The GST reform debate is a complete mess. If this was in doubt, the Council of Australian Governments meeting last week made it unambiguous: the Government is pushing ahead with a solution to a problem that it has not yet defined. The solution is a 15 per cent GST. Does anybody know what the problem is?
Most economists have a good, clean answer to that question. Basic tax theory tells us that consumption taxes are more efficient than most alternatives. Taxes that are easy to evade or substantially alter our behaviour are less efficient. Yet consumption taxes play only a small part of Australia's overall tax mix. The ideal tax from an efficiency perspective is low, broad, simple and does not encourage people to avoid saving.
Hence the Henry Review's position that "a broad-based consumption tax is one of the most efficient taxes available", and why lots of serious people these days talk about raising the GST and expanding it to fresh food and financial services.
But theory and practice are very different things. At last week's COAG meeting the state and commonwealth governments were discussing a complicated tax bargain, where two levels of government would trade off fiscal favours with each other. In the Australian Financial Review, Phillip Coorey has a good run down of the proposals.
Jay Weatherill's plan is that the Commonwealth Government would keep the revenue from a GST increase, which could be used to finance income tax cuts and compensation to low income households, while the states would be allocated a fixed percentage of the commonwealth's income tax take to spend at their discretion.
An alternative model is that proposed by Mike Baird, where the states would receive $5 billion between now and 2020 to recover some of the funding increases cut from the 2014 budget. After that, the states would be allocated the revenue from income tax bracket creep — the steady tax increase that occurs thanks to inflation every year.
Neither of these plans have much to recommend them. They would further entrench the fiscal imbalance in the federation — the distorted political incentives that arise from the fact that the states do not raise the money they spend. But Baird's plan is particularly awful. Not only does it rely on maintaining bracket creep as a fixture of the Australian tax system, it would create a constituency — the states — that would lobby hard against any future income tax relief.
The states are obviously clamouring for money. Having lost any real revenue base of their own, they've been reduced to begging the commonwealth for scraps.
The real question is why the Commonwealth Government is indulging any of this. The efficiency gains from replacing income tax with a consumption tax are unlikely to be realised once the Government starts compensating low income holders and bargaining with the states. Those compromises will impose their own efficiency costs — costs that do not get captured in the blackboard modelling that informs the debate — but those costs might swamp the benefits from tax reform.
There is a vast gap between an ideal, perfectly implemented tax system and the necessarily compromised and complicated system that emerges from the process of democratic bargaining.
The Government is correct to say that our tax system comes from an older era, and correct to point out that many of our tax rates are punitively high — particularly the income and corporate tax rates. But piecemeal changes could tackle these problems. Every budget includes its own minor changes to the tax system. Why not work through the normal budget process? Why the need for big-bang reform?
When the GST was first introduced by the Howard government, it was designed to replace the wildly inefficient, complicated and obscure wholesale sales tax, as well as stamp duties, taxes on financial institutions, and bed taxes. The one fell swoop approach suited our tax reform needs then. It does not anymore.
The flaws of the existing system have been created by the same political dynamic that makes a revolutionary jump to a substantially better system unlikely. And if the trade-off for a higher GST is to lock in bracket creep forever, as the Baird plan would, tax reform will have been worse than pointless: it will have been genuinely harmful.
The Turnbull Government can't even convince its own economic elders about the desirability of reform. Peter Costello (who brought in the GST in 2000) warns that a GST debate "will swamp everything". Peter Reith (shadow treasurer when John Hewson presented his GST plan) urges the Government to "shut down this discussion before Christmas". Neither of these two are the sole founts of wisdom on tax, of course, but something has obviously gone badly wrong.
On Tuesday the Government will release its Mid-year Economic and Fiscal Outlook, which will reportedly show that government expenditure is around 26.2 per cent of GDP.
This means the Australian government now spends more than it spent when the Rudd government was trying to pump-prime the economy during the Global Financial Crisis ("just" 26.0 per cent of GDP was spent in the 2009-10 financial year). We are at permanent emergency levels of spending. This — not marginal changes to the efficiency of the tax system — is what Malcolm Turnbull should be spending his political capital on.
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