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The revenue performance of any tax, including broad-based consumption taxes such as the Goods and Services Tax (GST), is limited by the environment within which it operates. Policymakers can set the statutory rate, change the statutory base and attempt to enforce the tax, but many determinants of tax revenues are beyond their control. Examples of these include the level of economic development, the composition of economic sectors, the volume of foreign trade, the performance of government institutions and fixed factors such as geographical location. Economists refer to these examples as tax capacity constraints.

Calculating GST revenue performance

Three measures are generally used to calculate GST revenue performance: a GST to gross domestic product ratio, a GST to total final consumption ratio, and a C-efficiency ratio. A C-efficiency ratio is a GST to final consumption ratio that controls for standard rate differences among countries. Each of these measures is useful, but they do not take into account the GST capacity constraints that policymakers face.

Using regression analysis, one can predict countries’ capacity to collect revenues from the GST, referred to as GST capacity. My recent article in the eJournal of Tax Research, Value-added tax effort, publishes an index of GST capacity for 129 countries. To construct the index, I consider GST capacity constraints likely to have the greatest influence on GST revenues. The constraints are political institutions, the level of economic development, trade openness, hard-to-tax supplies (agriculture and financial services), and fixed factors over the data period (2004-2014). Collectively, these constraints explain 94 per cent of the variance in GST revenues between countries. The model is therefore useful to predict GST capacity.

The index shows that Australia has a GST capacity of 14.4. This means that Australia has the capacity to collect GST revenues equal to 14.4 per cent of its final consumption expenditure. According to the data used in the article, Australia collects GST revenues equal to 4.9 per cent of final consumption expenditure. Actual GST revenues is therefore significantly below capacity.

GST effort

A measure that can be calculated by using the figures referred to above is GST effort. GST effort is defined as the amount of GST revenues collected, taking into account a country’s capacity to do so. The calculation is simple: divide the current GST ratio (4.9 per cent as above) by GST capacity (14.4 per cent as above).

Using this measure, which equals 0.34 for Australia, it is possible to rank countries based on their GST effort. Ranked from highest to lowest GST effort, Australia ranks 115th out of the 129 countries included in the article. This ranking is not likely due to the trend of developed countries to rely more on income taxes. Only four of the 14 countries that have a lower GST effort than Australia are regarded as developed: Canada, Japan, Singapore and Switzerland. Since broad-based consumption tax revenues levied at the state level are excluded from the calculations, Canada can be removed from this list.

Whereto with the GST?

The results from this study answers the question: Can Australia increase its reliance on the GST? Based on the findings the answer is a clear yes. But few things should be done simply for the reason that they can be done. Perhaps a more important question is: Should Australia increase its reliance on the GST?

Most empirical evidence finds that – consistent with economic theory – decreased reliance on income taxes improves long-term economic growth. This is, however, not always the case. A recent paper on OECD countries addresses some estimation issues in previous studies and finds no robust relationship between the tax mix and economic growth (Baiardi et al. 2017). If this result is relied on, equity considerations should be at the forefront when considering the tax mix.

Contrary to popular belief, empirical evidence often finds that policies aimed at reducing inequality can increase long-term economic growth (see for instance, Aghion, Caroli and Garcia-Penalosa 1999). Hence, the theoretical efficiency-equity trade-off does not hold. Only considering equity, the multiple-rate structure of an income tax can be preferred to the “best-practice” flat rate of a GST. This structure ensures progressivity where the GST cannot.

Taking the above into account, Australia can likely prefer revenues from the income tax to the GST. If income tax revenues are already collected at full capacity and additional revenues are required, then Australia has the capacity to turn towards the GST. The low GST effort of Australia is therefore unlikely to be an immediate policy concern.

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