This report questions whether payroll taxes affect firm growth by examining a recent cut in South Australia’s payroll tax rate for small businesses. The tax cut may have been counterproductive because it introduced a sharp increase in tax rates for firms with payrolls between $1.5m and $1.7m which made it less attractive for firms to grow. 

Findings:

• A large number of firms bunched just below the $1.5m threshold to avoid paying the higher marginal tax rate. The
  number of firms just below the threshold increased by 21%, while the number just above decreased by 18%.
• Many of the firms that bunched just below the threshold were growing firms that likely would have crossed the threshold if not for the policy change. Furthermore, many of the bunching firms appear to have been relatively productive, suggesting that the policy change created a material barrier to firm employment growth and may have lowered aggregate productivity in South Australia.
• Even though the payroll tax cut lowered the effective cost of labour for small firms, South Australian firms in aggregate may have decreased their use of labour because of the increased barriers to firm growth. It was estimated that firms just above the threshold decreased their payrolls by $5.9m (3.3%), more than offsetting a $3.5m increase by smaller firms. Findings highlight that firms do respond to changes in payroll tax rates and that protections for small businesses can be costly to firm growth.