Why have GST on food?

The issue of GST on food is once moregaining traction amongst various political parties and social groups. New Zealand’ssystem of GST is one of the best in the world because it has only one tax rateand that rate applies to almost everything.   We do not have the absurdsituation that exists in some countries where, for example, bread has no GST,chicken has no GST, but a chicken sandwich does have GST.   Or the situationwhere the chicken sandwich attracts GST if it is served warm, but not if it isserved cold.

Policy makers in New Zealand wisely decidedthat the administrative and compliance costs of having selected goods andservices exempt from GST would be too high.

While the current focus is on food, whenGST was being designed there was as much opposition to GST on other basic goodsand services such as energy and medical care.   Educators opined that GST onbooks would inhibit learning while producers of sporting goods suggested thatGST on their products would discourage exercise and make us all less healthy.  You can be sure if that if GST on food is ever removed, other calls forexemptions will soon follow.

Another reason for levying GST on as wide arange of goods and services as possible is that the wider the tax base, thelower rate of tax required for any given amount of tax revenue.   Removing GSTon all food would imply that GST on other goods and services would need to riseto realise the same amount of revenue.   This would strengthen calls for itsremoval on other basic goods and services.   The GST system would becomeprogressively more complicated and more open to cheating and avoidance.   So whynot get rid of GST completely?

If there was no GST income tax rates wouldundoubtedly have to be higher.   The higher a tax, the greater the incentive toavoid it and the more distortions it creates in the economy.   The main reasonfor GST being introduced in the first place was to enable government to obtaintax revenue in a more efficient manner – more efficient in terms of lowercompliance costs, and in terms of fewer economic decisions (such as what to buyor invest in) being determined largely by their tax implications.   GST isharder to avoid than income tax.

Many people believe that by removing GST onfood, food prices will drop by the full extent of the tax.   There are threereasons why this would not happen.

  1. The diagram shows the standard demand and supply curves familiar to any secondary school economics student.   As prices fall demand rises, so the demand curve slopes down.   The supply curve slopes upward because higher prices make it more profitable to produce.

Removing acommodity tax such as GST is akin to a shift in the supply curve. As far asconsumers can tell, prices fall for any given quantity supplied.   The marketmoves from A to B.   Note though, that while the price paid by consumers falls,it does not fall by the full amount of the tax.   The extent of the fall dependson the slopes of the curves.

  1. GST could be removed from the price paid by the consumer, but it would still exist on the prices of goods and services bought by food producers.   Even the last link in the product chain – the supermarket or green grocer – would still be paying GST on their inputs.   So although they wouldn’t charge GST on food sold to final consumers, they would still have to recover the cost of the GST that they pay on their inputs.   Thus the price reduction to the consumer would be very small.   The government could   reimburse all GST paid by sellers (making them zero-rated rather than GST- exempt), but while this would generate a bigger price reduction, it would be even more expensive, to say nothing of greater opportunities to cheat the system.
  1. Even if there is some reduction in food prices, there would be nothing to stop food retailers from rebalancing prices, in effect taking some of the potential price reduction in food prices and applying it to other products instead.   This becomes more likely when ‘food’ actually has to be defined.   Does wine count?   What about fast food?

So a broad based GST is a good idea forreasons of economic efficiency, compliance costs and avoidance potential.  Furthermore, removing GST on food is unlikely to generate much of a pricereduction.   That leaves the anti-GST on food lobbies with only one argument;that GST on food makes people less likely to have a healthy diet as they cannotafford good food. (Whether a diet based on good food is actually more expensivethan one based on bad food is highly doubtful, but that is beyond the scope ofthis article.)

There are two issues here – poverty and choice.  When GST was introduced income taxes and benefit rates were adjusted to ensurethat consumers were not made worse off.   Indeed, even if the offsets wereexactly one for one, the fact that the economy as a whole has a better taxsystem means that its growth should be higher, ultimately translating into ahigher standard of living.   Having said that though, if high food prices are ofconcern, the best means of immediate help is via lower income taxes, notabolishing GST on food.   Lower income taxes gives consumers more choice about howthey allocate their tax cut between food and other goods and services.

Removing GST on food may look likeassistance to cash-strapped consumers, but in the long term we will all feelthe adverse effects of a less efficient tax system.

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