A GST increase - taking the easy way out - The Centre for Independent Studies
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A GST increase – taking the easy way out

money dollarAs a result of the National Reform Summit, there has been increasing support for a rise in the GST to fund a company tax cut.

There is much to be said for a cut in the company tax rate. Research by the Commonwealth Treasury indicates this is the second-worst major tax in Australia (after stamp duty). This broadly means company tax has a particularly adverse impact on growth, wages, employment and household incomes. In contrast, the adverse impact of the GST is smaller. Treasury’s results are similar to the results of others (cited in the Treasury work).

So, superficially, a dollar-for-dollar cut in the company tax rate funded by the GST will help the economy. Growth, wages, employment and income should improve.

However, this is not what will happen. There won’t be a dollar-for-dollar switch in tax revenue from company tax to the GST.

Instead, substantial portions of the GST increase will be used for compensation for low income households, to address concerns that a GST hits them harder. And regardless of the compensation proposed by government, it is likely that the political process will result in it being increased.

Today’s politicians may have forgotten that when the GST was introduced in 2000, the compensation (spending and personal tax cuts) was greater than the revenue from the GST, and yet there were still massive complaints. The protests will be much more forceful if the revenue isn’t fully used for compensation.

Regardless, the need for compensation means that the package would require a net increase in tax. The benefits to the economy from a somewhat lower company tax could easily be overwhelmed by the adverse impacts of a more substantial increase in the GST. Together, the tax switch could be harmful to the economy. This is the exact opposite of the reason why many economists argue for the switch from income tax to consumption taxes.

The problems with the proposal don’t end there.

Increasing the rate of the GST will exacerbate the distortions caused by the substantial GST exemptions (particularly on food and water). These exemptions should be examined and addressed before any consideration is given to increasing the rate.

The compensation paid for a higher GST also increases inefficiencies by itself. The compensation will generally be in the form of higher welfare payments; and these welfare payments are reduced (or withdrawn) as income increases. Any increase in welfare payments has a trade-off: more households are hit by the withdrawal of welfare. It is well known that the withdrawal of welfare creates substantial disincentives: it discourages entry to the labour force; it discourages extra work effort; and it creates poverty traps.

So the compensation for a GST increase could cause further harm to the economy.

Therefore, policy makers should think twice about an increase in the GST that only partly funds a company tax cut. Any reform package could actually harm the economy, decreasing economic growth and productivity.

Instead of taking this approach to fund a company tax cut, policy makers should be applying themselves harder to looking at ways to reduce government spending. The Centre for Independent Studies’ TARGET30 program — which researches ways to slow the growth of spending below that of the economy until the spending share falls to 30% of GDP — has made many suggestions that could assist them with that task.

Michael Potter is a Research Fellow at the Centre for Independent Studies.