A dissenting economist on GST: we should charge more on beer and smokes

Recently, 49 prominent Australian economists were polled by the Economic Society of Australia on the issue of GST reform.

Each member of the panel was asked whether they agreed with the following statement:

Increasing government revenue collected through the Goods and Services Tax (GST) by removing exemptions (such as food, health and education) is better than achieving the same extra revenue by increasing the GST rate while retaining the existing exemptions.

Respondents were given five choices ranging from “strongly agree” to “strongly disagree”. The comments were highly varied, but a slight majority of respondents, 54%, chose "agree” or “strongly agree”.

I was among the 11% who chose to strongly disagree.

Among the respondents was Professor John Freebairn, an expert on tax policy. John focusses on the efficiency and equity aspects of the proposed removal of exemptions, arguing that “A broader base and lower rate reduces distortions to the mix of spending choices”.

Not surprisingly, he strongly agrees with the statement that exemptions should be removed, albeit subject to concerns about how the extra revenue is spent including possible compensation for low income groups on equity grounds.

My own comment in strongly disagreeing with the removal of current exemptions is that “it is appropriate for different categories of consumption to be discriminated for (food, health and education) or against (alcohol and tobacco) based on their considered contribution to social well being.”

The design of the GST, including the range of exemptions, was the outcome of a political compromise. In spite of the hyperbole that accompanied the political arguments of the time, the end result did arguably represent the will of the people.

Were people who favoured a GST with exemptions over a tax without exemptions poorly informed or misguided about the efficiency benefits of a broad-based tax over a discriminatory tax (in that it favoured some items of consumption over others)?

Many economists would answer yes to this question, but not me. Critical to my dissent is my view on the proper method for evaluating the benefits society derives from the goods and services consumed.

The standard method in economics for evaluating societal benefits from this consumption is to add up the benefits to each and every individual from their own consumption. Exceptions are allowed where a consumption activity has clear impact on others, such as smoking in an enclosed area. Otherwise, the method implies that government interventions that change the composition of what people consume are distorting in the sense of lowering overall benefits.

Sound good? Fortunately or unfortunately we live in a highly interdependent society. The consumption activities of each of us impact on our family, friends, neighbours and even the society at large. Although these impacts are usually very small, they do add up over large groups.

In this sense, there is a social impact of individual behaviour that often diverges from its private impact. Economists tend to downplay the difference between social impact and private impact, partly because we tend to be believers in individual liberty (“small l” liberals) and partly because economics lacks proper tools to deal with the difference.

So far I have dealt with general concepts; now let us turn to the specifics of the exemptions allowed under the current GST arrangements. Big exemptions, in terms of GST revenue foregone, are for health, education and most food consumed at home.

Using standard economic analysis of supply and demand, exempting these goods and services from GST means we have a healthier and better educated population that spends more time eating at home than would be the case with a uniform rate of GST. Is this good or bad for Australian society?

My fellow economists who agreed or strongly agreed with the statement posed by the ESA think the distortion of individual consumption choices through the GST is bad. Some explicitly mention the use of other methods to achieve socially desired results, but that involves reinterpreting the statement posed by the ESA. I evaluate the implied outcome of more education, more health care and more food at home directly on its merits and I think it is good for Australian society.

This is based partly on my own preferences about the type of society in which I live and partly on my understanding of how education, health and home life contribute to social cohesion. I’ll stop here, for the analysis of social cohesion would take me beyond the usual boundaries of economic analysis and the limits of my own expertise.

Harry Bloch does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond the academic appointment above.