Leaders debate the GST: what you need to know

State premiers and chief ministers meet Prime Minister Tony Abbott in Sydney today in a special leader’s retreat prior to Thursday’s COAG meeting, with reform of the GST planted firmly on the agenda.

The retreat comes before the official COAG and was called following tension at April’s meeting around the allocation of the GST among states, referred to as the ‘carve-up’.

Why is this so important? The states are facing a massive funding shortfall for education and health, as in its first year’s budget, the federal government announced it would not provide $80 billion to the states for future funding.

The federal government has repeatedly said it will not make changes the GST - either increasing the rate or broadening it to include currently exempt services, such as food and education - without going to an election, and would need a “parliamentary consensus”.

Abbott has described the discussion on GST changes today as the “beginning of a process”.

We are at the beginning of a process here and I want the process to ensure that Australians have better schools, better hospitals, better TAFEs, better services and at the same time, that we have lower, simpler, fairer taxes.

So who supports changes to the GST and who is against it?

Michelle Grattan answers:

NSW Liberal premier Mike Baird has proposed a rise from 10% to 15%, with all the funds going to health and to compensate lower income households who would be hit by the higher rate.

South Australian Labor premier Jay Weatherill has proposed broadening the GST to financial services. This would raise $3.6 billion annually. Weatherill says he is “open to the discussion” about increasing the rate as well as broadening the base, and believes Baird should be given the opportunity to put his case for the rate rise.

Weatherill says it’s “not my preferred solution” [to the states’ funding problem] but it’s worthy of discussion. Changing the GST would have to be done in such a way to protect low income earners, he says, and there would be a number of other issues.

The federal government would like to change the GST as part of a switch in tax mix to help finance tax cuts, but has said that reforming the rate or coverage would have to be backed by all state and territory governments and be bipartisan at the federal level.

Two Labor premiers, Daniel Andrews from Victoria, and Queensland’s Annastacia Palaszczuk are against increasing or broadening. Andrews wants health funding addressed by an increase in the Medicare levy.

Labor ACT Chief Minister Andrew Barr says he wouldn’t support a 50% increase to a regressive tax like the GST without measures to support low income families. He believes an increase of the Medicare levy to address health funding shortfalls should be discussed.

Tasmania’s Liberal Premier Will Hodgman is cold on the idea of GST change, believing an increase would be a burden on the taxpayers of his state. Meanwhile Hodgman is particularly worried about West Australia’s perennial push for a greater share of GST, which WA premier Colin Barnett always puts as his top priority.

Barnett believes that GST changes would have to involve more than a rate rise, which should be a “last resort”, and says current exemptions such as of fresh food could be looked at. Going to 15% would be too high, Barnett believes.

“The public may accept it going to 12.5%, but that cannot stand alone. It has to be a total package looking at all aspects of the GST.”

The GST is referred to as a “regressive” tax. What does that actually mean?

Roger Wilkins answers:

A regressive tax in this context refers to a tax on a higher proportion of income for low-income people than for high-income people. It is most easily understood in reference to income taxes, where a regressive tax would be one where the marginal tax rate is lower at higher incomes.

For example, if the marginal tax rate was 40% for incomes up to $50,000, and then decreased to 20% for income in excess of that amount, then a person with an income of $50,000 would pay 40% of their income in tax, while a person with an income of $100,000 would pay 30% of their income in tax. The higher-income person still pays more tax than the lower-income person, but it is a lower proportion of their total income. Hence, the tax is regressive.

A consumption tax is regressive if the total consumption taxes paid represent a higher proportion of income for low-income people. Whether a consumption tax is regressive will depend on what is taxed, but a broad-based consumption tax will be regressive because lower-income people save less than higher income people. For example, consider a 10% tax on all goods and services.

If lower-income people spend all their income on goods and services (and save nothing), the tax represents about 9% of their income ($4,500 for a person with an income of $50,000). If higher-income people spend half their income on goods and services (and save half), the tax represents about 4.5% of their income ($4,500 for a person with an income of $100,000).

Of course, fresh food, education and health care are exempt from the GST, which changes the equation. It is nonetheless still regressive in the technical sense.

Who will be worse off?

Alan Duncan answers:

In absolute dollars, more GST is paid by those who spend more on taxable goods and services. However, the important question to ask is who would be worse off in relative terms from an increase in the GST rate, and/or by a broadening of the GST tax base.

Lower income households spend proportionately more of their income on goods and services than middle and higher income households. Indeed, for some in the lowest income bracket this can exceed their disposable income, with debt used to sustain spending in the short term. We also know that around 40% of household spending is on GST-exempt goods and services – principally fresh food, education, health and rent.

Household data show that the poorest 20% of households pay around 9% of their disposable income in GST on purchased goods and services - an average of $34 each week. The richest households pay only 3.5% of disposable income in GST – which amounts to just over $120 each week.

Increasing GST from 10% to 15% would see the poorest fifth of households pay around 13.5% of their disposable income in GST – equivalent to $50 per week, nearly $17 more than currently paid. Middle income households would see GST rise to 8.2% of income - paying $105 per week, a rise of $35 - with higher income households also paying up to $80 a week more. However, they also have around nine times the income of the poorest households and are therefore more able to absorb the impact.

GST payments would increase further if a GST rate rise were to be combined with a broadening of the tax base - to 15.2% of disposable income for the poorest households, more than $23 extra per week on current payments. A middle income household would pay $47 more each week.

Without compensation, those households who would be most affected by a GST rate rise include those heavily reliant on government benefits as their main source of income, renters, single parents and elderly singles and couples all of whom are already over-represented in poverty numbers.

GST reform - along with other tax reform options – should be on the table, but a GST rate rise needs to be treated with care, and an adequate compensation package put in place, to overcome the regressive impact of such a change.

What about compensation? Would that work?

Patricia Apps answers:

An increase in GST would not only be regressive, it would also be very inefficient.

Compensation will be targeted and, in the case of couples, withdrawn on the basis of joint income. The withdrawal rates will raise effective marginal tax rates on low income earners and partnered women as second earners.

The labour supply of these groups, particularly that of mothers of dependent children, is highly responsive to changes in tax rates. They switch to part-time work or drop out of the workforce if they are taxed too highly.

As I have shown in numerous papers based on household survey data, with an expansion of the GST we can expect a negative effect on household labour supply and saving and, with the shift in the tax burden towards the “middle”, on aggregate demand and economic growth.

Are there other options that would raise the revenue the states need?

John Daley answers:

State governments can go a long way towards meeting their budget challenges by raising more revenues from their own tax bases. The states control the most efficient tax base available to any Australian government: property. Well-designed property taxes drag less on the economy for each dollar of revenue raised than any other tax. Unlike capital, property is immobile — it cannot shift offshore to avoid higher taxes. Concerns about the risks of multinational tax avoidance, the increasing mobility of global capital and the increasing value of residential property relative to incomes should make property taxes a priority in any tax reform.

Property Taxes, a new Grattan Institute paper, finds that a modest property levy of just $2 for every $1000 of unimproved land value would raise $7 billion a year for the states and territories. The annual charge on the median-priced home in Sydney would be $772, in Melbourne $560, and lower in other cities and the regions. A broad-based property levy could help plug the gap for schools and hospitals left by the Commonwealth’s decision to cut funding to these areas from 2017-18. Based on historical price trends over the past two decades, revenues from a levy on unimproved land values could double to as much as $14 billion by 2024-25, offsetting much of the projected shortfall from Commonwealth cuts.

Higher property taxes could also be used to fund the reduction and eventual abolition of state stamp duties on property. Stamp duties are among the most inefficient taxes because they discourage people from moving to better jobs, or to housing that suits their needs better. Their revenues are inherently volatile. Shifting from stamp duty to a broad-based property tax would provide a more stable tax base, spread the tax burden more fairly, and add up to $9 billion annually to GDP. The ACT is already phasing out stamp duty over 20 years, and replacing the revenues with higher municipal rates. Other states and territories could follow suit.

Alternatively, states could fix their existing land taxes, which are paid on around half of Australia’s land by value due to exemptions for owner occupied housing and agricultural land, and minimum thresholds below which no land tax is payable. These state land taxes raise $6.4 billion a year. Broadening their base to include owner occupied housing could raise about $5 billion in extra revenues. Reducing the tax-free thresholds would raise even more.

State payroll taxes are reasonably efficient taxes that raise $21.4 billion a year for state governments, and could raise more. However, thresholds and exemptions limit how much they raise, and distort economic decisions by discouraging companies from growing larger.

Victorian Premier Daniel Andrews has proposed increasing the Medicare levy on income tax to fund extra spending on health services. However, this would increase the gap between how much states spend and how much they collect in tax. Almost half of state revenues come from Commonwealth grants, much more than in other federations such as Canada, Germany and the US. Reducing this mismatch between revenue and expenditure would reduce the blame-game in which the states and Commonwealth blame each for policy failures rather than taking responsibility for the money they spend.

Alan Duncan is Director of the Bankwest Curtin Economics Centre. Bankwest Curtin Economics Centre is an independent economic and social research organisation located within Curtin Business School at Curtin University. The Centre was established in 2012 with support from Bankwest (a division of Commonwealth Bank of Australia) and Curtin University. The views in this article are those of the author and do not represent the views of Curtin University and/or Bankwest or any of their affiliates.

John Daley is CEO at Grattan Institute. Grattan Institute began with contributions to its endowment of $15 million from each of the Federal and Victorian Governments. In order to safeguard its independence, Grattan Institute’s board controls this endowment. The funds are invested and Grattan uses the income to pursue its activities.

Patricia Apps has received funding from the ARC for her tax research.

Roger Wilkins receives funding from the ARC and from the Department of Social Services, which funds the HILDA Survey.

Michelle Grattan does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.