Last month’s tax discussion paper reminded us Australia’s GST rate of 10% is one of the lowest among developing countries, and only just over half of the OECD average. It may therefore be tempting for government to take the “easy” approach of increasing the GST rate, which would require less legislative change than making various changes to the GST base.
However, it’s imperative Australia fully debates the GST base broadening issue before reaching for the relatively simpler option of increasing the GST rate on the current base. A rate increase on the current base would put us in (or at least move us towards) the same category as countries such as the United Kingdom - that have a relatively narrow GST base with high rates. It would also run counter to the widely accepted tax mantra of “broaden the base and lower the rate”.
Poor tax design
For many reasons, a “narrow base, high rate GST” is poor tax design. For example, the distortions to production and consumption decisions are magnified because of the greater difference(s) between the taxed and non-taxed items. In addition, inequities are compounded based on consumers’ spending patterns. It would also put us on the path to replicating the discredited wholesale sales tax, which was replaced by the “superior” GST.
GST systems are designed to tax private final consumption expenditure (PFCE). But if only a portion of PFCE is taxed, the whole point of a consumption tax is significantly undermined or compromised.
In 2012, Australia’s GST applied to 47% of PFCE. This is lower than the OECD average of 55%. New Zealand’s GST is a stand out, with 96% of PFCE taxed; it is seen as a model to aspire to.
The big untaxed items in Australia’s GST are basic food, financial services (financial services have a nominal amount of tax on them), health, medicines, education, aged care, childcare and water and sewerage. Each of these has its own reasons as to why they originally were not fully included in the GST base. The inclusion of all these items would move Australia well up into the 90% bracket of PFCE coverage, a very desirable position.
Solving equity issues
Basic food was excluded due to equity grounds. While health and education have a small equity aspect, the main reason was the challenge of dealing with both private providers (where there is a price signal) and public providers (where there is no price signal). Given the differing rationales for the original exclusion of each category, it is very unlikely one policy measure (outside or inside the GST) can address all concerns. That means that significant broadening of the GST base is likely to require a number of targeted solutions.
However, the regressive effect of a flat rate tax applying to more categories of PFCE is a recurring theme. When items are exempted from the GST base, all consumers, regardless of income level, receive the benefit of the exemption. The tax discussion paper highlights that while lower income households spend a higher percentage of their income on GST-exempt items, in dollar terms, it is higher-income households that receive the most benefit from GST exemptions.
For this reason, subject to the comment below, compensation through the direct transfer (social security) system is the best method of delivering compensation for the regressive effect of broadening the GST base, rather than dealing with the regressive effect through concessional treatment within the GST base.
The problem with compensation is that many voters (and many politicians) do not have faith in future governments maintaining the level of compensation over the long term. This distrust was at the heart of the Australian Democrats insistence that basic food be excluded from the GST.
Locking in compensation
Perhaps the solution lies in a “lock in mechanism”. There is no doubt the GST rate and base lock in mechanism has been very effective as a political check on the federal parliament acting contrary to it. This is in spite of the fact the lock in mechanism is legally meaningless.
A lock in compensation mechanism would necessarily be very different to the GST rate and base mechanism. It is very likely a compensation mechanism would not be legally effective because our federal parliament cannot generally bind future parliaments. But given the political sensitivities around the GST and the categories of PFCE listed above, there is every reason to think that a lock in compensation mechanism could be politically effective.
Dale Boccabella is Associate Professor of Taxation Law and Kathrin Bain is a lecturer in the School of Taxation ＆ Business Law at the UNSW Business School.
This opinion piece was first published in The Conversation.