- Australia’s GST has remained at 10 per cent since 2001 while in New Zealand it was increased to 15 per cent in 2010
- Worldwide, there is a shift away from income taxes towards consumption taxes
- New Zealand has experienced the biggest rise in inequality among wealthy countries
By Jessica Irvine
Sheep jokes being perhaps the primary example, Australians are guilty, on occasion, of belittling our Kiwi cousins.
So it is with no small degree of contrition that Australian policy makers have watched in wonder as the New Zealand Government has successfully embarked upon, and implemented, what many economists regard as the gold standard of tax reform: increasing the goods and services tax (GST) to fund personal income and company tax cuts.
Australia’s former Treasury Secretary Martin Parkinson recently expressed awe — jealousy perhaps — at NZ Prime Minister John Key’s ability to increase the GST to 15 per cent in 2010 with little “political heat”. There are “probably some lessons” there, he said.
The dividends for the Kiwi budget appear clear: a budget back in black, a top income tax rate slashed to 33 per cent and a company tax rate cut to 28 per cent.
Australia’s budget books, by contrast, continue to drip with red ink.
On Aussie soil, however, the GST remains a three letter swear word, if the shocked reaction of politicians and voters to its very mention is any guide.
Australia’s GST has languished for nearly a decade and a half now at the 10 per cent rate it was introduced at in 2001.
The biggest review of Australia’s tax system in recent times, led by former Treasury Secretary Ken Henry, was forbidden from even mentioning the abhorrent abbreviation. Instead, the final report referred obliquely to “consumption taxes” and the need to increase the proportion of revenue coming from such things.
Henry has since come out and declared reform of the GST “inevitable”. Fellow tax review member and Reserve Bank of Australia board member Heather Ridout has also called for a review of the rate and base of the GST.
With the Abbott government’s tax white paper process underway, calls for GST reform are heating up.
Treasurer Joe Hockey, to his credit, and in the face of immense pressure from the media and Opposition to exclude it from consideration, has insisted the GST remain on the table for review. Sure, his government has ruled out any changes in this. But could plans be afoot to take a ‘grand bargain’ to next year’s federal election, in which a higher GST could fund a package of corporate and personal income tax cuts?
Revenue starved, the Tony Abbott government’s first budget, packed with deep spending cuts, proved devastatingly unpopular.
Abbott’s second budget, due this month, is expected to be much softer. So the time has come to consider the other side of the ledger: tax.
Hockey’s first budget provocatively stripped Australian state governments of A$80b in health and education funding, a move seen at the time as designed to force a new discussion on overhauling GST revenues.
As Australia prepares for the tax debate ahead, it is worth revisiting the economic arguments for increasing reliance on consumption taxes like the GST. What lessons can the New Zealand experience teach? Will Australian politicians and voters ever summon up the guts to sensibly debate an increase to the GST as part of a package of reforms? And, given the regressive nature of the tax, would that even be desirable? These are issues worth examining in turn.
An efficient tax
The overwhelming majority of orthodox economists support increasing the proportion of the tax take from taxing consumption, particularly as part of a shift in the “tax mix” away from taxes on labour and capital.
From an economic perspective, GST — charged to consumers as a fixed percentage of their purchases of goods and services — has long been regarded as a relatively efficient tax.
Of course economists also tell us that all taxes are bad taxes in the sense that they distort behaviour. They prevent transactions that would otherwise have taken place between parties, on mutually agreeable terms, from occurring, thereby reducing the economic surplus. Another way to say much the same thing is that all taxes create “deadweight losses”.
The key to minimising deadweight losses is to impose taxes on things that can’t respond much to the imposition of the tax.
The Henry Tax Review identified four key sources of taxation in Australia: labour, capital, consumption and land. Of these, capital and labour are the most mobile, being able to shift to avoid the tax. Land is the least mobile, with consumption somewhere in between.
A low tax taken through “indirect” taxes — consumption and land taxes — means the burden of taxation falls more heavily on “direct” sources — personal incomes and company profits.
And this is considered bad because those activities can be more easily distorted.
Advocates of increasing GST in Australia note the proportion of total tax collected in Australia through consumption taxes (including excises) is relatively low, at just 23.3 per cent of total taxation versus the OECD average of 30.9 per cent, according to the OECD’s Consumption Tax Trends 2014. (In New Zealand, it is relatively high at 35.9 per cent.)
Worldwide, the shift is on towards consumption taxes and away from income taxes. According to the OECD, 21 countries increased their rates of Value Added Tax (VAT) between January 2009 and January 2014 lifting the OECD standard VAT from 17.6 per cent to a record 19.1 per cent — double Australia’s present rate.
On 1 April this year, Malaysia introduced a GST of 6 per cent. India’s parliament is also debating legislation to introduce one.
Perhaps the most convincing argument for a shift to consumption taxes is the increasing mobility of capital in a globalised world. In the face of increased “base erosion and profit shifting” there is a need for governments around the world to fortify their tax bases without discouraging investment.
Labour, too, is increasingly mobile with companies competing for talented young workers to buttress ageing populations.
In such a world, countries are increasingly looking towards domestic consumption as a stable tax base — after all, everyone’s gotta eat.
Lessons from New Zealand
On 15 acres of land, half an hour out of Auckland, former New Zealand Reserve Bank governor and National Party leader Don Brash has an orchard.
Brash chaired the advisory panel on GST before its introduction in 1986 at 10 per cent.
Today, Brash boasts that it takes just 10 minutes twice a year to complete his GST paperwork – a prospect that would make many a small business person in Australia weep.
When we speak, Brash is freshly returned from two weeks in the Bahamas — not a holiday, mind you. He has been advising the government there on introducing a GST as part of a package to drop customs duties in order to join the World Trade Organisation.
Not that he wants to lecture Aussies on what to do.
“I don’t want to sound like I’m telling Australia how to suck eggs, but the New Zealand GST is a good one and regarded as one of the best in the world. It doesn’t have the high compliance costs.”
The secret to New Zealand’s GST, according to Brash, is its lack of “carve outs” or exemptions
“The one thing that New Zealanders are totally unaware of and should be increasingly grateful for is that [then finance minister Roger] Douglas’ design of our GST did not impose as many compliance costs,” says Brash.
“Huge numbers of exemptions are a way of increasing compliance costs big time.”
The comprehensive nature of New Zealand’s GST is clear in a nifty measure compiled by the OECD called the “VAT revenue ratio” (VRR) which shows the ratio between GST-assessable items and the total goods and services that could potentially be assessed. A ratio of 1 means every good and service is taxable. A ratio of 0 would indicate no VAT at all.
New Zealand’s VRR is very high at 0.96. Australia, at 0.47, is more in line with the OECD average of 0.55.
We know that consumption taxes are generally regressive and personal income taxes are progressive, so a switch from taxing income to consumption would increase inequality.
Carve outs increase complexity for small business people, who must decide if a biscuit is GST-assessable but the ingredients used to make are not, as is the case is in Australia. In a business-to-business context exemptions create a “cascading” effect, Brash says.
“As soon as you cave on exemptions the political pressure to exempt other stuff multiplies hugely. If not food, then why doctors’ bills, etc?”
Which, of course, is exactly what happened to Australia’s GST in negotiations with minor parties in the Senate, leading to the exclusion of food, private health insurance, private schools, childcare, water and sewage.
The second lesson to emerge from New Zealand is that reforming a country’s GST is more palatable if you compensate poor people for the tax’s regressive effect.
Critics of the GST cite fairness as a reason to exclude certain items. But, according to Brash, it is better to tax the lot, avoid compliance costs, and then compensate people directly.
“Yes it’s true that low-income people spend a higher proportion of their total spending on food, so therefore we say GST is regressive. But most of the money spent on food in the community is not spent by low-income people. You give away a huge amount of revenue in order to benefit the low-income people and it’s just a very inefficient way to do it.
“You’re much better not to exempt food and provide direct cash compensation to low-income earners using a part of the revenue raised. I would certainly argue strongly for a no exemptions policy.”
According to Peter Vial CA, New Zealand tax policy lead for Chartered Accountants Australia New Zealand, the key to the Kiwi reforms was to not consider the GST in isolation.
“The 2010 GST increase from 12.5 per cent to 15 per cent was done as part of a package of tax reforms that included a reduction in the corporate tax rate and in personal marginal tax rates. So a holistic approach was taken.
“Adjustments were made to the transfer [benefit] system in 2010 to compensate low-income earners and beneficiaries for the GST rate increase. This alleviated some of the concern re the potentially regressive nature of GST.”
University of Auckland Economics Professor Tim Hazledine says compensation has been key to Kiwis’ acceptance of the need for tax reform.
“NZ seems to have been unusual in both the acceptance of GST as a system and our willingness to have to apply to just about everything, including food,” Hazledine says.
“The initial imposition of a 10 per cent tax was accompanied by substantial income tax cuts and the most recent increase from 12.5 per cent to 15 per cent also came with income tax cuts, which undoubtedly soothes the perceived pain for much of the electorate.”
But there are limits, Hazledine warns: “I do doubt that a further increase in GST would be popular, though. I don’t think any of the political parties have this on their agenda.”
A final — and very important — lesson from New Zealand’s experience is that if you want to increase GST it helps enormously to have no upper house of parliament; or states, for that matter.
Says Vial: “NZ is a unicameral state — so it’s easier for a government to pass law — and we do not have the complexity of a federal system. Therefore, it is much easier for a New Zealand government to react to fiscal challenges and tax policy challenges quickly and succinctly.”
Former Australian Liberal leader, John Hewson, who lost the leadership in 1994 due in no small part to his advocacy of GST, agrees the New Zealand political system is easier to navigate.
“Of course, they don’t have any states and they don’t have any upper house. Basically, if you win government you can govern.”
New Zealanders also have a better track record of accepting the need for difficult reforms, he says.
“People just said ‘well, it had to be done’,” he recalls of the difficult reforms in the 1980s to liberalise the New Zealand economy.
“Unions and employer groups sit down and engage in constructive conversation. They just work at it. They don’t just get out there and score points.”
In Australia, it’s different, says Hewson.
“I think the electorate has got to the point where they’re sick of both sides of politics, sick of the bullshit and lies.
“They don’t trust government in our case. They don’t see the benefits [of tax reform] and they’re just tired of the bullshit and lies that they get.”
Efficient but unfair?
Australians have recently demonstrated a highly-attuned radar for what is fair. Abbott’s first attempt at budgeting contained deep cuts to higher education, new general practitioner co-payments and pension cuts, which proved a bridge too far for Aussie voters.
Does an increased GST meet the Aussie fairness test? On the grounds of fairness, the Labor Opposition remains opposed to any move to increase GST.
“Much depends on what a higher GST replaces — other taxes on consumption or income taxes. We know that consumption taxes are generally regressive and personal income taxes are progressive, so a switch from taxing income to consumption would increase inequality. If there’s an efficiency dividend from this, we don’t know if it’s large enough to justify the loss of equity,” says Australian tax expert and blogger Peter Davidson.
Davidson says increasing consumption taxes is regressive in two ways. Firstly, in the obvious sense that spending on consumption eats up a bigger slice of poorer households’ income and exceeds it if they are living off debt or savings. Secondly, income taxes have the benefit of also applying to income earned on savings and investments — which high-income earners have more of — in shares, cash and property.
Consumption taxes only tax spending, not investment earnings, so to raise the same revenue, higher rates must apply.
Davidson points out that New Zealand, which has dramatically shifted its tax base from income to consumption and also cut benefits over the past 30 years, has experienced the biggest rise in inequality among wealthy countries.
More income inequality is socially harmful, and it’s also been found by the OECD to be detrimental to economic growth.
We don’t know what the growth dividend is from taxing income less and consumption more. We do know for certain that it would increase inequality. Governments can try to compensate for this through the income tax and benefit systems but that’s costly and of course the compensation can be taken away in future budgets, as happened in New Zealand.
“Advocates of such a change have to demonstrate that its regressive effects, and the political controversy that would stir up, are actually worth it,” says Davidson, who also doubts whether tax reform is the reason for the New Zealand economy’s current patch of sunshine.
“In New Zealand, the economy is narrowly based, so that the business cycle is determined by the fate of a few industries, such as dairy. They’re doing well at the moment, and supporters of recent tax changes say that these are responsible, but I doubt it.”
While no panacea, it is likely that New Zealand’s tax reforms will put it in good stead in a world of increasingly mobile capital.
Whether it’s a policy prescription for Australia’s economic and budgeting woes remains unclear.
GST helped kill John Hewson’s political career but he still thinks it’s a good idea that could be sold to the Aussie public.
“The budget is more a revenue problem than an expenditure problem, but no side of politics is prepared to say we might have to increase taxes.
“We have had so much damage done on this,” he reflects. But with proper economic arguments — and proper compensation — Hewson still holds out hope for GST reform in Australia.
“I think people would wear it if somebody was honest about it.”
Honesty in politics? Watch this space.
Jessica Irvine is a journalist based in Sydney.
This article was first published in the May 2015 issue of Acuity magazine.