Date created: 28 November 1996 Last modified: 18 November 1997 Maintained by: John QuigginJohn Quiggin
12 December, 1992
If it is to have any impact on Dr. Hewson's electoral prospects, the modifications to Fightback to be announced on 18 December must include some form of exemption for food from the GST. The taxation of food is the most regressive element of Fightback, bearing about three times as heavily on the poor (the bottom quintile of the income distribution) as on the rich (the top quintile) and has undermined all attempts to present Fightback as a fair package.
Much discussion of the GST, notably including the Opposition's own rhetoric, has suggested that Fightback is a seamless web. If the tax on food is dropped, it is argued, we might as well abandon the GST. This argument is surprising, since nearly all countries with a GST have exempted or differentially rated food. It is possible to zero-rate food while retaining nearly all of the efficiency benefits which have led many economists and others to support a GST.
The first benefit is the administrative simplicity of the tax, at least from the government's viewpoint. Any modification to the flat 15 per cent rate involves some increase in complexity, but food can be handled more simply than services such as health and education, already zero-rated under the Fightback package. The main requirement for administrative simplicity is that there should be no attempt to distinguish between luxury foods and necessities. Puritanical distinctions of this kind have bedevilled the wholesale sales tax and have no place in a GST régime. A second desirable objective is that food should be zero-rated, not merely exempted. This ensures that no effective tax is levied on food, either via the inputs to food production, or when food is used as an input in restaurant meals. The service component of restaurant meals would remain taxable at the full 15 per cent rate. Definitional problems under this scheme would be minor - much less than those arising from the exemptions already granted.
Apart from simplicity, the main reason for supporting a GST has been that the existing régime distorts relative prices. This causes three kinds of losses. First, because the tax is levied on the wholesale price, the structure of production and distribution is distorted. Value added at the retail level is untaxed, and is therefore subsidised relative to value added in manufacturing. As the name implies, the goods and services tax treats goods and services equally and avoids this distortion. Second, it has been argued that taxation of income rather than consumption distort savings decisions. Third, the prices faced by consumers are distorted, leading to reductions in consumer welfare.
Special treatment for food has no impact on the first two sources of benefit, the equal treatment of goods and services and of consumption and savings. The consumer losses are small because demand for food in aggregate is highly inelastic (unresponsive to price changes) and hence consumer choices will not be distorted much. A standard computation suggests that the welfare loss associated with zero-rating for food would be about 0.03 per cent of GDP - less than $10 per person per year.
In summary, anyone who supported the Fightback package on efficiency grounds should not change their mind because food is zero-rated. The real problem for the Opposition is that taxation of food is one of the big revenue raisers in the package. Zero-rating food will reduce the revenue intake from the GST by about $4.5 billion. There are a number of ways in which this cost could be met. Because of the reduced impact of the GST on household budgets, the compensation package for welfare beneficiaries could be scaled back, saving around $800 million. Other new spending initiatives, such as the tax-free savings scheme could be abandoned or deferred. However, it seems impossible to avoid the necessity of raising at least $3 billion more from income tax than was proposed in Fightback.
The cynical opportunism of the government's One Nation tax cuts provides the Opposition with some politically attractive, but highly undesirable, escape routes. First, Dr. Hewson could claim for himself the $2 billion in improved income tax collections conjured up by Mr. Dawkins in the last budget to plug the holes in the optimistic One Nation revenue estimates. The Opposition, along with independent commentators, has previously cast doubt on the feasibility of realising these gains, but might well be tempted to change its tune. This would result in a double counting error. Fightback already contains dubious claims that $1 billion will be extracted from the black economy by the GST. To claim the same money again from the Prescribed Payments Scheme would push creative accounting to new lows. When combined with the vagueness of the Opposition's expenditure cuts, it would ensure that the package generated an increase in the structural budget deficit. While there is a good case for short term fiscal stimulus in 1993, a long term return to surplus is a crucial element of any credible economic program.
A second undesirable route would be to abandon the proposed cut in the lowest marginal tax rate, applying to the income range from $7000 to $20000. Under the original Fightback proposals this was to be cut from 20 cents in the dollar to 16.2 per cent. Leaving the 20 cent rate unchanged would yield additional revenue of about $2.5 billion 1991-92 dollars. Further gains could be made by curtailing the proposed expansion of the tax-free threshold from $5400 to $7000. This would yield an additional $1.6 billion in revenue yielding a net increase of $4.1 billion. The political appeal of this approach derives from the fact that the competing One Nation proposal, targeted at the swinging voters in the middle of the income distribution, gives nothing to low income earners. However, the removal of any income tax compensation for low income earners would reveal even more starkly the regressive nature of the present Fightback package.
The only sustainable and equitable way to finance the zero-rating on food is to scale back the net benefits accruing to upper-income earners in the present Fightback package. Most upper incomes would receive net income increases of about 5 per cent, even allowing for bracket creep, expenditure cuts and the price impact of the GST. If the top marginal rate were left unchanged on incomes above $50 000 and the rate on incomes between $40 000 and $50 000 were cut to 42 cents, high income earners would still be better off than at present. Tax revenue would be $3 billion higher than under Fightback. Another $500 million could be obtained from bracket creep by deferring the final stage of tax cuts from 1 Jan 1996 to 1 July 1996.
With this change, the tax package would be essentially neutral for single taxpayers and somewhat progressive for families. The savings from expenditure cuts would be spread evenly across the board, rather than accruing to upper-income earners as at present. Such a change would focus attention on the question of whether a reduction in both taxation and public expenditure is desirable, without the distraction of regressive changes in tax incidence. It would also force the government respond seriously to Australia's economic problems, rather than relying on the cynical political manoeuvres that dominated the One Nation statement.John Quiggin is Professor of Economics at James Cook University and author of Great Expectations: Microeconomic reform and Australia, published by Allen & Unwin.
Read more articles from John Quiggin's home page
Go to John Quiggin's Weblog
Read more news articles from 1994 and earlier