GST change is not the answer

I have a warning for my Liberal and National Party colleagues: speculating on increasing the revenue take from the GST is playing with fire.

They are in serious danger of being dragged into a debate that does not stand up to economic justification despite all the so-called "expert" commentary on why it would be such a marvellous idea to increase the GST rate or alternatively expand the tax base by removing exemptions from fresh food, education or health services.

I am here talking about the economic case. The political case is even potentially more horrendous.

First to the economic case. When you boil it down most of the commentators arguing for changes to the GST are focused on increasing the tax take so they can spend more money on their pet projects. They are not really talking about tax "reform" at all. It is simply about extracting more money from the taxpayer.

The Premiers are calling for more tax revenue to fund massive increases in education and health expenditure that were promised by prime ministers Gillard and Rudd. They were always undeliverable promises and it was said so at the time of their announcements by many people. The premiers are being completely disingenuous on this issue. They want the commonwealth government to wear the opprobrium of raising higher taxes so they get the applause for spending more money. It is one of the great dysfunctional aspects of Australia's federal system.

There were two principal economic reasons for introducing the GST. First was the fact that the pre-existing indirect taxes like the wholesale sales tax were very inefficient because they taxed business inputs such that there was a cumulative cascading of taxes that added massively to business costs. This was particularly damaging to exporters and import-competing industries that we're battling with businesses from overseas that we're not suffering from the same handicap. The GST or value added tax, which is its more economically accurate name, removed that double taxation burden. This was the principal economic reform and it meant billions of dollars to Australian businesses. However, it is a reform that is completed. It was long overdue but it is now done. The efficiencies and productivity benefits have already been booked many years ago. No thanks to the Labor Party, which cravenly opposed its introduction although they knew it was a necessary economic reform.

The second big economic reason for introducing the GST was that it allowed for what became known as a "tax mix switch". That principally meant a reduction of the revenue burden on direct, income taxes to be replaced by indirect taxes. It is argued that this is important as high marginal tax rates on personal income have a largely negative impact on economic activity, discouraging work and productivity improvements. This is well known to be the case from decades of research, like that of the OECD. The Treasury Secretary, Martin Parkinson, has made similar observations.

A tax mix switch was attempted in the 2000 Howard/Costello tax changes. It was also the centrepiece of the previous Option C proposal of Paul Keating in 1985 when he was Labor Treasurer and the Fightback package of John Hewson and Peter Reith. However the bottom line is that it didn't really work for the Howard Government. At the time there was some substantial income tax cuts but we seem to still have a heavy reliance on direct rather than indirect taxes in Australia. The reason for that is bracket creep on the income tax schedules and a heavy call on corporate income tax.

Also there was to be significant replacement of inefficient state taxes. However a large segment of that was reneged on by state premiers. Ask Peter Costello about broken promises by state premiers – he has a fine old story to tell. That is why I would be highly reluctant about doing any future deals with state premiers on GST given that their predecessors displayed high levels of bad faith on delivering on tax reform over the last fourteen years.

The other point to make is that many of the same people who are arguing for increases in the GST to fund increased government services would immediately become the noisiest advocates for compensation through tax and welfare cuts that would soak up most of the new GST revenues, thus defeating much of the stated purpose for a change namely to pay for other things. To say again most of the advocates are simply arguing for bigger government, not a more efficient tax system. And I think that business organisations like the Business Council of Australia and the Australian Industry Group should shake off their naivety and be very careful about supporting such calls.

Another issue is the simplistic call for the removal of the GST exemptions for fresh food, education, health, sewerage and water, and financial supplies. Some people are claiming that these were all politically expedient decisions. Admittedly the fresh food exemption was the price of getting the support of the Australian Democrats in the Senate to pass the GST legislation. However, it would be entertaining to see someone try and sustain an argument for taxing fresh food more heavily when one of Australia's current problems is an obesity epidemic. As to the other exemptions they were not so much political decisions as instead tax administration decisions based on the difficulties of taxing these areas, especially given the heavy involvement of government in many of these sectors and the cross-jurisdictional issues of our Federation which could cause significant tax churning. They were not design flaws of the system but in fact design features deliberately taken for good on-balance reasons.

Lastly I just want to say again, considering changes to the GST is playing with fire without significant economic benefits.