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» Feature Article

20th September 1998

GST, a general overview of how a GST works

The Federal Coalition's GST is a variation of the goods and services tax proposed in the 1992 Fightback! plan.

John Dymond explores the likely consequences.

The GST unveiled by the Federal Coalition will not tax the goods and services as such, but rather the value added to them through the production/distribution process. This is how a value added tax works, and a goods and services tax is simply a value added tax by another name. The table below illustrates the concept.

 

 

 

 

 

 

 

Consumer pays 150+15=165

* Farmer receives credit for GST paid on inputs to production.

GST is collected by businesses from its customers (the amount of tax being equivalent to the sale price of the goods/services supplied to the customer multiplied by the GST rate) and remitted by the business to the tax office by means of completion of a return. Upon receipt of the return, the tax office would process the detail and issue a cheque to the business for the tax paid by it on business inputs. The retailer in the above example, for instance, would pay $15 tax and, some time later, receive a $10 refund.

You are probably already thinking this process creates some interesting issues. Let me discuss some other aspects of this tax which are likely to emerge in the Australian context.

If we assume that the Government backs away from using a GST to alter the "tax mix" (i.e. proportion of indirect taxes to direct taxes), as seems likely, the GST is simply replacing the wholesale sales tax, which is now universally condemned as being overly complicated and contentious, with various rates of tax, numerous exemptions and arbitrary decisions leading to an ever narrowing tax base, an ever increasing backlog of litigation and an exceedingly non-competitive manufacturing sector. That being the case, the argument for a GST would supposedly be that it employs simply one rate, broadens the tax base (through the inclusion of services) and is much simpler.

Oh were it to be so! Alas, the Government will succumb, at least to some degree, to a number of complications to the relatively simple model illustrated in the above table. It is likely that numerous goods and services will be exempt and that numerous goods and services will be zero rated. Why is this so? Will this lead to a tax system which is destined to become as ineffective as the present wholesale sales tax system?

The major hurdle for any Government in bringing in a value added tax is that it is easily misunderstood. It is readily perceived by the lay community as a tax on what they spend, that is a bare consumption tax. As the table above shows, this is simply not the case. The incidence of the tax lies with the addition of value through the production/distribution process. If the retailer in the above example sold the item for $100, no value would be added, no net tax would be paid by the retailer, and no tax would need to be charged to the consumer, especially if the retailer were allowed to net off gross tax payable against tax credits receivable.

Despite this fact, we are bound to be told at least once between now and the next election that a 10% GST will increase the cost of everything by 10%. As can be seen from above, this would only happen if every retailer passed on the full gross cost of the GST, resulting in a spontaneous increase in the profit margin of all retailers throughout Australia as the direct result of the imposition of a new tax! I don't think so.

We are also bound to be told such things as:

» it is immoral to tax baby food;
» it is immoral to tax books;
» it is immoral to tax health;
» it is immoral to tax education;
» it is immoral to tax clothing;
» it is immoral to tax shelter (rent);
» it is immoral to tax insurance, etc.

As a result of this lobbying, many items will be zero rated or, even worse, exempted. Let me explain why this action is so misguided.

If an item is zero rated, it means that GST applies to it, but at a zero rate. This means, referring to the table above, if what the farmer produced was zero rated, no GST would be paid by the farmer, but as the item was subject to the GST regime, the farmer would be able to claim GST credits for any GST paid on inputs to the production process. All things being equal, this would make the item cheaper, and perhaps the farmer could pass on this cost saving. So far, so good. However, by creating a different rate and arbitrarily deciding that a particular good and/or service qualifies for that different rate, one immediately establishes the classification battleground that characterises the present wholesale sales tax mess.

Exempting an item is even worse. By taking the item wholly outside the GST regime, whilst no GST is payable on the item, no GST credits are claimable in respect of inputs to production. Depending on the extent to which value has been added and the cost of inputs, exempting an item could, in and of itself increase the end cost of the item!! The classification battleground argument raised above would of course apply here also.

O.K., so what about the first issue raised, the lodgement of returns and claiming of credits? Clearly, the frequency with which returns must be lodged, and the speed with which refunds are processed and dispatched is of crucial importance.

A related issue of critical importance will be whether the GST liability is to be calculated on a "paid or received" basis or a "payable and receivable" basis. Many businesses pay for their purchases some time before they receive money for their sales. As the gross GST will nearly always exceed the amount of GST credits allowable, by making businesses liable for GST on an accruals ("payable and receivable") basis the tax office would typically be requiring payment of tax by the business before the proceeds of sale had been received, a practice which could severely disadvantage small businesses.

You may think I'm dwelling overly on detail here. The point is, whereas the wholesale sales tax system affects approximately 70,000 wholesalers throughout Australia, a GST will affect every Australian business. That's over 900,000 businesses. It is vitally important that the GST is simple, easy and efficient to comply with, and does not bring with it adverse cash flow consequences.

So, if we're going to have a GST, the GST we want is one with no exemptions and no zero rates, which allows GST credits to be offset against GST payments, and which is quick and simple to comply with (and no different rates or exemptions will assist greatly in this regard). How close we come to this ideal will depend on the quality of the forthcoming debate. Hopefully this contribution can go some way in making the debate an intellectual, and not an emotional, contest.

  Stage of Production Sales Purchases Value Added Gross 10% Refund 10% Tax 10%
1 Farmer* 40 - 40 4 - 4
2 Processor 60 40 20 6 4 2
3 Manufacturer 90 60 30 9 6 3
4 Wholesaler 100 90 10 10 9 1
5 Retailer 150 100 50 15 10 5