Treasury has put forward theidea of rebalancing the tax system by raising the emphasis on consumption taxesand lowering the emphasis on direct income taxes. This view has merit, but italso needs to be accompanied by a redesign of the Goods and Service Tax (GST),for if the tax is raised, the current discrimination against service exportsembedded in GST will be accentuated.
The GST is on the whole a well designed value-added-type tax:
- It is broad-based
- It is based on real transactions and so easy to enforce and apply
- It does not interfere with production efficiency by taxingintermediate consumption
- It is, broadly speaking, self-policed
- There is just one uniform tax rate, which simplifies collectionand enforcement
The design of the New Zealand GST adheres to the"destination principle". The destination principle implies that if a good orservice is purchased in New Zealand it should be liable for GST. In principlethis means that imports should be subject to GST, as the goods and serviceswill be purchased in New Zealand. Exports on the other hand are exempt asfinal consumption will be offshore.
However, GST does not operate in this pure way in practice. This is because of the difficulty in applying the destination principle toservices such as tourism or educating foreign students. The national accountsrightly treat the expenditure by New Zealanders abroad as an import and theexpenditure of foreigners visiting New Zealand as an export. However, the waythat the destination principle is applied by the New Zealand GST means that theexpenditure of New Zealanders abroad escapes having to pay GST. It also meansthat tourists who visit New Zealand are liable to pay GST and other expendituretaxes during their stay in New Zealand.
As a result, GST raises the relative returns of exportinggoods above that of exporting services. It also encourages consumers to spendtheir money on trips abroad ahead of travel within New Zealand or indeed on anyother product available within New Zealand. Although the misapplication of GSTlooks like a tax on overseas tourists, it is in reality a tax on the incomes ofthose in the tourist industry and other traded services industries. By loweringthe relative returns from exporting services, like tourism and education, GSTlowers incentives to invest in the service export industries and so constrainstheir pace of growth.
For example, if a tourist arrives in New Zealand with a budget of $NZ1000, the tourist industry is likely at most to receive $888.89 ofthis while the remainder is collected as GST by the government (ignoring otherduties such as excise and tariffs). If the same person spent their money onsheepskin products (either overseas or at a duty-free store) the export sector(including associated services) would receive the entire $NZ1000.
By artificially lowering the relative returns from theseservice exports, the distortion created by GST artificially creates winners andlosers, and so misallocates our investment resources. This lowers New Zealand’s overall pace of growth, incomes and living standards.
Attempting to correct this distortion using the currentdestination principle will simply generate excessive administrative andcompliance costs. Instead a paradigm shift is required. And there is aremarkably simple solution – the GST design should shift from using thedestination principle to the origin principle in determining who should payGST.
A GST designed using the origin principle would exempt allimports from GST, but would tax all exports (including the service exportsalready taxed). That is, rather than attempt the exceedingly complex task ofremoving the unfair tax on the tourism industry, simply remove the dispensationcurrently provided to other exporters. Similarly, instead of attempting theimpossible task of taxing New Zealanders who travel abroad, simply remove alltaxes on imports.
An obvious objection that many might have to this approachis to question what the impact of applying GST to our exports will do to thecompetitiveness of the export sector. The short answer is very little. In thepresence of a flexible exchange rate, the shift to an origins-based GST willtrigger a one-off exchange rate depreciation, so the taxation of exports willno lasting impact on the competitiveness of exports. This exchange ratedepreciation will neutralise the effect of raising GST on the exports thatcurrently do not pay GST, and at the same time will provide a correctivestimulation to the service exports that are already paying GST.
The advantages of this approach are that it:
- Restores the principle that transactions between countries shouldnot be taxed
- Treats all exports uniformly and also all imports uniformly
- Greatly simplifies the administration of GST
- Does not penalise exporting
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