An empirical note on the comparative macroeconomic effects of the GST in Australia, Canada and New Zealand

Economic Papers (Economic Society of Australia), March, 2005 by Tom Bolton, Brian Dollery

Australia, Canada and New Zealand have a multitude of cultural and economic characteristics in common that facilitates interesting comparisons between them. This short note takes advantage of this shared heritage by providing a brief empirical comparison of the macroeconomic effects of the introduction of the goods and services tax in the three countries. We consider summary data on some selected macroeconomic variables, including various neutrality measures, aggregate consumer price changes, economic growth effects, tax yield effects, and current account balance effects. It is concluded that not only was the GST highly successful in raising tax revenues, but it was also significant in terms of growth effects, price effects, current account effects, and the effect on the budget balance.

Keywords: Goods and services tax, Macroeconomic impact, Tax policy

1 Introduction

The limited purpose of this short note is to present a comparative empirical evaluation of some of the more important macroeconomic effects of the introduction of the Goods and Services Tax (GST) in Australia, Canada and New Zealand. Prior to the introduction of the GST in each of the three countries, considerable public debate occurred concerning the probable costs and benefits of its introduction, including the nature and extent of any efficiency gains and the nature and magnitude of the macroeconomic effects. Anticipated effects included changes in macroeconomic variables such as economic growth, the general price level, government revenue, and the current account balance. This note attempts to compare and contrast some of the observed macroeconomic effects of the GST package in each of the three countries in question.

The note itself is divided into three main sections. Section 2 provides a synoptic description of the implementation of the GST in the three countries. Section 3 examines the observed macroeconomic effects of the introduction of the GST, including various neutrality measures, aggregate consumer price changes, economic growth effects, revenue effects, and current account balance effects. We conclude with a brief recapitulation of the major findings in Section 4.

2 Institutional Background

Australia, Canada and New Zealand have many common cultural and economic features. All share a British colonial heritage with similar political institutions, a relatively sparse population, and an historical dependence on commodity exports. In the late twentieth century all three countries were undergoing a significant economic transition, with substantial public sector reform and the service sector growing rapidly as a proportion of GDP. Moreover, significant similarities existed in the structure of the taxation systems of the three nations (see, for example, Commonwealth Treasury, 2003). Since the 1930s all had had a wholesale sales tax of some form, the base of which was being eroded through economic development and technological change. The Manufacturer's Sales Tax (MST) in Canada and the equivalent Wholesale Sales Tax (WST) in Australia and New Zealand shared a long history of criticism. All three taxes had been introduced following the First World War and were based on a similar structure, base, rates and legislative rules. In all three countries this old tax was replaced as part of the transition to the GST.

The GST came into effect in New Zealand on 1 October, 1986 (see, for instance, Bollard, 1992; Kelsey, 1996; Walker, 1989; and Stephens, 1991). It was designed to align with existing international Value Added Tax (VAT) principles. Businesses (and other persons) engaging in a 'taxable' business activity were required to register for the tax. In essence, firms charged the tax at the set rate on sales and supplies and paid it to the national government taxation office. Certain products were tax exempt. Firms that charged the tax or bought zero-rated supplies were able to claim a refund for the GST paid on its inputs. Exemption of supplies or purchases made by unregistered persons could not be obtained. New Zealand's scheme was different from many existing schemes of VAT in Europe at the time in that it only had a single rate of 10 per cent. It also contained extremely limited exemptions. Financial services and residential accommodation were exempted, and exported goods and services and sales of businesses were zero-rated. In 1989, the GST was increased to 12.5 per cent, with income tax being restructured to two rates (24 per cent and 33 per cent) and the top company tax rate coming down to 28 per cent (but later it was increased to 33 per cent). It had been argued by the (then) Labour Government that the redistributive effects of the GST could be offset by transfer payments and lower income tax.

The GST came into effect in Canada on 1 January, 1991, at a rate of 15 per cent and replaced the 13.5 per cent Manufacturer's Sales Tax (MST) which had been in existence since 1924. The MST had been criticised over the years for many reasons, including its complexity. It was subject to more than 22,000 special provisions and administrative arrangements. In common with the GST in New Zealand, Canada's GST is a multi-stage VAT levied on a broad range of goods and services (Brooks, 1992). Firms are entitled to an input tax credit on the GST they pay for the goods and services they purchase as inputs. The GST applies to a broad range of goods and services, but does not apply to zero-rated or exempt items. In Canada, zero-rated items include basic groceries, most medical services, prescription drugs, and residential rents. Intended to offset the regressive impact of a broader taxation base on low-income Canadians, the GST credit (a refundable income tax credit), was introduced along with the tax.