A Simple and Effective GST

Commentary, Taxation, Don Brash

In 1984, a reforming Labour Government came to power in New Zealand.  One of their first acts was to announce their intention to introduce a goods and services tax.  I was invited to chair the three person committee to seek submissions from the public on the proposed tax, and make recommendations to the government on its optimal design.

From the beginning, our instructions from the Minister of Finance were to minimise the compliance costs which would inevitably be imposed on small businesses by the new tax.  The Minister had heard horror stories about the compliance costs imposed on small businesses in other jurisdictions where a value added tax had been introduced, and was determined that those costs should be minimised to the fullest extent possible.

The committee received a very large number of submissions – some from tax experts with sophisticated arguments about tax design, but a great many from people who wanted to argue that particular goods and services should be exempt from the tax.  In some cases, those in the latter group were self-interested vendors of those goods and services but in other cases they were people deeply concerned about the social impact of imposing a tax on goods and services of particular importance to low income New Zealanders.

For example, there was genuine concern about the impact on low income New Zealanders of taxing food, children’s clothing, shoes, books, and medical bills.

The committee listened very carefully to all of these submissions, and in particular we understood the concern of those who were worried about the impact the proposed tax would have on low income people.

In the end, we recommended to the Minister that almost all goods and services should be subject to the tax, and at the same rate.  The only exceptions were domestic rent and international airfares – the former because domestic rent has many of the same characteristics as payments on the mortgage on an owner-occupied home (and it was not deemed feasible to impose the tax on financial services) and the latter because it was recognised that a tax on international airfares would be very easy to evade.

We specifically recommended against an exemption for food, clothing, medical bills, books and similar items.

There were three reasons behind our strong recommendation that there be virtually no exemptions.

First, it was very easy to see that having virtually no exemptions and a single rate of tax was the best way to minimise the compliance costs imposed on the businesses which would have to collect the tax.  They could simply divide their total gross (tax inclusive) sales by the relevant tax rate, divide their gross (tax inclusive) purchases by the same number, calculate the difference, and either send off a cheque or claim a refund, depending whether the difference was positive or negative.

Second, while it was acknowledged that low income people spend a higher proportion of their available income on food and clothing than do those in higher income brackets, it was clear that most of the money spent on food and clothing in the community was spent by those on higher incomes, and there was no obviously pressing reason to exempt those on higher incomes from the tax.  In other words, exempting food, clothing and similar items would have involved foregoing a very considerable amount of tax revenue, most of which would benefit not those on low incomes but those on middle and high incomes.  It was seen to be much more efficient to compensate those on low incomes for the impact of the tax quite directly rather than forego a very large amount of revenue. 

Third, and this was a political economy point, it was recognised that to exempt any significant class of goods or services would create huge political pressures to exempt other items.  If food was exempt, why not clothing?  Why not books?  Why not doctors’ bills?  Why not shoes?  Multiple exemptions would quickly see compliance costs escalate exponentially while the rate of the tax would have to be very much higher to generate sufficient revenue.

In the end, the Minister accepted all our recommendations.  Income tax rates were reduced to offset the effect of the GST on most people, and direct income support was provided to low income New Zealanders who were not paying income tax.

Don Brash oversaw the design of New Zealand’s GST in 1986. He is former Governor of the Reserve Bank of New Zealand, and former Leader of that country’s National and Act Parties.  He writes here for the Frontier Centre for Public Policy. www.fcpp.org