Date created: 28 November 1996 Last modified: 17 May 1999 Maintained by: John QuigginJohn Quiggin
May 2, 1996
The idea of a Goods and Services Tax (GST) also known as a value-added tax (VAT) has a curious status in Australian political debate. After the failed attempts to introduce such a tax by Paul Keating, through the tax summit, and by John Hewson, through Fightback, a GST is seen by many as the Holy Grail of tax reform in Australia. By others, it is seen as the ultimate bogey. The 'GST by stealth' label is used as a term of abuse for almost any conceivable form of indirect tax. The benefits and dangers of a GST have been greatly exaggerated. The adoption of a GST with appropriate exemptions, such as the exclusion of food, would be a modestly beneficial tax reform.
A switch from a wholesale sales tax to a GST or VAT is really two reforms in one, as the alternative names indicate. First, whereas wholesale sales tax is applied exclusively to goods, a GST applies to services as well and is therefore a more broadly based form of consumption tax. Second, whereas wholesale or retail sales taxes are applied at only a single point in the marketing chain, the idea of value-added taxation is that the tax is applied at every stage in the production and marketing chain, but only to the amount of extra value added at that stage. This is implemented by allowing credits on the tax paid on inputs to production.
Both of these reforms are desirable. As the share of services in the economy increases, a tax levied solely on goods becomes increasingly narrowly based and must be levied at steadily higher rates to yield a constant proportion of GDP as revenue. The practice of levying taxes at a single point in the chain generates arbitary variations in the effective tax rate, depending on the extent to which retail services add value to wholesale good.
As well as replacing wholesale sales taxes, it would be desirable to use a GST to replace payroll taxes and a range of narrowly based state and federal indirect taxes and license fees. A more difficult question is whether it is desirable to use a GST to increase the share of consumption taxes relative to direct income tas as a source of government revenue. The effect of such a switch on aggregate savings is unimportant in comparison to the direct effect of changes in the level of public savings. The main issue is whether the distributional benefits arising from taxing capital and labour income equally are offset by the distortion in patterns of consumption over time arising from the taxation of interest income. In this respect, a more important reform would be to end the taxable and tax-deductible status of nominal income, which results in exceptionally high effective rates on taxation for fixed interest investment, as well as a net drain on revenue.
Unfortunately, the history of the GST in Australia has led its supporters both to make untenable claims in support of the tax and to associate proposals for such a tax with dogmatic and unjustifiable assumptions about the supposed necessity for absolute uniformity in tax rates.
The silliest of the claims made in support of substituting a GST for income taxes is that it will put a stop to tax evasion, of the kind practised, for example, by plumbers who are willing to charge a lower price in return for payment in cash. It should be obvious, at least to anyone trained in economics, that a change in names will change nothing; plumbers who fail to report their income to the Tax Office will also fail to report their sales to the officials responsible for the GST. For those who prefer a formal general equilibrium analysis, a paper by Simon Grant and Steven King proves that replacement of an income tax by a GST will make no difference in the extent or incidence of tax evasion.
A more important error is the belief that the benefits of a GST will be fatally undermined by any exemptions or variations in tax rates for different commodities. In fact, most countries either exempt food from the GST, or tax it at a low rate, just as we currently exempt food from wholesale sales tax. The effect is to convert a GST from a highly regressive tax to an approximately proportional one, with no significant efficiency losses. The question of whether the existing exemption from sales tax for food should be removed is logically separate from that of whether wholesale taxes should be replaced by a GST. The introduction of a GST will be a hard enough road to travel without encumbering ourselves with the ideological baggage of the 'level playing field.'John Quiggin is Professor of Economics at James Cook University and author of Great Expectations: Microeconomic reform and Australia, published by Allen & Unwin.
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