Increase the GST to 20%? Yes, but I wouldn’t recommend it

Tony Abbott won’t raise the GST without a voter mandate - a smart move if he wants it to succeed. AAP

It looks like the GST will feature prominently in yet another election. The government is running a scare campaign on whether the Coalition will raise the GST after the election. In the meantime Tony Abbott has stared down the camera lens and said, “There will be no GST increase under a government I lead”. Well, actually no; he didn’t say that at all.

What he has said is that the GST isn’t going up. Period.

It isn’t clear to me that hammering this point is good for the ALP. It does invite comparisons with the carbon tax. In 1996 John Howard said “never ever” to a GST, but then changed his mind and campaigned on introducing a GST at the 1998 election. He defended that choice at the 2001 election. By contrast Julia Gillard’s carbon tax wasn’t taken to an election and isn’t being defended at this election – it has been abandoned.

The point being that tax policy is hard policy and good policy is never rushed. It takes time to garner community support for new taxation. This has been the lesson of the last six years – if anything it has been tax policy that cruelled the Rudd-Gillard government. It was the mining tax that eventually killed Rudd Mark I and Gillard never recovered from breaking her “no carbon tax under a government I lead” commitment.

The question remains, however, would it be good policy to increase the GST or to change the GST tax base? I got asked this question yesterday on Radio National and my answer was very typical of a two-handed economist.

In short; yes but no, I wouldn’t actually recommend it.

I can imagine a situation where Australia had a 20% GST with no exemptions. I would also reduce taxation in some other areas. For example, personal income tax can and should be lowered – especially for high-income earners. Corporate income tax could be lowered too. The academic literature suggests that high rates on personal and corporate income tax retards economic growth. Conversely inefficient state taxes could be eliminated.

Eliminating the exemption on fresh food would reduce the compliance burden that retailers bear in administering the GST. It would also raise additional revenue. Increasing the GST rate to 20% would massively increase the GST revenue gathered and increase spending on the kinds of services most Australians would like to see.

Whenever we have a tax debate in Australia and tax cuts are mooted, people always worry about spending on police, education, health, and the like. Those functions are state government responsibilities and if you worry about those sorts of things then it is the states which need to raise more revenue, not the Commonwealth. Higher GST means more spending at the state government level.

Mind you, that would only happen if the Commonwealth kept handing over all the cash to the states. We saw when Kevin Rudd was trying to take over the hospital system that the Commonwealth could easily keep some, or all, of the GST revenue.

The Henry Review indicated that the GST had a deadweight loss (the loss of value that occurs when a tax is imposed) of some 8 cents in the dollar, compared to 24 cents for personal income tax, and 40 cents for the corporate income tax. So increasing the GST and reducing income tax rates looks like a win-win for everyone. On a purely economic assessment that is what many economists would recommend.

But there is much more to the story.

The GST is a regressive tax – for some this is viewed as a positive feature. It forces low-income earners to make more of a contribution to the public purse than does an income tax. For others, however, the regressive nature of the GST is an anathema.

Then we need to worry about the so-called fiscal illusion aspects of the GST. Raising GST revenue is very easy – it is almost lazy. If community acceptance of changes to the GST were to occur, very quickly we’d find ourselves paying more and more in GST. That is very much the European experience.

In their monumental study The Power to Tax, Australian economist Geoffrey Brennan and Nobel laureate James Buchanan make the argument that the “low rate and broad base” tax arguments that economists often make are not necessarily efficient from a taxpayer perspective. Politicians cannot credibly commit to not increase taxes in future. Taxpayers know that politicians can and will overtax them and so they make it hard for politicians to raise new taxes.

So it comes to the GST. If we were governed by angels I would happily recommend a higher GST. As James Buchanan has argued, too many economists give advice to politicians ignoring the political realities and constraints of democratic governance – the GST falls well within that constraint.

Voters and taxpayers do not want Canberra to have too much access to easy tax dollars because they know full well the power to tax will be abused.