ECONOMICS by Colin TeeseNews Weekly
Higher consumption tax will bite in everyday bills
, August 15, 2015
Herman Goering, Deputy Fuhrer under Adolf Hitler, was reputed to have once said, “Every time I hear the word ‘culture’ I reach for my revolver”.
I react pretty much the same way whenever I hear the words “tax reform”.
All the usual suspects are preaching the gospel of a higher consumption tax (GST). The idea at present attracting attention is increasing the tax from 10 per cent to 15 per cent, either on all goods taxed at 10 per cent under the current arrangements or, among the more ambitious, 15 per cent across the board, including for goods and services not currently taxed, such as health, education and financial services.
Arguments in favour of increasing our consumption tax (they always call it “tax reform”) vary from the fantastic to the merely silly.
Free lunch, anyone?
Thank goodness, Ross Gittins, in The Age on July 23, brought a sense of reality to the debate. Any new largesse in tax revenue, he pointed out, from whatever source, could serve only one purpose. It could not, for example, help cut the deficit and give tax relief to, say, higher-income earners and business.
No less an important question is whether the solution to any of Australia’s current economic problems (and they are many) is to fiddle with the tax mix, whether it involves collecting more tax or less.
Commonwealth government tax is currently levied mainly as a tax on the earnings of individuals and businesses, and, to a lesser extent, on the consumption of some, though not all, goods and services.
Traditionally, tax on earned income has been collected on the basis of what is called a “progressive” scale. The higher the income earned, the larger weight of the tax burden. The rate of tax imposed rises disproportionately with the rise in income.
However, fair and reasonable though this may seem, pressure applied over the last 30 years has resulted in the tax paid by the highest earners being significantly reduced.
Business tax has always been at a fixed rate, regardless of income earned, though the rate has been reduced in recent times.
Consumption taxes are now widely used in developed economies. Rates and details as to the direction and incidence of this tax do, however, vary widely.
In Australia the consumption tax (the GST) applies at a rate of 10 per cent to almost all goods and services except fresh food, health, education and financial services.
A consumption tax, in whatever form, is acknowledged to be “regressive”. Clearly, the burden of a flat rate consumption tax hits low-income earners more heavily for the simple reason that such taxpayers, and especially those supporting a family, usually spend almost all their income on everyday needs.
By contrast, those on high incomes have more money left over after catering for basic needs. The remainder can be saved or used for discretionary expenditure.
These implications are rarely discussed in so-called tax reform based on the introduction or increase of a consumption tax. Such discussions do indeed involve “change” (another name for “reform”). But it is about a special form of “change”. In reality it is about who will be contributing more to the total tax pool and who will not.
Also left unclear in the same context is whether the total tax take is intended to be larger. Recently there has been talk of the need for a new source of revenue to replace that lost from income and company tax collections.
Here again the unspoken implication is that, if more tax is collected by means of “regressive” taxes, lower-income groups will be paying comparatively more than those on higher incomes.
Since most of the services to be funded are of greater benefit to lower-income earners, there is no prize for guessing which sort of tax those on high incomes would prefer!
Business also has the same view. If new tax is to be collected, better that it not disturb business profits.
The carrot and the stick
Higher wages and taxes on business are said to cause higher levels of unemployment. In this context economist John Kenneth Galbraith once observed: “It is as if the rich will only be encouraged to work if they are given more money, and the poor if they are given less.”
A tax on consumption, we are told, avoids all the disadvantages of income and business taxation. Collecting tax at the consumption end of the chain rather than at the point of production or distribution is better for the economy.
Ignored in all this is the fact that a consumption tax is, for example, inflationary. Although they do acknowledge this, proponents of a consumption tax argue that it is a one-off impact. That view ignores the fact that every time the price of a taxed good or service is increased the amount of the tax rises as well.
None of this takes account of the fact that the burden of a consumption tax falls most heavily on those with limited spending power; taxing low-income consumers means more of their income will be siphoned off in taxation and less will be available for spending into the economy. Economic growth will be slowed. Business, and those on higher incomes, who presumably benefit from a healthier economy, will be unable to avoid this consequence.
We have evidence of the adverse consequences flowing from an increase in consumption tax. When Japan increased its consumption tax last year, consumption fell and economic growth suffered.
Land of forgotten promises
Further, in the context of the current debate, it is worth recalling that when the tax was introduced in the Howard years its purpose was said to be the provision of a new revenue stream for the states. In the current debate that is conveniently forgotten, as are the solemn promises that the tax would not be increased or extended. Legislation provides that the GST cannot be changed without the agreement of all state governments.
Prime Minister Tony Abbott is all over the place on the issue. It is hard to know what he really thinks, except that he badly needs a fresh revenue stream as the returns from conventional tax on income and business dry up. And the states are short of the revenue they need to fund what they are obliged to do.
To understand how the states fit into the picture, we have to take a look at the Australian Constitution. A High Court decision delivered more than 70 years ago permanently transferred the states’ power to collect income tax to the Commonwealth. Thereafter it was the responsibility of the Commonwealth to fund state activities by direct grants from its revenue collections.
However, each state did not necessarily get back what had been collected there in income tax. Commonwealth distributions to the states were on the basis of need (part of the revenue collected in the richer states was given to the more needy). In a federation like Australia’s, that was quite proper, but it could only work in the context of the times; remember, back in 1943 the political climate embraced the idea of sacrifice and cooperation for the wider good.
Commonwealth turns states’ banker
Even so, the Commonwealth did cheat a bit.
Under our federation only a narrow band of functions specifically stated in the constitution are reserved for the Commonwealth. States are responsible for the rest, including health and education.
By contrast, in Canada the opposite is true. In its federation, all the functions not specifically assigned to the states are the responsibility of the central government.
Yet tax collections by the two central governments don’t reflect this fundamental fact. With far fewer responsibilities Canberra takes 82 per cent of the total tax take, while the Canadian government, with a much greater spending needs, takes only 45 per cent. Our state governments are, on that basis, being shortchanged.
And yet the Prime Minister is on record as saying that the states must finance more of their own spending, even though the basis for doing so has been absent for 70 years. True, they have had available to them the proceeds of the consumption tax since the Howard government introduction of that tax in 2000. That, however, should not be seen as an unalloyed gain: as the comparison with Canada makes clear, the Canberra tax take has eaten into what should be funding state government operations.
Introducing the consumption tax to fund states has allowed the Commonwealth government to maintain its extravagant spending level; which includes Commonwealth spending on state areas of health and education.
If the budget suffers from lack of revenue, then it should be recognised that low wages, high unemployment and slow economic growth make that inevitable. The solution is to stimulate growth; collecting more tax from low-income earners will only make things worse.
The state governments, with so much of their spending responsibilities linked to community needs, are feeling the pinch, and their concerns are affecting their ability to cooperate in making our federation work.
All this at a time when the federation idea is already under pressure – just ask the Eurozone. Cooperation is out of fashion in a world where individuals are encouraged to believe that simply pursuing their own self-interest benefits the economy.
Neither does “tax reform” sit happily with the idea of the strong helping the weak, a factor that once played an important part in making our federation run smoothly.
Tax policy has left the states with no option but to play the game of “every man for himself”.
That is not good for them, or us, or our federation.