Regressive GST could be good for workers and the poor

Tobacco tax is regressive because low-income earners spend a higher proportion of their income on smoking.

Yet Labor is willing to use it to raise money for the budget because the low-income smokers and their families are seen as beneficiaries of a policy that would make cigarettes less affordable.

So why not apply the same basic logic to the GST?

Like the tobacco excise, the GST is regressive: high-income earners consume a smaller share of their income than low-income earners.

But that's part of the reason why the GST is an economically efficient revenue raiser.

All taxes do some harm to economic activity, but the GST does less harm than personal and company income taxes. That means a shift in the tax mix from income taxes to the GST would end up making the economy bigger which would give the government more tax revenue to redistribute in cash or in kind to low-income earners.

As Deloitte Access Economics' latest Budget Monitor report reminds us, part of that redistribution already has been promised. All we have to do now is pay for it.

In designing taxes and transfer payments, governments have to make a trade-off between efficiency and equity. We need a mixture of both to help grow the pie as well as redistribute it.

The GST's relative efficiency comes from three things: it does not have a progressive rate structure, it does not double-tax saving, and consumer spending is still relatively immobile despite the growth of international e-commerce.

COMPENSATION FOR INFLATION

Because it is not progressive, the GST does not impose a tax penalty on increases in income. And because it taxes saved income only once (when it is spent), it gives people a higher after-tax rate of return on their investment. Compare that with income tax: it taxes saved income when it is earned, which reduces the principal, and then taxes the nominal income earned from the investment including the compensation for inflation.

The fact that most consumption spending in Australia is relatively insensitive to the GST contrasts with the increasing sensitivity of business investment to differences in national company tax rates.

This is the result of the globalisation of capital markets and, more recently, the growth of international production chains.

The increased mobility of capital has radically changed the effective incidence of company tax.

Before globalisation, company tax was borne mainly by shareholders. Now it is estimated that about half the burden of the tax is borne by workers.

The reason is this: our relatively uncompetitive company tax rate results in less investment in Australia which, in turn, reduces labour productivity and real wages.

Of course, we will never cut company tax by enough to stop companies relocating their production and profits to tax havens. Part of the answer to that problem is going to be the strengthening of our company tax rules. But another part of the answer is to supplement the profit tax with something more robust, like the GST. Companies can transfer profits to low-tax countries, but they cannot so easily transfer their sales out of Australia.

The GST would be even more economically efficient if its base were broadened. Leaving fresh food out of the GST base, for example, directly reduces the regressiveness, but it is a very inefficient way of achieving that equity objective. The households in the top-income quintile spend two to three times as much on food as households in the two lowest quintiles. The difference in the consumption of fresh food probably is larger.

The smarter way to deal with fresh food is to include it in the tax and compensate low-income households so they are no worse-off.

That's easier said than done, particularly in the case of working, low-income households. However, the standard solution is to overcompensate low-income households to minimise the risk of anyone being worse-off.

That allows the government to raise more money with a smaller increase in the overall GST rate, which is a further advantage.

Why? Because the economic damage done by a tax rises disproportionately with the tax rate.

The exception to that rule is where the high-tax rates are being used to deter damaging activities such as smoking or greenhouse gas emissions.