Cutting the GST: a dumb idea from the textbook

The financial crisis has been the making of Gordon Browne we’re told. While Hank Paulson was holding masterclasses in crony capitalism Gordon Browne’s rescue package showed how it was done. His recapitalising the banks by buying equity in them was right out of the textbook, maximising state upside and minimising moral hazard.

Anyway, his next step has also been out of the textbook. But it seems dumb to me. He’s cut the UK’s VAT (which in this country we call a GST) by 1.5%. It’s a temporary cut. And the textbook tells you that this is better at stimulating consumption than giving people (say) a temporary 1.5% increase in their take-home pay because that gives them no incentive to spend the money now. I suspect that lurking here is the idea that the GST offers a very broad base over which to offer the goodies and that’s usually a nice thing – it’s one of the things that makes a GST more efficient (other things – like revenue – being equal) than a narrower tax base.

But I think there are big problems with this. A small but far from trivial point is that the GST is administratively intensive. And changing the rate means at the very least reprogramming everyone’s accounting system, dealing with a bunch of transitional issues and for really small operators like small stores, you might have to wander through the shop sticking new price labels on every item. All this for a price change of 1.5% some of which won’t even be passed on.

More importantly there will be a whole lot of things that are not price sensitive – food being a classic example, you can’t stock up on fresh food, for instance – you buy it as you go. A great many things are like this. And for more discretionary purchases will 1.5% look like a sufficient bargain to make a difference. I don’t think so. So I think a better policy would be to spend the same amount of money (revenue foregone) on larger and more targeted temporary subsidies or tax cuts for items which can be expected to be sensitive to incentives to pull forward consumption/investment. (Actually that just made me realise another objection to a GST reduction. Business only collects GST – it doesn’t pay it – so the change in rate has no effect on their bottom line except in additional costs for bookkeeping and what’s called in the jargon, ‘menu costs’ – changing labels etc.)

The increased first home owners grant for newly built houses is an example of targeted pulling forward of purchases. Some temporary depreciation allowance or whatever for new car purchases could do the trick (though it would have a low multiplier given the import intensity of the industry), but there are lots of places where you could pull forward activity with temporary tax credits, subsidies or whatever. One could have them for equipment, buildings, improvements to houses – extensions, or if one wanted to be more worthy, environmental improvements like insulation, solar hot water and water tanks for instance.

Anyway, Peter Martin seems to think temporary GST cuts make sense and has quoted a bunch of economists from a Crikey! ring around sounding encouraging. I raised some of these things on Joshua Gans’ blog but he was unimpressed – observing “Nicholas, that is what you do for a fiscal stimulus. It is expensive.”

Joshua hasn’t responded to my reaction to this comment, but my objection to it is precisely that it’s more expensive and so less efficient than alternative more targeted measures.

I’m pleased to see the Govt’s not interested. But perhaps I’m wrong. I’d welcome anyone with a good knowledge of the literature or any other insights I’m lacking setting me straight.

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vanaalst.robert
vanaalst.robert(@vanaalst-robert)
13 years ago

I think here you are bumping into the difference between economics and politics. I think the reduction in GST is better than targeting certain groups, because targeting certain groups simply reminds me too much of pork barelling and wasting money. It’s all very well to have arguments for wasting money on particular groups when money needs to be wasted (assuming it can be done efficiently), but I’d prefer to have a more inefficient measure as deliberate targeting of certain groups which will simply look like vote buying to many. Why habituate people to political corruption? It’s easy to see this mentality dragging on across the economic cycle, even when it is not needed, and it will simply give politicians an excuse for it e.g., “Well, Labor gave specific group X handout Y, and that helped out, and now we’re just doing the same…”

Also, on a different note, what is the argument for reducing GST rather than income tax, the second of which is easy to stick up again via stealth later on?

Joshua Gans
Joshua Gans(@joshua-gans)
13 years ago

Nicholas, did I miss a meeting? There is GST on food now?

It is completely unclear that it is more expensive or less efficient than alternative measures. For instance, the cash payment to pensioners is clearly neither.

On the accounting nonsense, a simple software patch will allow for a different GST rate. That is a hardly a big cost. And what is more, there is no requirement that your prices have to follow GST tax rate cuts so there is no issue there. After all, petrol prices are fluctuating and in my reading stores are having no trouble at all changing their prices.

So you want to target different industries for tax breaks? Give me a break. Those are distortionary and do not have broad implications. To do this under the guise of macroeconomic policy would be an outrage.

The first big principle of taxation is minimise distortion. You are rejecting that in virtually everything you are recommending on the tax side these days. The problem with temporary targeted tax breaks is that they tend to stick. So they are not a stimulus at all.

That said, I can see the case for using direct government expenditures thoughtfully, such as on infrastructure for the environment or telecommunications, to bring forward stimulus.

Dave from Albury
Dave from Albury
13 years ago

My layman’s opinion is that a GST cut would be pointless. As Joshua points out, there is no requirement that prices follow GST rates, which means that they probably won’t. That’s very nice for the retailers and service providers, but I hardly think that increasing these people’s profits is an effective way of stimulating the economy.

I much prefer infrastructure spending as an economic stimulus and I think that the Federal Government’s decision to hand money directly to local Councils will give good results.

Joshua Gans
Joshua Gans(@joshua-gans)
13 years ago

Well let’s continue the point scoring.

First, you need to read the menu costs literature more closely: the point of that literature is that such costs are not incurred. So how much will be lost in menu costs? My guess would be 0.

Second, not targeting? I read housing and cars in your post.

Third, two words: “dividend imputation.”

Joshua Gans
Joshua Gans(@joshua-gans)
13 years ago

What I’m concluding is that you are easy to provoke.

In any case, on the GST issue, too many have ruled it out as untouchable. That is dangerous thinking. Instead, we need to actually run the cut through a macro model like the British did and work out whether it is worth it. Then, of course, unlike them, we will have to persuade all of the States to adopt the change. Not an easy task but perhaps with all of the extra money they have been given …

murph the surf
murph the surf
13 years ago

I’m a partner is a really small business and the administrative costs wouldn’t be high – partly as we are a service provider and

JM
JM
13 years ago

“changing the rate means at the very least reprogramming everyones accounting system”

Yeah. This can actually be far nastier than you might expect. I was in the UK in April 1990 when they increased the rate from 15% to 17.5%.

At that point I discovered two nasty problems with the accounting package I was using (cheap, not a lot above shareware but nonetheless I’d paid for a license)

1. I couldn’t change the VAT(GST) rate myself but had to wait for them to release an upgrade (for which I would have to pay)

2. It was programmed to assume that your financial year was the same as the tax year* and assumed a constant rate throughout the year. Change it mid-way? Welcome to month after month of manual adjustments.

I hacked my way round the first (which took a couple of hours), but the second I couldn’t defeat.

* For those not familiar, it is common in the UK for small companies to have financial years that differ from the tax year – this allows you to start a company in March (say) just before the budget, but only be required to lodge one return rather than two. You still have to comply with the conditions in the different years but the accounting costs are reduced.

Tel_
Tel_
13 years ago

A small but far from trivial point is that the GST is administratively intensive. And changing the rate means at the very least reprogramming everyones accounting system, dealing with a bunch of transitional issues and for really small operators like small stores, you might have to wander through the shop sticking new price labels on every item. All this for a price change of 1.5% some of which wont even be passed on.

Compared to the old Wholesale Sales Tax system, GST is a walk in the park. The only thing hard about GST is that some items get it and others don’t so you have to track each item through the system (otherwise you could ignore the items completely and just 10% the total).

When I was doing GST transition programming, I always made sure that the 10% was a global variable somewhere in the system. From talking with other people doing similar work, everyone expected the 10% to change fairly soon. One thing that dealing with government really beats into you is never trust what they say, and expect them to change their mind quickly.

If they really want to increase programmer’s wages, they might consider setting different rates for different line items. Ha Ha Ha!

Niall
Niall
13 years ago

Joshua, I’d suggest you’re correct when you postulate Nicholas’s provocation threshhold to be low, however, econo-gibber aside, I fail to see how a cut in the GST can be good for the economy as a whole. The GST provides governmental revenue, which if I read the news correctly, the government – state and federal – are spending in a bid to stimulate the economy, as a whole, create jobs, etc. As much as I despise the cobbled together nature of the GST, and the fact that it doesn’t replace all other indirect taxation, it is now a fixture and functional part of Australia’s economic system. Mucking with it, either up or down, would seem to me to be counter-intuitive.

TerjeP
TerjeP
12 years ago

Menu costs might be avoidable in some instances if the supplier simply increases quality (or quantity or both) modestly instead of decreasing prices. So the pizza place my make the pizza 1.5% bigger for instance. Or the consultant may think 1.5% harder during that one hour consultation. Or when you buy that toilet brush at the supermarket you might find that the checkout queues are slightly shorter than normal. ;-)

Tel_
Tel_
12 years ago

The GST provides governmental revenue, which if I read the news correctly, the government – state and federal – are spending in a bid to stimulate the economy, as a whole, create jobs, etc.

It doesn’t provide government revenue (pretending that something was created out of thin air). Like any tax, it diverts private money into government hands. Private people also spend money (after all, money is no use if you never spend it) and stimulate the economy, creating jobs etc. Do you have any evidence that government spending would be more efficient at achieving this result?

More importantly there will be a whole lot of things that are not price sensitive – food being a classic example, you cant stock up on fresh food, for instance – you buy it as you go.

People with more money tend to buy better quality food so their spending can increase even when their energy intake remains constant. People with a real lot of money pay someone to prepare their food and pay for a nice place to sit and eat.