Swallowing a camel: carbon tax v income tax

A carbon price, whether implemented as an ETS or as a carbon tax, would feed into consumer prices, especially electricity prices. That's why it's politically dangerous.

The obvious remedy is to implement the price as a simple carbon tax and use the revenue to abolish not only the existing fuel excise, but also that other “great big tax” that notoriously feeds into consumer prices, namely the GST. But that would damage international competitiveness because the GST has a consumption or “destination” base, which taxes imports but not exports, whereas a simple carbon tax (or even an ETS) would have more of a production or “origin” base, which taxes exports but not imports.

Admittedly, the simplest possible carbon tax, namely an excise duty on the carbon content of Australian fossil fuels, would inevitably be balanced by a customs duty (tariff) at the same rate on comparable imports (as is already done with tobacco and liquor), so the combination would not be entirely origin-based; but it would still be inferior to the pure destination base of the GST.

Geoff Carmody, the Access Economics co-founder who now runs his own firm, draws the obvious inference that value-added taxes have been unilaterally adopted by many nations because of their consumption-destination base, while carbon taxes have been resisted because of their production-origin base. Accordingly he advocates a VAT-like carbon consumption tax, involving input credits that are refundable on exportation, and assuming (in order to comply with GATT/WTO rules) that imports have the same carbon content as locally produced equivalents. This sacrifices simplicity and precision for competitiveness.

But Carmody, in common with almost everyone else, has a great big blind spot. In the Australian Financial Review on July 12, he declared that “Governments unilaterally proposing a production-origin GST would be ridiculed”. In the same paper on June 23 last year, he described the Carbon Pollution Reduction Scheme as “the GST from hell” and asked: “Why should any country unilaterally tax its exports and effectively subsidise its imports, for no global emissions reduction?”

In fact, Australia already has a unilateral production-origin VAT with a broader base than the GST, at about three times the rate; but we hide its true nature by splitting the base between individuals and firms and calling it “income”. The income tax hits exports and gives a deduction for imports, for no global or local emissions reduction except through a general suppression of economic activity.

There are two essential differences between an income tax and a VAT. First, GATT/WTO rules allow a VAT to be border-adjusted by zero-rating exports and disallowing credits on imports, to achieve a destination base. Second, income tax gives employers a deduction for wages/salaries - but only because the same wages/salaries are taxed in the hands of employees. When the corporate and personal bases are combined, an income tax is a production-origin VAT! Like any other VAT, it feeds into prices. And food isn't exempt.

If we abolish personal income tax while preserving net (not gross) wages/salaries, and disallow the corresponding deduction for employers, we officially turn income tax into a VAT without changing after-tax wage relativities. If the rate is set to preserve overall tax revenue, no extra income needs to be found from higher prices to pay extra tax, so there is no overall rise in prices.

The conventional view that replacing income tax with a VAT would raise prices and regressively redistribute spending power assumes that gross (not net) wages/salaries would be preserved in the transition. That assumption is arbitrary and unwarranted.

Preserving net wages for existing appointments would mean that two half-time workers would be paid more than the equivalent full-time worker. To achieve the same effect for new appointments, a new IR regime could provide a lump-sum per-shift bonus which would serve the same purpose as the controversial minimum-shift provisions of existing awards, but without the minimum shift.

We could border-adjust the new VAT without breaking WTO rules. Then we could turn it into a retail tax to reduce compliance costs. The resulting elimination of input credits would make it easy to have a different retail-tax rate in each state. To do this without breaching ss. 51(ii), 90 and 99 of the Constitution, the Commonwealth could collect the retail tax at a federal rate plus a state surcharge rate, setting the surcharge in each state at the request and consent of the state parliament; and the surcharge revenue collected in each state could be refunded to that state.

This arrangement would leave no need for the GST either as a token consumption tax or as a means of funding the states. We could then afford the luxury of replacing the GST (and the existing fuel excise) with a carbon tax optimised to do just one thing: put a price on carbon.