GROWTH FORECAST

2.75%ECONOMIC GROWTH

117KNEW JOBS – FY17

5.75%UNEMPLOYMENT

Budget overviewVictorian Treasurer Tim Pallas delivered a traditional election-year Budget, with significant investment in health, education, employment, law and order and infrastructure projects. The state’s coffers are bursting at the seams with taxation revenue, allowing the Andrews Labor Government to spend up big in the lead in to the election later this year.

Strong economic growthOn the back of strong economic growth, which has averaged 3.2% over the past three years, Victoria’s operating surplus for the 2018/19 financial year is forecast to be $1.4 billion, with total surpluses of $7.6 billion forecast over the next three years. Taxation revenue is projected to reach $24 billion this year, and is then expected to grow by a further 4.5% over the forward estimates. Although this growth rate is below the five year average of 7.6%, it nonetheless continues to provide the government with a very strong platform from which to deliver on its spending commitments.

Balancing the books with property taxes revenueThe government continues to rely heavily on property taxes to balance the books. In 2018/19 the total property taxes revenue of $11.5 billion is forecast to comprise a whopping 48% of the total tax revenue of $24 billion. However, of note from the forward estimates is the fact that property taxes revenue as a proportion of total tax revenue is expected to remain at 48% in 2021/22.

This is the first time in many years that the government’s numbers do not predict a continuing increase in the size of the property taxes pie over the forward estimates. This is consistent with the feedback from our clients, who are telling us that a combination of factors including the removal of the off-the-plan stamp duty concession for investment properties, the stamp duty and land tax foreign surcharges, a non-user friendly planning environment and the increasingly complex finance landscape are impacting their sales figures and making projects more difficult to get off the ground.

We are concerned that measures such as the changes to the off-the-plan duty concession and the foreign surcharges could eventually result in a significant and sustained downturn in the property development sector. If such a downturn occurs, it would have a negative impact on housing affordability through a decrease in supply, employment (given the significant number of people employed in the building and construction sector), and the government’s bottom line. The forward estimate projections in respect of land transfer duty may well be overly optimistic when you consider that many of the apartment projects, which are now struggling to find buyers, will complete in two to three years’ time.

No tax relief in sight for the majority of middle market businessesThe Budget measures specifically targeted at middle market businesses are limited to the further reduction in the payroll tax rate for businesses based in regional areas. Although this tax relief will no doubt be welcomed by the small number of clients who qualify for the reduced rate, their counterparts in the metropolitan areas could well be forgiven for asking why they haven’t been given more relief from an ever increasing tax burden, including significant bracket creep in the areas of land tax, payroll tax and stamp duty. On the basis of the government’s spending commitments in this Budget and on the assumption they are still in office following the election later this year, it is unfortunately hard to foresee any real reduction in the cost of doing business in Victoria on the horizon.

Significant investment in health, education and infrastructure projectsHealth and education will be major beneficiaries of the spending announced in the Budget. A total of $7 billion will be spent on improvements to Victoria’s health infrastructure and services together with the construction of new schools and upgrades of existing schools. In addition, TAFE will receive a significant boost with more than $300 million directed to new training places, and 30 TAFE priority courses to be made available for free.

The government will continue to make significant investment in public infrastructure, including both road and rail projects, many of which are planned for regional Victoria. Infrastructure investment is forecast to average $10.1 billion per annum over the next four years. The most significant projects had already been announced prior to 1 May, including the Metro Tunnel and the North East Link. However, a number of other road and rail upgrades have been provided for in this Budget.

2018/19 Victorian State Budget: A changing landscape

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COMMENTARY

EDUCATION

HEALTH

INFRASTRUCTURE

A changing landscape

The government will continue to make significant investment in public infrastructure, including both road and rail projects.

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COMMENTARY

Payroll taxPayroll tax is expected to generate revenue of $6.2 billion for the State Government in 2018/19. The Andrews Government announced a further reduction in the payroll tax rate for regional Victorian employers, albeit all employers will benefit from a slight increase in the tax-free threshold from 1 July 2018.

Payroll tax rate reduction for regional employersEligible Victorian regional businesses will see a reduction in the payroll tax rate from 3.65% to 2.425%. In effect, from 1 July 2018, they will pay tax at half the rate of their Melbourne counterparts, which presents significant cost advantages.

To illustrate the savings, an eligible regional employer with an annual wages bill of $1 million will pay approximately $8,500 less in payroll tax than a Melbourne based employer with the same size payroll. In comparing employers with annual wages of $2 million, the savings for the regional employer increase to approximately $32,750 compared to their Melbourne equivalent.

Who is an eligible regional employer?

Not all businesses with wages paid to employees in regional areas qualify for the lower rate. To be an eligible regional employer, the ABN registered business address must be in regional Victoria and at least 85% of total Victorian wages must be paid to employees who work mainly in regional areas.

Annual threshold increaseThe annual payroll tax tax-free threshold will increase from $625,000 to $650,000 with effect from 1 July 2018. This increase was first announced in last year’s Budget.

Based on the current payroll tax rate of 4.85%, the increase in the threshold will result in an annual tax saving of $1,200 per business group.

It is worth noting that even with the increase in the tax-free threshold, Victoria still has the second lowest tax-free threshold, the lowest being South Australia ($600,000). This is still significantly behind the highest tax-free threshold of $2 million in the ACT, and trails both Queensland ($1.1 million) and New South Wales ($750,000).

A case for payroll tax reformPitcher Partners has always supported significant reform to payroll tax to attract new business to Victoria and incentivise pre-existing Victorian businesses to employ more staff. Reform in this sense includes both increasing the tax-free threshold and reducing the rate of tax. However, recent changes have not kept pace with wage growth, meaning much smaller businesses are now caught within the payroll tax net and most others are paying much more tax.

Between 2002 and 2018, the tax-free threshold increased from $550,000 to $650,000, representing a modest increase of 18.2%. However, over the same period, full-time adult total earnings rose by 79.5%. What this means is that an employer now only has to employ the equivalent of 7.6 full-time employees to be liable for payroll tax compared to 11.6 full-time employees in 2002, so businesses with four less employees are now subject to payroll tax compared to their 2002 counterparts.

If we compare businesses with 20 employees in 2002 to now, based on full-time adult total earnings, the overall tax payable has increased by 136% compared to wages growth of 79.5%. Payroll tax has clearly outpaced wages growth over that time largely due to the reluctance of successive governments to adequately increase the tax-free threshold or reduce the rate of tax.

PAYROLL TAX

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As part of a platform for employment growth, we will continue to encourage the government to consider significant structural reforms to payroll tax, ensuring smaller businesses are no longer liable for the tax and those that remain liable only pay their fair share.

PAYROLL TAX

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InfrastructureInvesting in the future The Andrews Labor Government is forecasting a further increase of more than 10% in infrastructure spending during the 2018/19 financial year in comparison to last year’s Budget. While this increase does not match the 28% increase from the previous year, it must be seen in light of the capacity of the State to take on new projects.The infrastructure expenditure, which is currently driving economic activity in Victoria, will continue to represent opportunities for businesses. There is no doubt that the level of investment in infrastructure spending is having a positive impact on economic activity across the state.

The government also recognises that the unprecedented level of construction activity in Victoria and across the eastern seaboard of Australia, is resulting in negative impacts that will need to be managed. These include “lower bidding rates, less contractor competition, constrained availability of plant and resources, and increased costs.” (Budget Paper 4, p 4). This will represent an ongoing challenge to the government to ensure that Victorian taxpayers receive value for money in delivering these projects. No doubt it is a challenge to relish.

Significant spending on public infrastructure projectsExpenditure on transport infrastructure continues to be a key hallmark of the Budget. Some projects have been announced in previous Budgets and will progress in the course of the next year. A number of new transport initiatives have also been announced.

While transport continues to be a key focus of infrastructure spending by the state, it is by no means the sole area of expenditure. Hospitals, schools and law and order are other areas that will benefit from the government’s big spending Budget.

As many Victorians who are caught up in bottlenecks and delays due to construction activities will attest, there are a number of well advanced projects across the state. No doubt the short-term pain will be offset by the long-term gains once these projects are completed and they deliver the promised efficiencies to the Victorian community.

Impact on middle market businessesBusinesses in the construction and building industries and associated service industries will welcome the continued focus on infrastructure spending. This expenditure will continue to provide opportunities for growth and jobs in the Victorian economy. Many middle market businesses will continue to be in a position to take advantage of the opportunities arising out of the Budget.

INFRASTRUCTURE

Infrastructure investment by total estimated investment – summary ($ thousand)

Estimated expenditure

Sector 2016-2017 2017-2018 2018-2019

General government

New projects 1,404,468 1,215,269 1,537,726

Existing projects 3,021,786 4,708,066 5,060,314

Public non-financial corporations

New projects 967,305 875,395 1,294,816

Existing projects 3,468,033 4,550,722 4,636,661

Total new projects 2,371,773 2,090,664 2,832,542

Total existing projects 6,489,819 9,258,788 9,696,975

Total projects 8,861,592 11,349,453 12,529,517

Year on year % increase (est) 28.07% 10.39%

Source: Budget paper 4 – State Capital Program

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INFRASTRUCTURE

$2BSUBURBAN ROADS

UPGRADE

$684MSTAGE TWO OF THE MONASH

FREEWAY UPGRADE

$540MSUNBURY TO CRANBOURNE-PAKENHAM RAIL CORRIDOR

$689MLARA PRISON

PRECINCT

$313MUPGRADE TO

SHEPPARTON RAIL LINE

$1.3BTO IMPROVE ACUTE HEALTH

INFRASTRUCTURE

$1.3BNEW SCHOOLS AND UPGRADES

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PropertyIs the government’s property taxes cushion starting to lose its shape?In previous years, the strength of the property market has seen state taxes revenue grow consistently, through strong revenue collections of property-related taxes. In this year’s Budget the government recognises the housing market has started to moderate, but we question their ongoing heavy reliance on property taxes and whether the impact on the market of recent tax changes has been fully examined and factored into the assumptions underpinning the Budget and forward estimates.

Budgeting for propertyUnlike the last few years, this year’s Budget does not introduce any new property taxes. However, the Budget highlights the risk of the government’s heavy reliance on property-related taxes (which comprises approximately 48% of total state taxes revenue), which are prone to fluctuations in the market.

The Budget also raises concerns about the impact of the property-related measures introduced in recent years, which include the limitation to the off-the-plan concession to home buyers who qualify for the principal place of residence stamp duty concession or those who are eligible for the first homebuyer stamp duty concession. This change has resulted in a significant change in the property market landscape, as investors are no longer able to benefit from the off-the-plan concession, resulting in large increases to the amount of stamp duty payable on investment properties.

The strength of the property market has boosted state revenue over the last decade, as is apparent from the overall growth in state revenue from the collection of property related taxes (land tax and land transfer duty), in conjunction with the growth in other taxes (such as payroll tax).

This year’s Budget recognises that the contribution from property-related taxes, particularly land transfer duty (which typically has had the highest correlation with growth in total taxation revenue), is expected to decrease as the housing market cycle moderates and growth rates ease, as indicated by auction clearance rates, housing finance data and property price growth rates. Land transfer duty, for example, is now expected to grow by a relatively modest 3.8% to $7.1 billion in 2018/19, which is significantly less than the estimated 11% growth rate that appeared in last year’s Budget.

The forward estimates assume that property taxes revenue as a proportion of total tax revenue is expected to remain constant at around 48%. We question whether this assumption is too optimistic in light of the expected completion of many apartment projects in a few years’ time, which are already struggling to find buyers. We are concerned the estimates have not factored in the impact of recent tax changes that are distracting investors, in particular, the changes to the off-the-plan concession.

Possible rethink and reformWith the State election due later this year, we think it would be timely for the government to review the impact of the changes to the off-the-plan concession, as well as other recent measures such as the vacant residential land tax, the absentee owner land tax surcharge and foreign purchaser additional duty, to determine if there should be a rethink in relation to these measures based on the market impact. In our view, now is the time to consider tax policies that re-stimulate the property development market. In the absence of a change in policy, we are concerned there could be a sharp or sustained downturn in the residential property sector. If such a downturn were to occur, there would be significant flow-on effects to employment in the building and construction sector and the government’s bottom line.

PROPERTY

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PROPERTY

Impact on middle market businesses There were no new property taxes introduced in this year’s Budget. It is positive to see that the abolition of stamp duty for first time buyers of homes up to $600,000 in value (with a tapered discount applying to homes valued between $600,000 and $750,000) and the doubling of the First Home Owner Grant have seen an increase in the number of first home buyers purchasing homes across Victoria, which have created investment and planning opportunities for developers, especially in Victoria’s growth areas.

However, it will remain important for property investors and developers to consider the impact of property related taxes on their future plans. In light of the complex suite of new property taxes introduced in recent years, which create additional costs and complexity for property acquisitions and holdings, combined with changeable economic, planning and financing environments, we think that it is as crucial as ever to ensure that appropriate consideration is given to the impact of these taxes on all facets of property-related ventures and investments.

Young farmer land transfer duty exemption broadenedFor property settlements from 1 July 2018, the young farmer stamp duty exemption threshold will be lifted to $600,000 (from $300,000). This means that young farmers under the age of 35 buying their first farm could qualify for a full exemption from stamp duty for land purchases valued up to $600,000 (with a concession applying to purchases valued between $600,000 and $750,000), similar to the current exemption/concession for first home buyers.

PROPERTY TAXES REPRESENT

48%

OF TOTAL STATE TAXES REVENUE

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Health and educationA pre-election spending spreeThe 2018/19 Budget invests $4.2 billion in health, an increase from $2.9 billion in last year’s Budget. Education is again a focus point for the government, with spending of $1.5 billion up on last year.

Health The building and construction industry should benefit from a record $1.2 billion allocated to build new hospitals and expand existing hospitals across the state. Regional Victoria will continue to benefit from this investment with more than half of those funds to be invested in the regions. This includes $462 million to redevelop and expand Ballarat Base Hospital and $115 million to expand the Wonthaggi Hospital Emergency Department.

A further $2.1 billion will be diverted to supporting 1.96 million patients that will be admitted to hospitals. $218 million will be spent on cutting waiting times for elective surgeries. This is equivalent to 14,370 hip replacements or more than 76,000 eye surgeries.

There is continued focus in the 2018/19 Budget on mental health. $705 million has been pledged to assist Victorians facing mental illness and addiction, building on the significant investment for mental health in last year’s Budget. This amount will go a long way to supporting additional inpatient beds, establishing six new emergency crisis hubs and a new recovery care facility for at-risk youth. Regional Victoria will benefit from new residential drug rehabilitation treatment facilities in the Barwon, Gippsland and Hume regions.

EducationIn a move typical of both a Labor and an election Budget, there is also a continued focus on education. Since 2014 Labor has invested approximately $8.8 billion in education as part of its vision to make Victoria the Education State.

Spending on new and planned schools of $353 million, $272 million to purchase land for new school sites and $483 million on upgrades to existing schools is likely to favour the construction industry, with works planned across both metropolitan and regional Victoria.

In recognition of the skills shortage across Victoria (something that has been identified as a potential limiting factor on proposed infrastructure plans) the government has allocated $172 million to make training at TAFE free for 30 priority courses from 1 January 2019, and $304 million to create thousands of new TAFE training places.

Regional Victoria is also not forgotten with a dedicated focus and significant funds allocated for improving the state of education across regional areas.

What’s the impact for middle market businesses?The clear winners out of such a strong investment are those directly impacted by the health and education sectors, however we consider there is also opportunity for those businesses in the building and construction industries who may seek to take advantage of the significant infrastructure program.

In terms of Melbourne’s growth areas, it is encouraging to see continued focus on delivering schools and health services. This should have a further positive impact on residential developers operating on the urban fringes of Melbourne.

EDUCATION AND HEALTH

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EDUCATION AND HEALTH

$58.5MIMPROVE AMBULANCE

RESPONSE TIME

$232MMENTAL HEALTH INPATIENT BEDS

$396MFUND AUSTRALIA’S FIRST

STANDALONE HEART HOSPITAL

$42.9MBUILD AND UPGRADE EARLY

LEARNING FACILITIES

$27.2MKINDERGARTEN PLACES IN RECOGNITION

OF POPULATION GROWTH

$8MSUPPORT THE EARLY CHILDHOOD

EDUCATION WORKFORCE

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Rural and regional VictoriaA push for bigger rural and regional communitiesThe government recognises that enhancing rural and regional communities, and encouraging the development of those communities, can help to relieve some of the population stresses that are apparent in the greater Melbourne area. The long-term trend of smaller rural communities is one which this government hopes to arrest. Investing funds in regional and rural areas and maintaining those investments into the future could help those communities to prosper and thrive.

Cutting the payroll tax rate for regional employers will hopefully lead to greater employment in rural areas and is a welcome measure. The government is also establishing a new government hub in Bendigo, which should help generate jobs in that city.

Funds are being made available to help promote regional tourism in Victoria whether this be by local, interstate or international visitors.

Further funds are being provided to improve digital connectivity in regional areas, which will assist businesses, farmers and families.

The government initiatives to inject funds into the TAFE sector are welcomed by country Victoria, where TAFE facilities in Bendigo, Morwell and Sale will receive a significant injection of funds to upgrade their facilities.

Education in rural and regional Victoria is marked for a welcome boost with a number of schools destined for upgrades.

In recognition of the fact that Victorian country roads have suffered from decades of under-investment, more than $940 million has been earmarked for a number of road initiatives across the state.

Public transport is not being left behind with over $700 million being made available to connect rural and regional communities to Melbourne and to each other.

Investment in regional healthcare is a recognition by the government that regional and rural Victorians cannot always easily access the best medical facilities. Ballarat Base Hospital will receive a major expansion and, the Wonthaggi Hospital redevelopment coupled with a number of other initiatives, will also benefit rural patients. This includes the areas of mental health and drug related initiatives.

Sport is often a key ingredient of rural communities and the government has earmarked funds to help develop facilities and encourage greater participation in sports.

Supporting agriculture and the environment are other initiatives announced in the Budget.

RURAL AND REGIONAL VICTORIA

12

RURAL AND REGIONAL VICTORIA

What’s the impact for middle market businesses? Many businesses in regional and rural Victoria will have opportunities to take advantage of the government initiatives and to establish or grow their enterprises. With the right support, they can become key economic drivers of those communities.

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