Ideas@TheCentre
GST and the Ratchet Effect
On 1 October, New Zealand got a new tax system. Lowering the tax rate and broadening the base were the catch cries of the government. ‘Rearranging the incentives in the economy’ was one of the awful phrases trotted out by the government.
Income tax rates underwent a modest reduction, while the Goods and Services Tax (GST) was increased to 15% – this despite Prime Minister John Key explicitly promising before the 2008 election that there would be no increase to the GST. He had argued then that the government would grow the economy so an increase in GST would not be necessary.
Unfortunately, Key also promised to keep many of the previous Labour government’s entitlements, or handouts, to favoured political groups and not to slash spending. These promises were not compatible, of course, and some had to be broken. As is always the case, it was easier to raise tax.
Although the government argues that the changes are revenue neutral (that is, they will collect the same amount of tax, albeit from different people), they show the ratcheting up effect that occurs with consumption taxes over time.
When the GST was introduced in 1986, it was accompanied by a slashing and abolition of other tax rates. New Zealand’s snakepit of taxes were untangled, the top income tax rate halved from 66% to 33%, and the GST was set, with no exemptions, at 10%.
Twenty-four years later, the top tax rate is being reduced to 33% and GST increased by 15%! Admittedly, GST has been at 12.5% since 1989 but income tax rates were raised in the meantime – the top rate being 39% under the Clark government.
And here is the GST paradox. It is such an effective income raiser, and the least economically harmful, that the temptation is always to raise it in increments. The 10% tax on all consumption is now a 15% tax on all consumption. And it is true that GST is regressive in absolute terms – the higher it is, the more it affects those on the lowest incomes.
Fortunately, New Zealand does not have European levels of taxation, but it pays to be aware that consumption taxes in European countries have slowly been ratcheted up, and that is a risk that over time, New Zealanders must be aware of.
Luke Malpass is a Policy Analyst with the Centre’s New Zealand Policy Unit.
