As the Australian government foreshadows imminent tax changes, some politicians, commentators and think-tanks are again proposing increasing and broadening the GST. However, the practicalities of compensating those who can’t afford the price increases might rule out even minor change.
Apart from how compensation would work, there are other reasons. One is having all states and both federal houses agree. Another is whether the midst of the COVID-19 pandemic is the right time to have tax induced price rises for consumers and increased GST paperwork for businesses. Experts would raise concerns about increasing the price of fresh food and the cost of education, by any percentage, let alone 15%.
However, if the proponents are really serious about increasing the GST because of the amount of revenue it can raise, we can achieve the same monetary result more easily and fairly. Thus, assuming that all individuals on low to medium incomes would have to be fully compensated for the higher prices, only those on high taxable incomes would principally pay the higher GST. Below we show that by increasing the top marginal tax rates, and not touching the GST, we can obtain exactly the same net revenue outcome with little if any disruption to our current taxation system.
Here I only look at the extreme GST model that has been mooted for Australia: ‘15% tax on 100% of goods and services’. I call this the full model.
It is a ‘back of the envelope’ analysis that many could easily do from available data and by making some broad assumptions. It won’t be too far wrong in terms of illustrating the complexities of change.
The assumptions, of course, can be challenged. The Medicare levy is one factor I have ignored. Also ignored is that someone on a gross income of $300,000 might have so many deductions that their taxable income is reduced to $18,000 and they pay no personal income tax yet the GST they pay on their purchases might be $20,000.
Between this full ‘15% on 100%’ model and our current model, there may be a workable compromise. There may well be ways of making the tax less distorted and/or simplifying the compliance tasks of businesses. However, this examination of the full model, even in a simplified, guesstimate approach, questions whether even a minor change to the GST is feasible or necessary if the real goal is to raise revenue.
We need to show why the GST is largely untouchable for practical, not political, reasons.
The aim of this article is to broadly illustrate the complexities.
Our current GST exemptions
Conflicting information is given about the coverage of our GST. In 2016, the Treasury stated that GST is applied to around 47 per cent of Australia’s national consumption. Here I assume it may have increased since then with changes to overseas purchases. We will assume that 50% of consumption is currently subject to GST and 50% exempt.
Which goods and services are subject to GST? It is far from easy to summarise. According to the ABC “The Tax Office’s lists on what is and is not exempt from GST are long and incredibly complex. For food alone the list is 88 pages long, …”
Notable GST exemptions are fresh food and some health and education items.
The full GST model is equivalent to a 200% tax increase
Thus, currently Australians pay 10% GST on about 50% of consumer expenditure meaning that, in effect, our average GST rate is only 5%.
Broadening the base to 100% of goods and services and charging 15% GST on everything means those 50% of items already on 10% GST will go to 15% tax (for example, a fruit muesli bar), and the other 50% of items will go from 0% to 15% tax (for example, an apple).
To illustrate: Assume your total food expenditure before GST is evenly split between fresh and processed food: $100 on each or $200 in total. After GST is applied, fresh food remains at $100 while the processed food costs $110. Your total food budget at the checkout is $210. The average GST paid is thus 5%. If 15% GST is applied to all, the bill at checkout will be $115 for fresh food and $115 for processed. A total of $230. The average GST paid is thus 15%. The amount of GST paid goes from $10 to $30, a 200% increase.
As prices will go up on average by around 10%, if your current expenditure is around $90,000 per annum, in broad terms, expect to find close to an extra $9,000 a year. Or drop your living standards by 10% by reducing the ‘volume’ of goods and services you consume or by switching to cheaper products. Or take on another job.
In particular, expect to be able to find an extra 15% to maintain your current consumption of fresh food, health and education. (A private health insurance premium of $4,000 would cost $4,600, a kilogram of salmon currently at $40 a kilo would cost $46. Would tertiary students pay a few more thousands in fees?)
The effect would apply from year one onwards, or until the GST was changed again.
The false attraction of the GST
In 2015 when there was a debate about going to a New Zealand model of 15% tax on close to 100% of goods and services, it was estimated the amount raised would double. (The New Zealand model dates from 1986 and had few exemptions; the Australian model dates from 2000 and had around 50% of expenditure exempted.)
It is estimated that the GST in Australia today raises $70 billion. Current proponents only seem to look at one side of the GST – the extra $70 billion dollars it would raise.
But any increase would also mean billions of dollars of outgoings in compensation for those who can least afford the increased living costs.
Treasury documentation shows that the introduction of the GST in 2000 involved a comprehensive compensation package, with “… significant reductions in personal income taxes and large increases in government payments to families, pensioners and low income earners”. Ditto for the Gillard government’s carbon tax.
How much compensation today?
In 2015 the Grattan Institute, in reviewing the GST then, suggested that, for their model, 30% of the extra revenue should go to those on welfare and another 30% on modest tax cuts in the lower brackets. Their 60% compensation would fully offset the GST increase for households earning up to $100,000 a year.
In this article I use $90,000 or less as a benchmark income as it defines a tax threshold and best illustrates the complications. If we increased the total compensation to 70% of extra revenue (to also cover those outside the tax and welfare system and for running the new system, which is likely to be very costly) that leaves 30% of extra revenue retained; $21 billion left of the extra $70 billion raised. (Of course, it can be legitimately argued that a different benchmark income should be used, or that the compensation percentages should be different.)
At this point note that with everyone else receiving full compensation, those with taxable incomes over $90,000 would receive no compensation even though they would pay the average 10% higher prices under the full (15% on 100%) model.
It is easy to show that Australia would end up with an unusual income taxation system and a more complex welfare system. At the same time we would expect to have even more GST evasion through the black market.
True, a coverage of 100% of goods and services would make it easier for businesses to handle GST red tape. But there are major mitigating costs in other ways, mainly in compensating the less well-off for the 5% and 15% price increases.
How compensation would work
To be fully compensated for many years into the future, households would need to receive back the effect of the 10% increase on their expenditure on goods and services.
For welfare recipients (pensions, job seekers, family allowances, …) it should be easy enough to increase payouts for those on full benefits, and possibly partial benefits.
It is not so easy for those independent of the welfare and tax system, self-funded retirees in particular. How will they be identified and compensated and tracked year after year?
For higher personal incomes, the marginal rates can be varied easily.
The real complication is that those on low taxable incomes don’t pay enough tax to be compensated by tax refunds. How will they be identified and compensated?
Part 2 examines the complications of compensating those in the lower tax brackets and explains why those complications can be avoided by changing the marginal rates in the top brackets to achieve the same net revenue result as any change to the GST.