The hazards of a higher GST - The Centre for Independent Studies
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The hazards of a higher GST

GSTA higher GST is being advocated in tax reform debates as a miracle cure for budget deficits, dysfunctional federalism and excessive personal and company income tax. It can’t achieve all those goals, may not achieve any of them, and is most likely to feed the relentless growth of government spending.

This has been the experience of other countries that have lifted their GST/VAT to 15% or 20% or even more in some cases. The international experience should make us wary of starting down that path. This also goes for the New Zealand experience, which is often cited as an example that Australia should follow. New Zealand engineered a trade-off between a GST increase to 15% and a cut in income tax, with a top rate of 33%. If only we could do the same, lament the tax policy hard-heads on this side of the Tasman – but it’s not that simple.

A New Zealand government with a reliable majority has a much freer hand as it has no upper house and no states to contend with. In Australia, everything would have to be negotiated through the Senate. The Howard government managed to negotiate the GST into being in the ‘A New Tax System’ (ANTS) reform of 2000, but the outcome was imperfect. The Senate is a much more difficult beast today. The result would be not merely imperfect but a pale imitation of what reformers want. The politics of bringing a company tax cut into the equation would be especially difficult. It wasn’t even attempted in the ANTS package, but was dealt with by a separate review of business taxation.

Those who see an enlarged GST as providing the revenue to fund personal income tax cuts are also likely to be disappointed. Political pressures to mitigate the ‘regressive’ nature of a GST increase would lead to a large allocation of revenue to over-compensation of pensioners and other recipients of social benefits, and a skewing of income tax cuts towards low incomes, leaving less available for cuts in the higher rates of personal income tax, let alone company income tax. The result would be more churning – people on low incomes paying more in GST and getting it (and more) back in higher social benefits.

A trade-off between the GST and income tax also faces the problem of government policy being inconsistent over time. Governments change, and they change their minds. The success of a trade-off can’t be judged by what happens at the point of implementation. It’s what happens over time that counts. There is a risk that income tax cuts would be reversed or dissipated over time by bracket creep. The end result would be a higher GST and the same (or higher) income tax as applied before the trade-off.

Something like this has happened in New Zealand, where the introduction of the GST at 10% in 1986 accompanied a halving of the top personal income tax rate to 33%. Subsequently the GST was lifted to 12.5% and the top rate to 39%. The current government then lifted the GST further to 15% as a trade-off for restoring the top rate to 33%. The result is that the 33% rate has been paid for twice, once by the introduction of the GST and again by increasing it to 15%. The same thing could well happen in Australia over time. As long as growth of government spending remains the problem it is, the pressure for a further GST increase and the reversal of income tax cuts would surface.

Trade-offs worked in the ANTS reform, but that was because the GST replaced taxes that were completely uprooted from the system – wholesale sales tax and various state financial transactions taxes. It is much more difficult for abolished taxes to return than it is for a pruned tax to regrow.

Further dimming the prospects for a GST/income tax trade-off is the fact that under the intergovernmental agreement currently in effect (and backed up by legislation), the proceeds of a GST increase would accrue to the states while the costs of compensation and income tax cuts would fall on the federal budget. The Commonwealth could effectively claw the money back from the states by cutting tied grants (which in itself would be a desirable reform of federalism), but as the states clearly have their hands out for a substantial net gain in revenue from these changes.

A GST increase would need to be packaged very carefully to limit the risks. It is not a miracle cure.

Robert Carling is a Senior Fellow at the Centre for Independent Studies