The significant level of fiscal stimulus undertaken by the Federal Government to limit the impacts of the coronavirus-induced downturn has resulted in a return to a heavy budget deficit, compared to a previously forecast budget surplus of $7.1 billion in the 2019-2020 financial year. This highly expansionary fiscal stance with a high deficit can be achieved in one of two ways, or a mixture of the two. Firstly, the Federal Government could borrow from the private sector, although this would increase public sector debt and potentially lead to the “crowding out” effect – which is counterintuitive in stimulating household consumption and business investments due to higher interest rates.
The second option is to raise additional revenue from taxes. Australia has a relatively low GST rate of 10%, compared to the OECD average of 19.3%. By increasing the GST to a proposed 12.5% and broadening the GST base, the Federal Government will raise tax revenue directly from consumers. PwC estimates that the increase in the GST, and expanding it to “essential goods” such as fresh food, education and healthcare, will raise $40 billion in additional taxation revenue annually.
The GST is an ad valorem consumption tax of 10% levied on most goods and services. However, even though a “flat” rate of 10% is imposed, the GST does not affect all consumers equally. Low-income earners have a higher average propensity to consume (APC) than high-income earners. This is largely the result of autonomous consumption, which refers to consumption on necessary goods and services such as food, housing and utilities that must be consumed regardless of income. In other words, low-income earners will spend a greater proportion of their income on consumption, and will therefore pay a greater proportion of their income as GST.
An increase in the GST to 12.5% will predictably hurt lower-income earners to a greater extent than higher-income earners. At this proposed higher tax rate, households in the lowest income quintile will pay approximately 11% of their income as GST, while households in the highest income quintile will pay approximately 4.8% of their income as GST.
The higher prices of goods and services may reduce consumption because there is an inverse relationship between the quantity of goods demanded and their prices. This is especially the case with non-essential goods with more elastic demand. Because consumption of goods and services may contract, real economic growth will fall.
However, the higher GST rate allows for more taxation revenue for government expenditure. The government could use this money to invest in public capital such as roads and healthcare to boost economic growth. However, in times of economic difficulties (as is the case now), an increased proportion of government expenditure will be diverted to transfer payments and not to GDP-generating projects such as infrastructure.
Businesses may face difficulties in adjusting their pricing or complying with new tax regulations. These costs associated with changing prices due to unexpected inflation induced by the GST change are referred to as menu costs. Indeed, PwC quotes that
"Tax reform in the middle of an economic shock will pose another level of disruption to businesses."
The lower profitability of businesses could increase levels of cyclical unemployment and hinder economic recovery.
However, PwC does recommend that changes to the GST be implemented as soon as Australia has recovered from the immediate downturn, in order to repay newly-acquired public debt and assist in returning to a fiscal surplus as quickly as possible.
Increases to the GST can come with the compromise of abolishing stamp duty taxes. This will remove significant compliance costs to housing ownership, thus stimulating demand for housing. However, in the current environment, house prices are very high, and potential buyers must have significant savings to even acquire a mortgage (because of minimum deposit stipulations).
However, the higher GST will reduce the real incomes of consumers. Real incomes refer to the quantity of goods and services that can be purchased with an individual's income, whereas nominal incomes simply refer to the dollar amounts that an individual earns. Considering this distinction, in order for households to retain the same standard of living as prior to the GST increase, they must spend a higher proportion of their nominal incomes to consume the same number of goods and services (since they are more expensive).
Because consumption is negatively related to savings (given by the relationship Y = C + S), the higher level of consumption will lead to a slower rate of savings accumulation. It is therefore more difficult to save the funds required for purchase of property.
Cost-push inflation is expected to increase because of the GST increase. For reference, when the 10% GST was introduced in 2000, the headline inflation rate as measured by the percentage change in the CPI rose to 4.46% from 1.41% in 1999.
However, in the current climate, the change to inflation is not expected to be detrimental, especially because inflation has been below the RBA’s target band of 2-3% for a prolonged period of time, and there is risk of deflation due to a decline in demand for goods and services.