There are plenty of reasons to like a tax that hits your spending rather than your earnings.
Politicians usually want to be seen cutting taxes, not bringing in new ones. But around the world, many are doing just that. Stagnant wages and weak company profits have shrunk government tax revenues, and now many treasurers and finance ministers are considering imposing or tweaking a consumption tax to boost depleted national coffers and repair fiscal balance sheets.
On 1 April, Malaysia became the latest nation to join the consumption tax club, putting in place a 6 per cent goods and services tax (GST).
Consumption taxes such as a GST or value-added tax (VAT) are already in place in 164 of the world’s 196 nations. India could have a GST next year if Narendra Modi sticks to his current plans. And the six member countries of the Gulf Cooperation Council are actively looking at a VAT. But in the US, efforts to start a national discussion on a consumption tax have so far had little success.
Why a GST?
Most economists see consumption taxes as more conducive to economic growth than taxes on income. Workers taxed on their wages may not want to work any extra hours if a bigger percentage of the extra money they earn goes in tax. Taxes on capital income (profits, dividends, interest and capital gains) also deter saving and investment, and increase business costs.
Last year, Australia’s then federal treasury secretary, Martin Parkinson, argued for greater use of indirect taxes such as the GST, noting that “increased reliance on … more efficient sources of revenue, including indirect taxes, can support higher growth and higher living standards by increasing workforce participation and lifting productivity”.
According to the OECD, indirect taxes “have a smaller impact on business costs and profits as well as work incentives compared with other major tax bases, notably corporate income tax and personal income tax.”
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Just as compelling for countries with an ageing population is that a GST or VAT reduces a government’s reliance on income tax from wage earners for revenue. And in a world where capital is extremely mobile and multinationals routinely shift income to minimise the tax they pay, a consumption tax has the added appeal of being neutral as to where income is earned.
The revenue plunge
Across much of the globe, economic activity is in the doldrums. The International Monetary Fund has slashed its global growth forecast for 2015 to 3.5 per cent (down from 3.8 per cent). Growth next year isn’t expected to be much stronger.
Lacklustre economic activity, combined with a plunge in the oil price, has raised the threatening spectre of deflation and a drop in demand both in Europe and Japan. This is making governments and central banks more desperate than ever to foster growth. At the same time, they are trying to repair balance sheets savaged by the effects of plunging revenues and higher welfare costs.
The overall tax take of governments is still below the levels seen prior to the global financial crisis almost a decade ago. Among OECD countries, tax revenue as a proportion of GDP plunged from an average 34.2 per cent in 2007 to 32.7 per cent in 2009, and was at 33.7 per cent in 2012. And while income tax revenues are slowly recovering from the sharp falls seen in the depths of the financial crisis, as a percentage of overall tax revenues across the OECD, income tax is still almost 3 percentage points below where it was in 2007.
"In India, the plan is to have a single national GST replace a hodge-podge of state VATs and federal excise and customs duties."
Faced with this weak revenue and rising costs, many governments have focused on cutting back spending. But austerity on its own is not a complete solution; governments need to boost their tax take as well.
The problem is that raising income taxes reduces the amount of money that households have to spend and risks stifling economic recovery. Increasing a tax on consumption, however, is viewed as a growth-friendly alternative. And that’s exactly what countries including Japan, the UK, France, Italy, Spain and New Zealand have done, raising their VAT or GST rates by between 0.4 and 5 per cent since 2009.
What gets taxed?
There’s no doubt that a GST can replace less efficient revenue sources. In Malaysia, for instance, the GST is supplanting a system of sales and services taxes. When the GST was introduced in Australia in 2000 it saw the abolition of state banking taxes, a wholesale sales tax and several fuel taxes. Income tax was also trimmed.
In India, the plan is to have a single, national GST replace a hodge-podge of state VATs and federal excise and customs duties and services taxes.
But although consumption taxes are becoming more important, they remain a supplement to income taxes in most countries. In 2012, across the OECD they accounted for around a fifth of revenues, compared with personal income taxes (25 per cent), corporate income taxes (9 per cent), social security contributions (26 per cent), property taxes (5 per cent) and payroll taxes (1 per cent).
The relative benefits of a GST are often muffled by the numerous carve-outs and exceptions on which most governments insist. Despite the OECD’s
argument that compensation payments, rather than GST exemptions, are a much more efficient way to cushion low-income households from extreme hardship, only two of its 34 member countries have put in place a consumption tax with close to no exclusions.
Exclusions can apply for a mix of practical and policy reasons. Some countries view collecting a consumption tax on finance and insurance services as just too hard. Others want to avoid a GST’s impact falling too heavily on lower-income households, so exclude basic household items from the tax. Favoured industries may also get a GST break.
In Australia, for example, there is no GST on fresh food, health and education services. In other countries, these items may also be exempted or taxed at a lower rate.
Whatever the rationale for these exemptions, the foregone revenue can be huge. The OECD has compared what countries raise from consumption taxes with what they could earn if there were no exemptions. It estimates that its members, on average, collect only 55 per cent of potential revenue.
Australia, the OECD analysis suggests, is missing out on almost A$50 billion in revenue because its GST is not applied uniformly. That’s about the same as the country’s current budget deficit.
Dr Ken Henry, Australia’s federal treasury secretary from 2001 to 2011, is among those arguing that the country can’t afford to leave such a huge pool of potential revenue untapped.
But for the moment, the Australian Government is refusing to increase or expand the tax. It’s a political fight it wants to avoid. “As for the GST – it can’t and it won’t change unless all the states and territories agree,” Prime Minister Tony Abbott told the National Press Club in February.
"Consumption taxes are already in place in 164 if the world's 196 nations."
“It can’t and won’t change unless there is political consensus. That means – leaving aside any minor administrative changes – that the base and the rate of the GST won’t change this term or next, unless it’s supported by the likes of [opposition leader Bill Shorten] and the Labor premiers.”
Raising taxes is, after all, not for the faint-hearted.
Selling a GST
Introducing a new tax is rarely easy, particularly if it’s designed to hit consumers directly in the hip pocket. John Howard, who introduced a GST in Australia, suffered some bruising negotiations to secure its passage through the parliament, even though he’d secured a mandate to introduce the tax at the 1998 election. Eventually he had to spice the deal with exemptions for basic foods and income tax cuts.
Australia’s former Treasury secretary, Dr Ken Henry, lamented that to successfully implement tax reform, governments were regularly forced to over-compensate taxpayers. Simply aiming for tax neutrality was not enough.
The situation is different in India. There, the concept of a national GST has been gestating since the mid-2000s. With the election of Narendra Modi’s government in May 2014, the idea for a single national GST has received fresh impetus, and it may become a reality as early as next year.
It’s proposed that all state VATs and federal excise and customs duties and services taxes will be brought together under the umbrella of a single GST collected at the point of sale. But the hazards of changing a GST once introduced have many in India urging Modi to make sure he gets it right first time.
Many observers see Japan’s experience as a cautionary tale as to what can go wrong. In April last year, the country brought in the first stage of a two-part legislated increase in consumption tax, raising its GST from 5 to 8 per cent, with a jump to 10 per cent scheduled for October 2015.
But Japan’s prime minister, Shinzo Abe, has indefinitely delayed the second rise after a collapse in consumer spending saw the economy slump back into recession in the middle of last year. Some commentators blamed that slump on the first consumption tax hike. Whether right or wrong, the claims have chilled the Abe Government’s appetite for tax reform.
This article is from the April 2015 issue of INTHEBLACK.