With appropriate investment in design and explanation, a larger GST reform package could be one of the most effective and easiest options to help reverse Australia’s lagging productivity growth.
Changes to the GST, Australia’s broad-based consumption tax, is said by the main political parties to be off the agenda. However, a tax mix change reform package with a larger GST used to fund replacement of other more distorting and inefficient taxes would result in a significant increase in national productivity and incomes.
A New Zealand-type comprehensive GST tax base, which removes current exemptions for food, health, education, child care and water, would result in a more efficient and simpler Australian GST. Equity, and especially for those on low incomes, is more directly and effectively achieved by recycling the extra GST revenue as better targeted increases in social security payments and larger reductions in income tax rates at the lower end of the income tax schedule.
As was the case argued for the introduction of the GST in 2000 — and the arguments were accepted at the preceding election — the revenue with a higher rate GST can be used to fund replacement of current more distorting state indirect taxes and commonwealth income taxes.
Because a comprehensive base and low-rate GST changes very few decisions, it largely operates as a transfer of revenue from households to governments with relatively small efficiency costs. The Henry Review, for example, estimates the efficiency cost of another dollar of GST tax revenue at about ten cents per dollar raised.
Top of the list of inefficient state taxes to be replaced are the stamp duties on insurance and conveyance duty on the transfer of property by businesses and households. A more comprehensive land tax and flat rate land tax should be a part of the reform package for removing conveyance duty. An increase of the GST rate from the current 10% to about 12.5% would fund replacement of stamp duties on insurance and a half of the conveyance duty.
Using the Henry Review estimates of the efficiency cost of 75-85 cents per dollar of conveyance duty tax revenue and 31 cents per dollar of stamp duty on insurance, compared with the lower cost of extra GST revenue, results in the tax reform package generating a large increase in productivity. In addition, removal of the two taxes would contribute to greater simplicity.
Using a higher rate GST to fund replacement of relatively inefficient state taxes will require a review of Commonwealth-state financial relations. Currently, the Commonwealth collects the GST and then redistributes the revenue as untied grants to the states according to a formula designed to achieve equity of opportunity among the states. Approximate revenue neutrality would require that all of the extra GST revenue go to the states as an increase in untied revenue. But the extra GST revenue would be allocated among the states on a formula close to a per capita allocation, rather than the current formula.
The extra revenue from a much higher GST tax rate, such as the current New Zealand rate of 15%, could be used to fund reductions in income tax rates in a way which would approximately retain the current redistribution effects of the tax system as a whole. Such a higher consumption tax and lower income tax reform package can be approximately revenue and distribution neutral; have a minimal net effect on labour supply decisions about workforce participation and hours of work; and induce an increase in both the aggregate quantity of investment and the efficiency of the investment mix.
Since Australia is both a net capital importer and a small open economy, the supply of international capital for investment is very elastic and, in the extreme case, Australia is a price taker. In this context: optimal tax theory for greater tax efficiency requires a much lower income tax rate on the more elastic in-supply factor capital than on other business inputs and on consumption; and a lower tax rate on capital induces more investment in Australia, then more capital and technology per Australian worker, resulting in higher labour productivity. In the long run, the tax cut is passed on to employees as higher market wages.
Given the hybrid tax treatment of different saving and investment options, a lower income tax rate reduces the magnitudes of differences between the effective tax rates on the different options. A GST for lower income tax mix change package results in a less distorted and more productive mix of investments across housing, different businesses, financial deposits, and other options.
Developing and explaining tax reform packages which include a more comprehensive GST tax base and a higher GST rate to replace other more distorting taxes is a challenge. But it is certainly possible: Australia succeeded in 2000, and the UK and NZ have made similar changes as recently as 2010.
Professor John Freebairn will present a lecture on taxation reform and the GST tonight as part of the University of Melbourne’s Public Policy Lecture. More details can be found here.