Scepticism about GST tax swaps is well grounded

Mike Baird wasn’t to know, but reports of the latest version of his plan for a 15% GST coincided with the release of a Newspoll showing a majority opposed to such a GST increase, even if accompanied by offsetting income tax cuts. The Newspoll is further evidence of how hard his plan would be to sell.

The Newspoll result shows people are innately sceptical when politicians promise to give back with one hand what they take with the other. This is a healthy scepticism and there is more basis for it than gut feel.

Many economists and tax experts believe, rightly, that a switch from income tax to consumption tax would be beneficial to the economy, even if it leaves the overall tax take unchanged (‘revenue neutral’, in the jargon). Many studies have supported the idea that income tax (on individuals and companies) is a bigger deadweight on the economy, per dollar raised, than a broad-based consumption tax like the GST.

Be that as it may, those responding to the Newspoll are not economists and tax experts and fail to see the point of receiving more in one pocket while the taxman takes more from another pocket. If our politicians believe what the economists and tax experts advise them, they have a lot more work to do in convincing their voters of the point.

But that’s not all. The voters are also sceptical because they doubt the tax swap will last over time. Even if it is revenue neutral at the point of implementation, it will turn out to be a net tax increase over the years ahead. Opposition Treasury spokesman Chris Bowen is fond of saying everyone knows the GST increase will be permanent but the compensation will be temporary, and he is onto something here.

History shows that tax swaps engineered at a point in time tend to unravel over time. Income tax bracket creep is the main reason. Research by Michael Potter and myself shows that just in the six years from 2012-13 bracket creep will add 2.3 percentage points to the average income tax rate across all taxpayers, which means they will be paying on average $1,180 a year more as a result of six years’ bracket creep. This example illustrates the potency of bracket creep even in an era of low inflation.

Baird’s previous plan was explicit in relying on bracket creep to finance growth of states’ public hospital costs after 2020. Although he has now modified that plan, one wonders if post-2020 bracket creep is lurking in the background.

But it’s not only bracket creep that can unravel tax swaps over time. Marginal rates can also be increased. This is exactly what has happened since the income tax cuts that accompanied the GST in 2000 and the Howard governments’ later cuts. The marginal rate for most taxpayers was reduced to 30% with the GST, but is now back to 32.5%. The lowest marginal rate got down to 15% but is now back to 19%. The reduction in the top marginal rate has been fully reversed (supposedly only for three years). And everyone has faced a 0.5 percentage point increase in the Medicare levy.

Certainly, the thresholds for all marginal rates are now much higher than before the GST was introduced. However, their real value is being steadily eroded by bracket creep. The full-time average wage earner is now on the brink of entering the second top marginal rate of 39% (including Medicare levy).

Even the much vaunted New Zealand experience gives cause for pause. The Key government is praised for swapping a higher GST for a lower (33%) top income tax rate, but what you are not told is that both GST and income tax had been increased by the previous government, and Key was merely restoring income tax to the level established when the GST was originally set at 10%. Taxpayers have paid twice for the 33% income tax rate. You wouldn’t know it from the commentary, but New Zealand has a higher overall tax level than Australia.

There is no way — short of a constitutional amendment — of stopping a future government from reneging on a GST/income tax swap implemented today. If government spending continues to put upward pressure on taxation, that pressure will find an outlet one way or another. But there is no doubt that increasing the GST by 50% would make it a lot easier for overall taxation to rise over the years ahead.

If, against all the legitimate doubts, there is to be a GST/income tax swap, the income tax cut should be designed so as to minimise the risk of future reversal. Just fiddling with thresholds to make up for past bracket creep would be totally inadequate. The adjustments would be eroded by future bracket creep. Marginal rates need to be cut, and as advocated by Michael Potter and myself, thresholds must be automatically indexed to average wages to stop future bracket creep.

Robert Carling is a Senior Fellow at the Centre for Independent Studies, and co-author with Michael Potter of Exposing the Stealth Tax: the Bracket Creep rip-off