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John Quiggin

Dump the GST on food

John Quiggin Australian Financial Review

5 June 2008

With petrol and food prices soaring, it is unsurprising that our political leaders are scrambling to ‘do something’ to fix the problem. It is equally unsurprising that most of the measures that have been proposed are useless or worse.

The Rudd government’s initial response, the Fuelwatch scheme has some merit. Cycles in petrol prices have the effect of increasing search costs, as motorists drive further to check prices. This allows the industry to engage in price discrimination. Those who are willing to search get the low price, while others pay a high price.

Ending this cycle would be socially beneficial, but it would not help everyone. Unfortunately, the losers are those who are most focused on the price of petrol, so Fuelwatch is unlikely to solve the political problem of high prices.

Fuelwatch is mostly harmless. The same cannot be said of the Opposition’s proposal to cut excise or the counterproposal that the excise component of fuel prices should be GST-free. Then there’s the Queensland government’s attempts to rescue its failing $500 million fuel subsidy scheme by making motorists present a state license to get the discount.

In a world of scarce oil and climate change, it needs to be clear to everyone that the price of petrol will rise over time. Throwing revenue away in a futile attempt to slow the process down is worse than useless. In general, the best way to help households deal with rising prices is to give them money directly, through tax reductions or increases in benefits.

There is, however, one measure that could directly reduce pressure on household budgets while improving the efficiency of the tax system and reducing the administrative burden it imposes. The measure would undo the messy compromise under which some kinds of food are taxed while others are not.

This compromise dates back to the decision by the Australian Democrats in 2000 to support the introduction of a GST provided that food was exempt from taxation, as it had been under the old wholesale sales tax. This decision was politically risky, (it contributed to the breakup of the party a few years later) but it was economically sound.

The regressivity of a tax on food far outweighs any benefits from administrative simplicity or from the revenue it generates. That’s why nearly every country that has introduced a GST/VAT has exempted food. The only notable exception is that of the zealots who ran the New Zealand economy (into the ground, some might say) in the 1980s.

The Howard government, eager to maximize revenue, resisted pressure to exempt food. Eventually a compromise, tailored to Democrat sensibilities, was reached. Food was exempted, but only if it was ‘fresh food’.

Defining ‘fresh food’ was a Byzantine nightmare, complicated further by the desire to ensure equal treatment between grocery stores (generally exempt from GST on food) and restaurants (subject to GST). The outcome bears little relationship to any standard idea of ‘fresh’. Freshly made cakes are taxable, but tinned cakes are GST-free. Frozen meals designed to be part of a healthy diet are taxable, but fish fingers are GST free. Anomalies are everywhere.

The simplest solution to the problem would be to make all grocery food items GST-free. This would not resolve all the problems in the existing system, since it would still be necessary to tax take-away food.

A better solution would be to zero-rate food, so that only the service component in a restaurant or take-away meal would be taxed. Some definitional problems would remain, but all tax systems face such problems.

Depending on which of these alternatives is chosen, the cost could range from $1 billion to $2 billion a year. This is only a little more than the amount the Opposition proposes to save drinkers of ‘alcopops’ by blocking the budget measure to tax these drinks as spirits.

The abolition of food taxes will be an important item for the government’s review of the tax system to consider. Initially it appeared that this issue, along with the GST in general, would be excluded from the scope of the review.

One of the few positive results of the populist outburst of the last week is that this position is no longer tenable. Having floated the silly idea of taking GST off petrol, the government can no longer regard the whole question as out of bounds.

Removing taxes on food would not stop rising prices. But it would help households and it would make good economic sense.

John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.

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