Inside Story

Raising the GST to cut income tax is pointless churn

Australia needs holistic tax reform for the post-Covid-19 era

Adam Triggs The Economy 9 November 2021 1038 words

Under pressure? Treasurer Josh Frydenberg at Parliament House in August. Lukas Coch/AAP Image

It was Halloween recently so perhaps we should expect to see more zombie economic ideas around than usual. These are the ideas that keep popping up no matter how many times they get killed off.

One of those ideas, raised most recently by the never-boring economist Steven Hamilton and the sometimes-boring OECD, is that we should cut income tax and fill the gap with a broader and higher GST. The GST is currently set at 10 per cent — lower than most advanced economies — and excludes things like fresh food, education and healthcare.

Dr Hamilton argued that Dominic Perrottet should use his newfound position as NSW premier to take the lead on this reform. The OECD made a similar recommendation in its latest economic survey of Australia. The proposal has popped up many times before that.

It’s a popular idea, but is it right? Sadly, reducing income taxes and filling the gap with a larger and broader GST would do next to nothing for the economy. It would involve a lot of churn for little gain. It might even send us backwards.

There are several reasons for this. First, the GST is about as close as you can get to a flat rate tax on wages. Because lower earners spend a larger share of their income on consumption, they lose a much greater proportion of their income to the GST. The higher the GST, the more regressive its effects, which is the opposite of what we expect from Australia’s income tax system.

Reducing the progressive income tax and increasing the regressive GST means poorer people would need to be compensated through the welfare system. But so will those who don’t receive government payments, such as self-funded retirees. People who spend a lot on healthcare, fresh food or education — all of which would be covered by a broadened GST — will call for, and no doubt receive, extra compensation. The argument that we could get away with compensating pensioners and welfare recipients based solely on the consumer price index doesn’t gel with the political reality.

The result would be a big increase in government spending. And this means that replacing revenue raised through income tax with a higher and broader GST is not a one-for-one trade-off. Every $1 we don’t raise from income tax will require an additional $1 raised via the GST, plus additional revenue to pay for this new compensation to households.

Broad-based consumption taxes (like a broadened GST) are good in theory because they are less likely to distort people’s decisions. If the government taxes apples but not bananas, people buy fewer apples and more bananas. The tax distorts consumer behaviour and doesn’t raise as much money as first thought because consumers switch away from the taxed good. But if you tax apples and bananas (and every other good and service) then people can’t switch away from the tax and thus the government raises more money without distorting the economy.

The problem is that these benefits from an expanded GST would likely be modest, and even those modest benefits would probably be offset by the increase in government spending needed to make the reform politically palatable.

The other claim is that raising the GST is a good way to stimulate investment. By taxing consumption instead of savings, the argument goes, we get more savings and thus more investment. But this argument falls flat in an open economy like Australia’s, where the link between domestic savings and domestic investment is weaker because we can (and usually do) borrow the shortfall from overseas.

Nor do we lack savings. In fact, our savings rate has gone through the roof during Covid-19. Corporate profits, share buybacks and dividend payments are all at elevated levels. Businesses and households are sitting on mountains of cash and could easily get more given historically low interest rates. Trying to boost investment by throwing even more savings at the economy is like giving a glass of water to a drowning person. There’s no evidence to suggest that our anaemic rate of investment reflects insufficient savings.

It’s also misleading to think that the GST is harder to avoid than income tax. Australia already has one of the world’s most comprehensive systems for withholding income tax — that’s why almost everyone’s pay packet has the tax already deducted — which forces taxpayers to justify any reduction in the amount they pay. Put simply, raising the GST won’t suddenly make tradies declare income for cash-in-hand services.

Collecting GST on imported services is also a problem. Given these are increasingly important in the global economy, a heavier reliance on the GST would mean a growing amount of lost government revenue.

To be sure, those calling for a greater reliance on the GST are correct when they say we should be doing more to remove investment tax barriers and improve the fairness and efficiency of savings taxation. But plenty more direct options exist. Lower and broader taxes on savings as part of a Scandinavian-style dual-income tax (where business income is split between labour income — taxed at progressive marginal rates — and capital outcome — taxed at a lower rate) would improve fiscal sustainability, economic resilience and fairness. A corporate equity deduction (where businesses can deduct the imputed cost of using their equity for investment) would help drive domestic investment.

And it is absolutely right to be focusing on the tax system. Covid-19 has devastated federal and state government budgets. The ANU’s Tristram Sainsbury and Bob Breunig have shown that government won’t return to a sound structural budget position simply by relying on “natural” revenue growth from current tax sources. Comprehensive tax reform will be needed to repair the budget and better align incentives to invest, save and work. Switching one tax for another will achieve neither of these things, and result in nothing more than pointless, and potentially costly, churn.

The NSW premier is already driving a push to replace stamp duty on housing with land tax, certainly the most difficult and substantial tax reform since the GST was introduced more than twenty years ago. Right now, this should be the main feature. Let’s leave zombie ideas for the late-night reruns. •