GST: Where to Next?

Historically, household consumption has been relatively stable as a proportion of gross domestic product (GDP). For over 50 years, tax reform reviews in Australia have accepted that the revenue from a tax on consumption expenditure would grow in line with the broader economy.

Consistent with that prevailing view, the 1998 A New Tax System White Paper proposed a value-added tax for Australia. The so-called goods and services tax (GST) commenced on 1 July 2000.

The objectives of the GST set out in the White Paper were to:

• secure and grow a source of revenue for the States and Territories;
• remove the reliance of the States on Commonwealth grants and distorting taxes; and
• ensure that ‘the erosion of indirect tax revenue is halted permanently’.

My review of the GST’s performance published in UNSW Business School’s eJournal of Tax Research concludes that the existing GST system is unlikely to satisfy the objectives set for it in the White Paper. It suggests that the growth and stability of GST revenues is unlikely to be achieved by merely broadening the base and/or increasing the rate due to the reasons discussed below which include:

• the areas in which the GST base can be expanded do not grow in proportion to increases in GDP. Consequently, if the base from which GST can be collected is a diminishing proportion of GDP, the rate of GST would have to be indexed regularly to maintain GST’s proportion of GDP;
• Increases in savings diminish consumption and hence GST revenues;
• Losses from GST non-compliance are an increasing proportion of collectable GST.

Subsequent to undertaking my review, the negative effects of COVID-19 on the economic environment and forecasts have been significant.

My recommendations from the review relating to the GST’s policy gaps are summarised hereunder. But further administrative and tax integrity reforms will be necessary to address GST’s diminishing proportion of GDP.

GST today

The 2020-21 Budget statement of revenues and GDP for 2019-20 are:

• total GST revenues – $60,263 million;
• GST revenue as a percentage of total Commonwealth tax revenue – 13.96 per cent;
• GST revenue as a percentage of GDP – 3.04 per cent.

The 2020-21 Budget forward estimates show that GST revenues as a percentage of GDP were at a record low in 2019-20 of 3 per cent and will grow to only 3.35 per cent by 2023-24.

The data of the OECD indicates that, in the 2017-18 fiscal year, GST/VAT as a proportion of GDP in Australia was 3.3 per cent as compared with an OECD average of 6.8 per cent.

Sustainability of GST revenues

Recent publications of the Parliamentary Budget Office, Trends affecting the sustainability of Commonwealth taxes (2018) and Structural Trends in GST (2020), foreshadowed decreasing GST revenues (as a proportion of GDP) and concluded that the reduction is likely to continue.

The 2018 report writes that:

When the GST was introduced, GST receipts were 3.4 per cent of GDP. GST revenue peaked shortly after, in 2003-04, at 3.8 per cent of GDP, reflecting the maturing of the new tax. Since then, GST receipts have declined as a share of GDP to 3.4 per cent in 2016-17…

… [T]here is a likelihood that taxes on consumption will continue to trend downwards … If these risks to tax receipts eventuate, and in the absence of other taxation reforms, maintaining Commonwealth Government revenue at recent levels as a share of GDP will lead to an increasing reliance on taxes on labour income through the personal income tax system.

The 2018 and 2020 PBO Reports identify the trends contributing to the decline in GST revenues.

1. Since the GST was introduced the proportion of household spending on goods and services that are input taxed or GST-free has increased.
2. The prices of goods and services that are not subject to the GST have increased faster than those goods and services subject to the GST (consider prices of televisions (subject to the GST) versus health and education (which are GST-free)).
3. The rampant consumption in the early 2000’s was replaced by higher household savings during the global financial crisis.
4. The increase in participation in the economy by individual or small operators who may fall under the GST registration threshold.
5. Household rent (actual or imputed) is the single largest component of household consumption and has increased faster than GDP over recent decades. But GST is not payable on household rent (it is payable on investment in new dwellings) resulting in GST revenue decreasing as a proportion of GDP.

Estimates of the revenue forgone as a result of the under taxation of the ideal base – referred to as policy gaps – are quantified in Australian Treasury’s Annual Tax Benchmarks and Variations Statements.

Bridging the policy gaps

The Tax Benchmarks and Variations Statement 2020 estimates the total GST tax expenditures for the 2020-21 year as $28.9 billion. The top 5 categories account for $27.643 billion.

• GST-free food – $7.9 billion;
• GST-free health services, insurance, care, drugs and appliances – $7.19 billion;
• GST-free education – $5.05 billion;
• Input taxation of, and reduced input tax credits (RITC) for financial services – $4.55 billion;
• GST-free child care – $1.45 billion;

Having considered each of these expenditures, my review concludes that food and financial services should be fully taxed.

These reforms would, on the basis of the Tax Benchmarks and Variations Statement 2020 numbers, raise an additional $12.45 billion in GST. On the basis of the 2020-21 budget forecasts, the reversal of these expenditures would increase GST to approximately 3.72 per cent of GDP in 2020-21.

In addition to the full taxation of food and financial services, if the GST rate were increased to 18 per cent, on the basis of the 2020-21 estimates, GST revenues would grow to 6.7 per cent of GDP – closer to the OECD average.

But, if the trends identified in the 2018 and 2020 PBO Reports continue as predicted, addressing these larger policy gaps and an increase in the rate would not leave us with a secure revenue source for the States and Territories that is likely to grow with GDP. The trends that act against GST revenues growing with GDP are:

• The prices of goods and services that are not subject to the GST are increasing faster than those goods and services subject to the GST;
• The proportion of household spending on goods and services that are GST-free continues to increase;
• In periods during which household savings increase, household consumption (and consequently GST) decreases;
• GST collected through input taxation of residential dwellings does not grow at the same rate as the GST collected on investment in new dwellings;
• The increasing GST revenue losses from non-compliance (called ‘compliance gaps’).

Bridging the compliance gaps

Non-compliance is an equally significant challenge confronting VAT/GST revenue authorities. The Australian Taxation Office (ATO) has estimated that the GST compliance gap in 2018-19 was 8.1 per cent or about $5.8 billion.

In addition to considering policy gaps, my review also considers increases in the GST rate, integrity measures and the value-added tax design itself to assess the implication for GST’s future as the dominant source of State and Territory revenue.