Few taxes have been as politically fraught as the GST. The deal, brokered by the-then prime minister John Howard and the Democrats in 2000, was not only controversial for its political ramifications, but for the economic debate that ensued.
Debate over the efficacy of its revenue, scope, and capacity for collecting and distributing revenue has continued, some 13 years after its inception. Agreement among mainstream economists, taxation experts, and business leaders is unanimous: the GST is in need of reform. Yet the topic is off limits for the Liberals, Labor and the Greens – even though some state governments are in support of a review.
The Australian goods and service tax began in July 2000 and was modelled on the EU’s value added tax system, although at a lower rate and flat rate of 10 per cent. A number of European systems, especially the Scandinavian countries, operate a three or two-tiered system of graduated taxes. The GST was designed to eradicate a number of state taxes and charges and to reduce tax avoidance through the cash economy.
While most taxes are inefficient and cause deadweight loss because they take more money from the system than they add to government revenue, VAT taxes are often portrayed as less inefficient because they are more difficult to avoid, and often the costs of collection are predominantly placed on consumers. Because they tax spending rather than income, they are theoretically fairer for pay-as-you-earn taxpayers.
Value-added taxes require re-calculation and payment to the authorities at each interval in the onwards sales chain. In this sense only, the value added between the transaction points are taxed and each producers is able to claim previously paid value added tax as a cost input. In this way, it differs from a sales tax, which is normally only levied on end-users (consumers).
Should we broaden the tax?
In short: yes. At present, the GST exempts educational services and supplies, fresh food and beverages and some other items. Any form of tax exemption encourages inefficiency and misallocation and adds complexity and transaction costs to a system. As to increasing the rate, in 2011-2012 the GST raised $45,861 million or about 4 per cent of GDP, compared to 7 per cent of GDP raised by VAT taxes in the OECD. By contrast, Australia operates a higher company tax rate (30 per cent) compared to OECD average of 25 per cent.
The OECD Going for Growth report (2012) argues the low rate of GST makes the Australian system relatively inefficient. There is clearly room to raise the level of the GST but this would need to be offset by reductions in personal and company tax. As well, the rate should be kept flat to avoid distortions in consumption.
Should there be exemptions?
No. The tax system should be a revenue generating mechanism, and therefore should be kept as simple and transparent as possible and cheap to collect. The potentially regressive nature of the tax should be compensated in other, more efficient ways, such as targeted social services rather than the exemption of a list of arbitrary selected products. This type of policy often leads to perverse outcomes. For example, processed food and fast food, which is more likely to be eaten by lower socioeconomic income groups, attracts GST while fresh food does not. This is also true for education services, where the middle and above-income earners are the disproportionate users of the service.
Would it have a significant impact on government revenue?
This would depend on offsetting reductions in direct tax. However, food and education are significant parts of household and company budgets. OECD estimates would indicate that a target of 7 per cent of GDP would be reasonable. On this basis, GST receipts would need to rise to $80,256 million (2011-12 figures). Given that fresh food accounts for about 7-9 per cent of household budget, the eradication of exemptions would probably not be enough to generate this. A rate increase would also be required.
What policy reasons are there to reform the GST?
The two errors made at the time of introduction were exemptions and a 'fixed rate', whereby the government put strict conditions on any altering of the rate. These both reduced the simplicity and the revenue-raising potential of the tax and made it difficult to use as a policy weapon. As a tax, the GST has the advantage of taxing (to some degree) parasitic industries such as tourism, by at least extracting some revenue directly from tourists. Used properly, it can reduce the cash economy, spread the incidence of tax and give some tax relief to PAYE taxpayers. The immediate issue to face would be the inflation effect on food prices and any distorting effect this would have on interest rates.
GST/VAT in other countries
It is dangerous to make direct rate comparisons because some countries operate different rates across various commodities. A VAT should always be placed in the context of the overall taxation mix. Other countries, such as Canada, split their VAT taxes into federal and state taxes. However, these warnings accepted, by way of comparison with reasonably similar systems we have Brazil (17 per cent to 25 per cent); Denmark (25 per cent) Finland (24 per cent but 13 per cent on food), Japan (5 per cent), South Korea (10 per cent), New Zealand (15 per cent); Singapore (7 per cent), UK (20 per cent standard but a significant group such as energy at 5 per cent). Overall, Australia is at the lower end in terms of tax rate and has the added advantage of being flat.
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John Mangan is a professor at associate dean at the Faculty of Business, Economics and Law at the University of Queensland. This story first appeared on The Conversation. Reproduced with permission.