During the recent debate about tax reform in Australia, changes to the GST have been made out to be a bogeyman. This article discusses why consumption taxes such as the GST are preferable to income taxation methods such personal income tax and company tax.
What are Income and Consumption Taxes?
A Consumption Tax, such as the Australian Goods and Services Tax (GST), is a tax levied on goods and services purchased by consumers. Consumption Taxes generally cover most or all goods and services traded in an economy but may have exemptions such as fresh fruit and vegetables in the case of the GST.
Alternatively, Income taxes are taxes levied on income derived from capital (interest, dividends, ect. ) and labour (wages, salary). Governments typically choose to make income taxes progressive by having tax brackets that determine an individual’s level of taxation.
All taxes, including consumption and income taxes, create deadweight loss. Deadweight loss is a deviation from market equilibrium which results in an inefficient outcome. In our current economic system, taxation by government is unavoidable. This means that we should strive to have a tax system that reduces deadweight loss to maximise efficiency in government revenue and in the economy generally.
The Disadvantages of an Income Taxation System
While Income Taxes generate significantly more government revenue that consumption taxes, there are distinct disadvantages that are tied to this revenue. Income Taxes create a disparity between the real value of labour/capital and what an individual receives for their work. This disparity dis-incentivises individuals from earning at their full potential (preferring to spend time at leisure rather than working) as well as saving, investment and consequently innovation.
In addition to this, Income Taxation creates a larger deadweight loss burden which can be detrimental to economic growth and development in an economy. As shown in a 2011 KMPG report, the Australian GST incurs a marginal deadweight loss of 12 cents per every dollar of revenue. As opposed to the 24 cents per dollar deadweight loss incurred by personal income tax or 37 cents per dollar of company tax, GST is a far more efficient system of taxation.
Argument Against Consumption Tax
Those against the use of consumption taxes to replace income taxes frequently argue that consumption taxes are inherently regressive and cause greater income inequality in society. There are several faults in this line of thought.
Firstly, consumption taxes can be designed in such a way that they are neutral or progressive by incorporating exemptions, deductions, rebates or graduating the consumption tax to target luxury items or other goods and services typically consumed by higher income individuals. Secondly, income inequality isn’t necessarily a bad thing, especially if it means every individual’s income is higher. Inequality of income incentivises individuals to either work extra hours, attempt to sell their labour at a higher price by moving firms or entrepreneurship or inventing and selling their own product. These incentives benefit the economy as it increases competition and innovation.
With all this in mind, we can now apply it to the Australian Government and its tax mix. In 2013-14, income taxes were biggest source of revenue for government at 57% of total revenue, with GST at 24%. By broadening the base and/or increasing the rate of the GST as has been suggested in recent debates the government could have significant increases in revenue. This in combination with reductions in income and company taxes could be a lucrative move for the government as it should implement the incentives discussed above, encourage saving and investment and importantly increase the Government’s ability to run structural budget surplus’ to reduce public debt.
With this evidence we can conclude that a GST is a more effective form of taxation compared to income taxes whether personal and company. The future of taxation could be dominated by consumption taxes and replace income taxes completely, but this would require reform greater in magnitude than the introduction of the GST in 2000. The Abbott and Turnbull Liberal governments have both flagged tax reform as part of their agendas. Our politicians must now sell economic literacy to the electorate and undertake crucial reforms to ensure an efficient government revenue stream and secure Australia’s economic prosperity in the future.