Date created: 28 January 1998

Last modified:18 December 2002

Maintained by: John Quiggin

GST claims fail taxing scrutiny

21 August 1997

Intro:

Because it should exclude food, a GST cannot be expected to provide a big pot of money for income tax cuts, warns John Quiggin.

Text:

The revived proposal for a GST combines two modest but useful reforms. The first useful GST reform would be to use a value added tax (VAT) as the central mechanism for the collection of indirect taxes. Second, the tax base would include services as well as goods. The GST would therefore permit the elimination of a range of ad hoc taxes on services.

The VAT approach to the taxation of goods removes arbitrary differences in tax rates that arise from variations in the retail markup. The main reform, however, is the inclusion of services in the tax base. The effective tax base for a wholesale sales tax comprises the primary, manufacturing and wholesaling sectors which together contribute less than 40 per cent of final consumption expenditure.

Unfortunately, the most enthusiastic supporters of a GST have been its worst enemies. Peter Costello has claimed a GST will boost exports, promote employment, and extract tax from the black economy. None of these claims stands up to serious analytical scrutiny, or to examination of the European countries that already have a GST. Under pressure, Costello has backed away from each of these arguments in turn, yet he continues making inflated claims for the benefits of a GST.

The benefits claimed for the GST have obscured the fundamental law of tax reform: for every winner, there will be a loser. (A GST may generate some modest net efficiency gains, providing small potential gains to everybody. Nevertheless, if the GST is to yield significant benefits to any large group in society, it must be at the expense of some other group.)

Because the fundamental law of tax reform has been ignored, the supporters of the GST have incompatible expectations. Costello expects big cuts in the top marginal tax rate. ACOSS expects compensation for lowincome earners and more revenue for social welfare programs. Road users expect the elimination of fuel taxes. The States expect a guaranteed revenue source to replace payroll tax, franchise fees and the like. And so on. Once it is necessary say how the GST revenue will be spent, the coalition behind it will fall apart.

But the biggest problem is that the GST proposal is being used as a stalking horse for the abolition of the existing exemption of food from sales taxes. Some GST advocates claim an exemption for food would be impossible to administer or that it would "open the floodgates" to an un limited set of claims for special treatment.

The first claim is contradicted by the fact that, in the great majority of countries where a GST has been imposed, food has been exempted, or taxed at a low rate. The second claim reflects the magical status attributed to the GST by its supporters. The idea that a GST, or any other tax, can be introduced without special treatment of some categories of income and expenditure is naive.

Even the GST proposed in Fightback Mark I was far from uniform. A partial list of the goods and services given special treatment in Fightback Mark I includes: alcoholic beverages, antiques, banking services, education, gambling, gold, health care, housing insurance, overseas holidays, road use, tobacco and tourist expenditures.

The case against taxing food is simple. A food tax is highly regressive. Households in the bottom two deciles allocate around 25 per cent of their income to food (excluding meals out and takeaway food). Households in the top two deciles allocate only about 9 per cent to food. A 15 per cent tax on food amounts to a 3.8 per cent tax on income for members of the lowest income households and a 1.4 per cent tax for highincome households. Any compensation package sufficiently generous to offset this regressive impact will consume most or all of the revenue from a food tax.

The success of scare campaigns against previous proposals for a GST including food was due to the fact that there was plenty for the battlers to be scared about. If we are to have a GST, food must be zero rated, so the food, but not the service, component of services such as restaurant meals is exempt from tax. The revenue from a GST should be used solely to replace narrowly based indirect taxes.

Additional revenue to fund either extra expenditure or cuts in marginal tax rates should be found by improving the taxation of income and wealth. The starting point should be the abolition of family trusts, taxation of private company income at the top marginal tax rate and the reintroduction of death duties. Revenue to fund new expenditure programs could be derived from a hypothecated levy on the model of the Medicare levy.

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