The basis of a consumption tax
A consumption tax is an expenditure or a cash-flow tax. Put simply, it is a tax on what people spend. Two economists¹ describe the difference between income tax and consumption tax this way: “Taxing income taxes what people contribute to the economy while taxing consumption taxes on what people take out.” In the US, few people advocate a consumption tax only or want the US Federal Government to replace or supplement the income tax with a sales tax or a VAT, although such arrangements exist in Europe.² Some tax experts and economists prefer consumption taxes over income taxes because this approach promotes economic growth.³, ⁴ This view was also evident in an article published by the Wall Street Journal in 2008.⁵ In Australia, the Federal Government taxes both income and consumption, which is similar to the situation in many countries.
Taxation can be broken down into three categories: capital, labour and consumption. Capital includes company tax, taxes on personal capital income and property taxes. Labour includes taxes on labour income (PAYG and the like), social security contributions and payroll taxes. Taxes on consumption include value-added taxes (like the GST) and excises in addition to taxes such as motor vehicle stamp duties and gambling taxes.
How Australia compares
Figures 1, 2 and 3 indicate that Australia is the highest taxed country overall for capital taxation among the OECD countries. This suggests that Australia relies heavily on non-consumption taxes compared with many European countries.
For the period 2009/10, the Commonwealth Government’s taxation revenue was $267,171 million. Of that, $78,865 million was from taxes on provision of goods and services (GST) equating to 29.5 per cent (this was compared with 28.4 per cent for the period 2004/05). Income tax for the same period was $187,016 (70 per cent). The other 10.5 per cent was from payroll taxes, property taxes and taxes on use of goods and performance of activities.⁶ This is for the Commonwealth Government only; slight variations of percentages are noted when considering all levels of government (state and local). Income tax levied on individuals for 2009/10 represented 38 per cent of total taxation revenue (all levels of government) whereas income taxes levied on enterprises represented 18 per cent, while GST (across all levels) added another 14 per cent.
When comparing the level of consumption tax across OECD countries (Figure 2), it can be seen that Australia is lower than a 33.3 per cent split on consumption tax. Interestingly, the US is the lowest, followed by Japan. And does it bear asking the question, what is the relative tax break-up impact on the overall economic strength of the various countries?
A breakdown of taxes across OECD countries (Figure 3) suggests Australia has a higher capital tax and labour tax than the GST as a percentage of gross domestic product (GDP). Given that the current tax system is heavily weighted to income tax/capital tax (56 per cent), what would be the benefits of having a total consumption tax system?
What would need to change?
First, the current approach to exemptions would need to be addressed. There is a strong feeling that by removing the exemptions it would make it easier to apply GST and would reduce the costs to those charged with collecting GST. Further, many feel that consumers are quite possibly ready to accept the exemption removal given the GST has now been in place for more than 10 years (although a carbon tax – in effect a consumption-based tax – now rearing its head and potentially adding an additional four to five per cent to the grocery costs, plus rapidly increasing costs in utilities, would possibly negate that view). In reviewing those taxes that would need to be removed, one would expect that the first ones would be payroll taxes and some capital taxes. Then there is the issue of labour taxes (eg, PAYG). If the tax system is to go to a wholly GST-based structure, then one would assume these would need to go also.
Second, reconsideration of the current arrangement regarding the apportionment of GST with the States and Territories would be required. This would be no mean task especially as we witness changes in the political landscape and with most states now led by Liberal/Coalition governments. It would be extremely difficult to get a consensus.
Finally, a change to the rate of GST, up from the current 10 per cent, would obviously need to be made although the present Government made an undertaking that the GST rate would be increased only under exceptional circumstances, such as the change considered here. There is a mechanism in place that renders it quite difficult to introduce a rate change (Trade Practices Act, 1974), whereby agreement from the Commonwealth Government (both Houses) as well as from all States and Territories is required.
What are the concerns?
Due to concerns about price exploitation, the Australian Government enacted specific legislation (Commonwealth-State Financial Arrangements Act 1999). It also empowered the Australian Competition and Consumer Commission to monitor and investigate price increases (though it has been with limited success). Compliance costs have always been an issue and highly controversial. This was highlighted by K. Marshall in the Australian Financial Review, where it was pointed out that there was evidence small businesses may be turning to cash to avoid having to deal with the GST tax (BAS).⁷ However, while the use of cash still remains an issue, compliance regarding BAS has certainly settled due to improvements made to lodgements as well as familiarity on the part of business operators.
In summary
So will we see a total consumption-based tax system in Australia? Well, the introduction of a carbon tax will change the percentage of consumption tax raised, so that will have some impact. But given the population size and the more volatile economic movement plus the current issues that have impinged on the economic well-being of Australia in recent times, such as floods and cyclones, it could be expected to be a slow progression, if at all. It will be a very brave Government that implements such radical changes.
Endnotes
1. Hall, R & Rabushka, R (2007), The Flat Tax, Hoover Institution.
2. Ehrbar, A. (2008) “Consumption Tax” in The Concise Encyclopedia of Economics, 2nd edition.
3. Greenspan, A. (2005), “Consumption Tax could help Economy”, Fox News, 3 March 2005.
4. Regier, P (2005), “Just how fair is the Fair Tax?”, Money, 9 June 2005.
5. “America the Uncompetitive”, Wall Street Journal, 15 August 2008.
6. ABS 5506.0. Taxation Revenue, Australia, 2009-2010.
7. Marshall, K. (2001) “Cost of Compliance a Much-evaded Subject”, Australian Financial Review, 8 May 2001, p. 18.
