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A couple of months back I wrote a column on New Zealand’s high and, at that time, accelerating rate of inflation. I concluded that column with the following comment:

There has to be some risk that, faced with growing public concern about inflation and the impact of the rising interest rates which the Reserve Bank is using to get on top of inflation, the Government will reach for a dopey policy like reducing GST to produce a one-off reduction in the inflation rate. That would do nothing to reduce the underlying rate of inflation – and could well accelerate it if Government failed to offset the loss of tax revenue by increasing tax rates somewhere else.

Since writing that column, the Government has announced that over the 12 months to November overall food prices rose by an astonishing rate 10.7%. Groceries rose by 10% over that 12-month period; meat, poultry and fish prices by 12%; and fruit and vegetable prices by a quite extraordinary 20%.

It is not hard to see why the Government might be tempted to find a politically popular policy which would ease the pressure on household budgets.

And if reducing the overall GST rate might cost too much in government revenue – keeping in mind that GST currently raises enough tax revenue to cover government’s entire spending on education (pre-school, primary, secondary and tertiary), together with spending on police, the justice system, and prisons – then perhaps they might be tempted just to reduce GST on food, or perhaps just on fruit and vegetables.

It’s easy to see why that would seem politically attractive to many voters.

But reducing (or eliminating altogether) GST on food, or just on fruit and vegetables, or indeed on any number of other items, would be a serious mistake. Any Government doing that, or promising to do that after the election, would be behaving in a seriously irresponsible way.

When in 1985 the Fourth Labour Government announced its intention to introduce a GST, the Minister of Finance, Roger Douglas, asked me to chair a three-person committee to design the tax. He told me that he was keen to widen the tax system to make it less heavily dependent on personal income tax but he was concerned about two issues.

First, he understood that a GST applied to all consumer spending would hurt those on low incomes more than those on high incomes because those on high incomes typically don’t spend all their incomes – those on low incomes are often obliged to spend every penny they earn. So he quite deliberately reduced income tax rates so that those on low incomes would be no worse off after the introduction of the new tax.

To the extent that those with dependants were not paying any income tax, or paying very little by way of income tax, he compensated those taxpayers for the effect of GST by introducing a kind of “negative income tax” in the form of a special family allowance. The only people he chose not to compensate for the introduction of the GST were those who were not paying income tax and who had no dependants.

His second concern was for the small businesses for whom the introduction of a GST could create significant additional compliance costs. He had heard horror stories from the United Kingdom about the difficulty which small businesses had had in operating with the British Value Added Tax, akin to our GST. He felt that large businesses with sophisticated computer systems could handle almost any complexity, but not so small businesses.

So his instruction to me was to design a GST which would minimize the compliance costs for small businesses. And of course it took no genius to work out that the best way to minimize compliance costs was to have a single rate of GST (then 10%), applied to virtually all goods and services without exception. So to this day we in New Zealand have arguably the simplest GST in the world. I am told that only the Singapore GST system comes anywhere close to the simplicity of the New Zealand GST: in this country, a business can often calculate the GST it owes in a matter of minutes.

But there were two additional reasons for not exempting any items from GST. The first was that if, say, fruit and vegetables were made exempt, why not also doctor’s bills, or children’s clothing, or books, or bus fares? The political pressure to exempt other worthy items would be intense and in no time the system would be complex and expensive to operate, as it is in many countries.

Secondly, exempting food from GST is an extremely inefficient way of helping those on low incomes. Yes, those on low incomes spend a higher proportion of their income on food than do those on moderate or high incomes, but most of the money spent on food is not spent by low income people: it is spent by those on moderate or high incomes. In 2018, the Government’s own Tax Working Group calculated that exempting all food from GST would benefit a decile one household (that is, a household in the lowest 10% of the income distribution) by $14.58 a week but would benefit a decile ten household (that is, a household in the highest 10% of the income distribution) by $53.03 a week.

So government would be losing a substantial amount of tax revenue with only a small part of it going to those who need it most. If helping those on low incomes is the imperative, much better to provide some form of direct cash benefit to those low-income people than to exempt food from GST.

The Government obviously knows this, and would almost certainly be strongly advised by Treasury not to tinker with GST as a way of helping those on low incomes, or artificially (and temporarily) lowering the inflation rate. If they nevertheless announce such a reduction that’s another reason to throw them out.

This article was first published at Elocal

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