The big problem with raising the GST

Mike Baird’s daring call for a 50% increase in the GST is in the spirit of the free exchange of ideas that this week’s special COAG retreat is designed to encourage. He has put a bold idea on the table and is to be commended for that. But that doesn’t necessarily mean his prescription is good for the country.

Clearly it is good for state governments – the recipients of all the GST revenue — frustrated with ballooning health care costs. But is it good for the country to acquiesce in a growing share of public expenditure and the growing tax burden to go with it?

Governments face myriad pressures to spend more and more. The act of increasing the GST by 50% would be tantamount to waving the white flag at those forces.

If that is what our governments choose to do, nobody should be in any doubt they have chosen the route to bigger government and a bigger overall tax burden, whatever they may say about offsetting tax cuts. Believers in the benefits of small government loathe broad-based consumption taxes like the GST while tax-and-spend social democrats love it for the same reason — because it is so good at raising revenue without the punters noticing too much. That is precisely why the big governments of Europe, with public spending of more than 40% and in some cases more than 50% of GDP, could not survive without GSTs (VATs) of 20% plus (and even then some of them struggle to survive). They also, by the way, have high income taxes.

Baird seems to think successive governments have been negligent because ‘the GST has not been touched since it was implemented fifteen years ago’. But why should increasing it be the standard? It is a percentage tax, not a fixed dollar amount, and the revenue grows as the economy expands. The 10% rate is a line in the sand that should only ever be crossed with careful anticipation of the ultimate consequences. The first increase is unlikely to be the last. If 15%, why not 17%, then 19%, then 20%? That has been the progression in European countries.

There is a stronger case for broadening the base of the GST provided the additional revenue is used wisely. Such action would remove distortions and lower compliance costs. The base can only be broadened once – unlike increasing the rate, it is not a potentially open-ended process. However, the additional revenue available from base broadening is quite limited, as some of the items currently outside the base are excluded for good reason.

By contrast, increasing the rate to 15% would raise an extra $27 billion a year in current terms before any costs of compensation are deducted. States would get all the revenue but compensation costs in the first instance would fall on the Commonwealth. The cost of administering the GST, which the states pay, would not rise at all. So it is a very attractive financial deal for the states and hardly a ‘reform’ of the GST as Baird describes it – it’s a straight out and very large tax increase.

The costs of compensation would be substantial, with the welfare lobby agitating for over-compensation of social benefit recipients and other low income earners as was the case when the GST was introduced and again when the carbon tax was imposed. There would be income tax cuts skewed to low incomes, such as a further increase in the tax-free threshold. The Commonwealth would not meekly stand by and bear these costs. They would claw them back from the states by cutting specific purpose grants, thereby taking a large bite out of the states’ extra $27 billion a year.

It needs to be understood that Baird’s blueprint is not designed to satisfy the demands of those who want a higher and/or broader GST to fund a New Zealand type trade-off for across-the-board cuts in personal and company income tax. That kind of trade-off would raise little or no net additional revenue. While Baird’s scheme allows for some income tax cuts to compensate low earners, the primary goal is to raise extra revenue for the states, and lots of it, to meet growing public health care costs. We would have both the high income tax we already have, left largely intact, and a much higher consumption tax.

Baird is right to highlight the fiscal problems that rising health care costs – much more of which are in prospect – pose to governments and taxpayers. If current trends are extrapolated, the public hospital system will swallow an ever-increasing share of state revenues, leaving less for other functions such as education, police and the criminal justice system. But the answer does not have to be more revenue. A better answer may well be to redesign the health care system and make it more efficient.