GOVERNMENT SENATORS' REPORT

MAIN REPORT FOR SELECT COMMITTEE ON A NEW TAX SYSTEM

Government Senators strongly disagree with the emphasis placed on some of the information contained in the body of the Select Committee's report. This is not a reflection on the professionalism of the Committee secretariat who worked under extreme pressure from the Chairman's advisers who seemed determined to ensure that the main body of the report was politically motivated, had no balance in its documentation of evidence received and was biased in the interpretation of that evidence.

Government Senators have worked on numerous Inquiries and have never been involved in a Senate Committee report where there has been so much direct involvement of Labor Party staff with the Committee secretariat in the finalisation of the Chairman's report.

Neither Senator Conroy or Senator Sherry attended a meeting to deliberate on the content of the report and we can only conclude that they were prepared to let ALP staffers determine the final content of the Committee report.

Government Senators also wish to note the unacceptable behaviour of some Labor Senators who at various times harassed and sledged some witnesses who were giving evidence contrary to their own biases and generally treated some witnesses with an appalling lack of courtesy and propriety. We hope this does not set a precedent for standards of behaviour at any future Senate Inquiries.

We have provided this report to support our separate conclusions.

Introduction

This Senate Select Committee on A New Tax System has terms of reference to inquire into the Government's tax reform plans as set out in the policy document Tax Reform: not a new tax a new tax system (ANTS).

This is the main report of the Select Committee, addressing specific terms of reference to:

…inquire into and report, on or before 19 April 1999, on the broad economic effects of the Government's taxation reform legislation proposals with regard to the fairness of the tax system, the living standards of Australian households (especially those on low incomes), the efficiency of the economy, and future public revenues… [1]

The conduct of the Select Committee, and the other References committees, has been nothing less than an attempt to circumvent the Government's mandate for tax reform that it received at the last election. Rather than seeking to impartially examine the Government's taxation reform legislation, Labor and Democrat senators have maintained their predetermined positions, often accepting assertions if it suited them rather than examining the validity of the evidence. This problem was somewhat worse on two of the references committees where Labor had a majority in their own right.

The biased conduct and findings were best outlined in the Government Senator's minority report for the Community Affairs References Committee:

The normal process for the Senate to consider legislation in detail is to refer it to Legislation Committees. The fact that this normal process was overturned and the ANTS legislation is before the Community Affairs References Committee, where the Government has minority representation, provided an early indication …. of how this Inquiry would be used. [2]

On many occasions during the public hearings for these committees Labor brazenly displayed their predetermined attitudes, and a breath taking ignorance of the issues and of the ANTS policy in general.

For example, Labor Party Senator Chris Evans let the cat out of the bag on several occasions including:

"I am a Labor Party senator. We are voting against it." [3]

Much of the modelling which was commissioned by the Committee was saddled with unreasonable “worst case” assumptions, rendering it useless to informed public debate. Thankfully, in some instances, the modellers chose to interpret the more ridiculous assumptions in a way that had some conceptual value, incurring the wrath of the Labor senators.

For example, the Chairman of the Select Committee, Senator Cook, left no doubt as to Labor's motives for commissioning work – to find people who are worse-off. Something, which under all reasonable assumptions, they failed to do, as illustrated by the following exchange.

CHAIR— …why did you not do all of the work that was commissioned?

Prof. Harding—To my knowledge, we did. But you feel that is not the case?

CHAIR—No. The terms of reference are on page 42 of the document you have submitted and they ask for the first year impact from July 2000. You have reported to us that you did not do that. I am just wondering why you did not do that.

Prof. Harding—Neil might want to come in here. I think it is pretty hard to work out conceptually what it is that you are modelling. Although we were asked to model it in July 2000, the terms of reference did also say that we should assume that all of the indirect tax increases were there and that all of the indirect tax cuts were there. Some of the indirect tax cuts are not scheduled to come in until 2001-02. So, in a sense, we felt that the brief asked us to abstract from the phasing of the tax reforms issue and try to give you a feel for what it was going to look like once the dust had settled.

CHAIR—If you had done that, there would have been more losers, wouldn't there?

Prof. Warren—The answer to that is no. [4]

Labor senators continued to badger the witnesses for failing to adopt Labor's unrealistic assumptions in their desperate attempt to find losers:

Senator FERGUSON—Let him (Prof. Warren) answer the question.

CHAIR—Excuse me, I am the chairman here, thank you very much! This is a quite serious threshold point. The terms of reference are quite explicit. This work was not done. I understand that, if it had been done, it would have shown that there are more losers than in fact we now have before us… [5]

The Democrats likewise were not immune from selectively listening to a day's hearing and then manipulating evidence to fit their predetermined position in a string of press releases which blatantly and deceptively contradicted the actual evidence put before the hearings.

Of the over 1,400 submissions received, approximately 350 witnesses were called on to give evidence before the committees, with around 35 appearing twice or more. Approximately 30 groups doubled-dipped across committees, and at least 4 groups appeared before more than two committees, peddling the same, or remarkably similar, submissions.

Many affiliates of national organisations also appeared, adding substantially to the duplication. For example ACOSS appeared three times (twice at the Select Committee and once at the Community Affairs Committee), and their affiliate state organisations appeared 4 times across 2 committees, raising no new issues.

Such behaviour lead to media attention with The Australian publishing an article headed “Déjà vu adds to farce of the GST inquiry junket” [6].

PREVIOUS SENATE COMMITTEE REPORTS ON A NEW TAX SYSTEM

The members of the Select Committee handed down their first reports on 18 February 1999. With no agreement being reached on the Chairman's draft, three separate reports were produced. Even the chairman and his colleagues would not fully endorse the Committee report (prepared by the Chairman), instead drafting a separate Labor report.

On the basis of evidence heard by the Committee and on the basis of the economic modelling commissioned for the Committee's first report, Government Senators concluded in their first report that there is substantial support for the Government's tax reform plans as set out in the ANTS policy document.

Economic commentators and modellers confirmed that benefits to the economy as a result of ANTS will come from:

• A boost to economic welfare
• GDP growth
• Employment growth
• Export growth
• Increased investment
• Continued fiscal responsibility; and
• More sustainable Commonwealth-State financial relations.

There was also clear support in the evidence from a wide range of witnesses from the business sector, the unions, farming representatives, academics and tax practitioners for the Government's view that the current tax system is broken. It was accepted that the existing indirect tax revenue base would continue to diminish as the services sector increases its share of the economy.

No case was made for removing food or other necessities of life from the GST base.

No evidence was submitted which showed, on reasonable assumptions, that the Government's compensation measures were inadequate.

The References Committees

Paragraph (17) of the terms of reference referred matters relating to the Government's tax reform plan to the Senate Environment, Communications, Information Technology and the Arts References Committee (the Environment Committee), the Senate Community Affairs References Committee (the Community Affairs Committee), and to the Senate Employment, Workplace Relations, Small Business and Education References Committee (the Employment Committee). These committees reported on 29, 30, and 31 March, respectively. Each of these committees had a non-government majority, with Labor having a majority in their own right on two (See Appendix A).

The Select Committee was given a co-ordination role in relation to the reports of the three specific references committees:

…in reporting on the matters referred to in paragraph (3), the committee have regard to the reports of the references committees referred to in paragraph (17) and integrate the findings of those committees into its final report where relevant. [7]

Given the non-government majority on each of the references committees, the majority reports of the Community Affairs Committee and Employment Committee represented the predetermined views of the Labor senators, with Labor and the Democrats sharing the honours in the Environment Committee report.

Community Affairs References Committee

Government senators were genuinely frustrated by the Community Affairs Committee's inquiry because from the outset it was apparent that Labor senators had a fixed position with respect to the Government's tax reform proposals without offering any meaningful alternative policy proposals.

Many witnesses and submissions also appeared to rely on assertion and anecdotes ("…I've been told that …") rather than primary sources such as the legislation and explanatory memoranda which have been public since December 1998. This situation led Government senators to refute the claims and conclusions of the Labor senators' report which arose in many cases from evidence containing inaccuracies.

The Community Affairs Inquiry largely focussed on charities and not-for-profit welfare organisations which provide essential services to the community in areas ranging from personal care to emergency accommodation and providing food and clothing.

Government senators on the Committee recognised and valued the services that charities and public benevolent institutions provide, noting that while government funding is provided to the community sector, the community-based organisations raise considerable funds themselves and deliver the vast majority of services.

The charitable sector is specifically recognised in the Government's tax reform proposals because its non-commercial activities have been accorded GST-free status. That is, GST is washed-out on purchases by a registered charity and there is no GST charged on the non-commercial services provided by charities.

Against this background, the main conclusions made by Government senators were:

Charities

GST-free treatment of the non-commercial activities of charitable institutions is generous by international standards and will see the running costs of the sector fall due to the industry cost reductions in the Government's tax package.

The FBT exemption cap of $17 000 of grossed-up taxable value per employee is a fair approach which allows the PBI sector to maintain an employment cost advantage while removing the scope for abuse. Government senators note that the FBT cap was also an ALP policy taken to the last election.

Local Government

Local government will be financially better off under the new tax system, and are expected to benefit by around $70 million each year by not paying WST embedded in their prices, and through savings on diesel.

The States will be provided with all GST revenue and as a result be required to maintain local government funding at least equal to the amount local government now receives under the financial assistance grant arrangements, adjusted each year for population and inflation movements.

[On 9 April 1999, the Commonwealth, States and Territiories signed an Inter-governmental Agreement on the Reform of Commonwealth-State Relations to formalise these arrangements.]

The Health Sector

The scope of GST-free treatment in the health sector is both comprehensive and fair.

Contrary to the conclusion of the Labor Senator's report, the Government has achieved the best possible outcome for GST-free health services in terms of `simplicity in administration and compliance' with `clear and definitive boundaries'.

The list of GST-free services, aids and appliances is comprehensive.

Aged Care and Disability Services

Aged care and disabilities were areas where a great deal of evidence provided was inaccurate and appeared to be based on anecdote rather than analysis of the Government's proposals. This was despite the fact the Government had distributed a comprehensive community sector briefing kit which covered most of the issues raised.

In regard to residential care, the legislation provides excellent GST-free coverage for the sector and indeed the supply of goods and services, using the Quality of Care Principles (subordinate legislation to the Aged Care Act 1997).

The Government has also ensured that most of the services that are important to carers will be GST-free. These include Home and Community Care and disability community support services – for example, home nursing, personal care, home help, delivered meals, day care, home maintenance and modification, and transport services.

The complexity of compliance was consistently overstated or misunderstood given that all inputs are GST rebated regardless of whether the service is GST free or taxable.

Child Care

As the Government has outlined, childcare provided at recognised facilities will be GST-free. That is, childcare provided at facilities that receive Commonwealth Government funding, or where the parents qualify for a government childcare payment (such as the use of recognised home based childcare), will be GST-free.

Childcare provided at non-recognised facilities, ie. those that do not receive government funding, or where the parents do not qualify for a government childcare payment, will be subject to GST. In practice, however, the GST will not apply to many of these services because the providers will be below the GST registration threshold ($100,000 annual sales for non-profit bodies and $50,000 annual sales for other businesses).

Employment, Workplace Relations, Small Business and Education References Committee

Employment

The Government senators concluded that the Government's tax package will lead to improvements in incentives to employ and be employed.

The modelling evidence and forecasts by respected economists overwhelmingly supported the Government's view that the tax package will substantially increase employment.

Even the generally pessimistic analysis by Professor Peter Dixon showed that the most likely impact on employment in the short-run would be an increase of about 30 000 jobs.

On a State by State basis, modelling by Professor Dixon indicated the following distribution:

STATE JOBS INCREASE %

New South Wales 12,412 0.40

Victoria 7,748 0.35

Queensland 5,444 0.33

South Australia 2,135 0.31

Western Australia 5,321 0.59

Tasmania 766 0.38

Australian Capital Territory 606 0.53

Northern Territory 307 0.29

Access Economics in their December 1998 AEM Model Forecast report say:

“The good news is that the tax cuts sweetening the GST are expected to stimulate renewed job growth, perhaps sending unemployment down to 7% in 2001.”

and

“In the long run the impact of the tax package raises national output by 2.5% and there is an additional 190 000 jobs.”

Looking at forecasts of unemployment, Access Economics has the unemployment rate falling by 0.9 of a percentage point in 2000-2001 [8], while Chris Murphy of Econtech has it falling by 0.6 of a percentage point [9].

Education

The education sector does extremely well under the Government's tax reform package, with its costs expected to fall by about $240m.

When ANTS was released in August last year it stated that virtually all education would be GST-free, with the overall scope to be subject to post-election consultation.

After the election, the Tax Consultative (Vos) Committee was established and charged with the task of making recommendations on the appropriate scope of four key
GST-free areas, including education.

The Government either accepted the Vos recommendations, or went further, extending more generous treatment to professional education for example.

Families will also be better off with the cost of many education related items, including computers and stationery, falling as a result of the removal of wholesale sales tax.

The education sector will benefit from a combination of falling costs to the sector, a generous GST-free treatment, and increased real disposable income for families as a result of personal income tax cuts and increased government benefits.

Environment, Communications, Information Technology and the Arts References Committee

Government Members of the Committee concluded that the proposed tax reforms will establish a framework for economic activity in Australia that is relevant to the twenty-first century. Within that context the benefits delivered to all Australians will increase the strength and diversity of the economy. A stronger economy, and improving technology, will enhance the capacity to respond to a variety of challenges, including those facing the environment.

In the arts sector, the robustness of the economy in general, the savings to business delivered by the package and the increased disposable incomes of consumers will contribute to a vibrant and growing industry.

PRINCIPLES OF TAX REFORM(a) Efficiency

Efficiency issues with respect to the Government's tax reform package are well summarised in the Econtech submission:

In the context of ANTS, which is primarily an indirect tax reform package, the relevance of the efficiency principle is as follows.

Narrowly based taxes, such as the wholesale sales tax, raise the price of taxed goods relative to the price of untaxed goods. This means that relative prices faced by consumers for different goods and services no longer reflect their relative production costs, leading to distorted economic choices. In simple terms, the industry pattern of economic activity is pushed out of shape. This lowers consumer welfare.

Replacing these narrowly-based taxes with a broad-based GST should mean that relative prices better reflect relative production costs. With a more neutral pattern of relative prices, economic choices will be more efficient, and the industry pattern of economic activity will gradually move into a more efficient shape. This leads to a sustained gain in consumer welfare. [10]

The following quote from the 1975 Asprey report also encapsulates the issues:

In so far as it can be presumed that, left to their own devices, individuals will spend their incomes wisely, and business will choose the most efficient means of production, the minimisation of waste requires that the tax system should not influence individual and business choices. This is the requirement that the tax system should be neutral. Thus the tax system should not interfere with the manner in which an individual spends his income by changing the relative prices of the goods he buys; it should not alter the relative rewards of the different types of work between which he has to choose, or the relative attractions of work and leisure, or the relative returns from different modes of investment; it should not alter the relative attractiveness of different types of business organisation, or the relative prices of productive resources; and it should not discriminate between different types of production.

The Committee is persuaded that neutrality should be the general aim when efficiency is under consideration. [11]

In terms of measuring efficiency gains, both Professor Dixon from the Monash University Centre of Policy Studies and Mr Chris Murphy of Econtech provided evidence to the Committee. It was clear from the evidence that Econtech's MM303 model was the best specified to measure gains in consumer welfare.

The Econtech estimate of the annual gain in consumer welfare from ANTS was $607 million. When ANTS was modelled with food being GST-free, as proposed by the Democrats, consumer welfare decreased. That is, in overall terms, making food GST-free would worsen the benefits of tax reform to consumers.

Government Senators conclude on efficiency grounds that the GST base should be as broad as possible and, to maximise welfare gains from tax reform, food must remain in the GST base as proposed in AntS.

(b) Simplicity

Simplicity refers to compliance and administration issues, and is often afforded less weight than may be warranted in tax design by economists, as opposed to tax administrators and taxpayers themselves.

… the economics literature on what is good tax design has focused largely on finding the optimal compromise between equity and efficiency, while ignoring administrative costs. This is a major failure of this literature. [12]

During the course of the Inquiries, several witnesses addressed administrative and compliance issues including Ms Angela Ryan from the ASCPA, Mr Michael Walpole from ATAX (who appeared in a private capacity), Mr Simon Holdsworth, President of the NZ Employers Federation and Mr Adrian Firmstone of the Institute of Chartered Accountants in Australia.

Mr Firmstone stated

We take the position that it is not desirable to extend the exemptions or concessions beyond where they are, because that will simply add layer upon layer of complexity in the system and cost upon cost to business of complying. [13]

Mr Holdsworth stated

For us, a GST system in the way it came about was a simplified system because of the simplicity and the fact that the tax applied to everything: we no longer had to distinguish between products with differing rates of wholesale sales tax. [14]

After Ms Ryan's appearance before the Select Committee, the ASCPA made further comments about the compliance costs of making food GST-free, saying it would cost the economy over $100 million annually in increased costs. They also made the following points,

The Senate Inquiry … appears to have all but forgotten the compliance costs of making food GST free and is in danger of losing sight of the impact on real people in the real world…

US research has shown that taking food out of the tax base increases compliance costs for those affected by 30 to 50 per cent. This is based on a definition of food that taxes restaurant meals and takeaway food.

Approximately 300 000 business operators will face a massive increase in compliance costs as a result of making food GST free. This is a dead weight on the economy and one that will inevitably be recouped through high prices. [15]

The aim of the Democrats in the Inquiries was to marginalise the importance of simplicity in the design of the Government's tax package. The lengths to which they went to achieve this is shown in the following exchange at the hearings [16].

Senator MURRAY—You might like to write these down because I do not think they are easily available. In New Zealand the general rate is 15 per cent and the food rate is 15 per cent; in Canada it is 10 per cent and food is nought; in the United Kingdom it is 17½ per cent and food is nought; in Germany it is 15 per cent and food is seven; in the Netherlands is 17½ per cent and food is six; and in Ireland it is 21 per cent and food is nought—and Ireland is not in that graph.

If you look at that graph, the highest percentages in commencement are New Zealand and the United Kingdom; and the lowest percentages I outlined were Canada. You made a point of emphasising in your articles the key differences between the United Kingdom and the New Zealand systems, and you refer to us adopting a New Zealand style GST. What explains the differences with these compliance costs, and how is it affected by what you refer to as `a New Zealand style VAT'?

Mr Walpole—What I refer to as `a New Zealand style VAT', for clarification, is one that is broad and covers everything. What explains these differences I am not sure because of the dangers in drawing these international comparisons. However, it may well not be the food exemption or the food exclusion that gives rise to, for example, the lower compliance costs in the UK as against those in New Zealand. It may well be something else. It may be the turnover threshold, and so on. So I cannot explain it clearly. Food might be the reason, but it may equally easily be something else.

Senator MURRAY—On page 3 of your submission, you list the net compliance costs for the United Kingdom of 2.3 per cent and for New Zealand of 7.3 per cent. On page 7 of the Policy article to which I have referred, you said that Canadian compliance was lower than either the United Kingdom or New Zealand. That means that both the United Kingdom, which taxes food at zero, and Canada, which also taxes food at zero, have lower compliance costs than New Zealand. I suggest to you that the evidence that differentially taxing food increases compliance costs is not there; it is just not there on the face of the figures, the percentages and the graphs that you have given us.

Mr Walpole—My response is that I can see that argument. But it seems to me that the explanation might be something else; it might be something other than food. It seems to me to be commonsense that excluding food will lead to complexity; it will lead to a business having to deal with this area of its taxation in a different way to everything else that is being put into the business or put out of the business.

Senator MURRAY—I agree with you that intuitively it should; that is commonsense. But the proposition I am putting to you is that, in the nature of the evidence available to us in your paper—and, indeed, in Neil Warren's paper—there is no statistical evidence which confirms that exempting or differentially rating food will result in higher compliance costs. I have your figure right in front of me, and I have quoted you the percentages you have given me.

Despite these clearly qualified remarks by the witness, Senator Murray put out a media release [17] headed "GST Free Food - No evidence of compliance cost problem".

Mr Walpole subsequently wrote to the Australian Financial Review, and, in a letter published on 24 March 1999 said

The better approach is to consider Australia's proposed GST and ask whether the food exemption here would make our tax system more complex and more expensive to comply with than it would be were food included in the GST base. The answer to this must be clear … - all other considerations aside, exclusions and exemptions will make compliance more difficult and expensive, and there is ample international evidence to support that contention.

Late in the Inquiry process, papers from Professor Sijbren Cnossen, an internationally acknowledged expert on value added taxation were tabled and a paper by Dr Jeff Pope, an academic widely recognised for his work in the area of compliance costs of taxation arrangements, was submitted to the Select Committee.

The importance of good design when introducing a GST was emphasised by Professor Cnossen in the following extract from one of his papers, an extract which Government Senators believe is an endorsement of the Government's GST design:

…it should be emphasized that the minimization of the administrative and compliance costs of the VAT starts with its design. A broadly based VAT with a single rate, few exemptions, and a generous small business exemption should help in keeping initial and ongoing operating costs within acceptable bounds. …operating costs of the VAT can be minimized by getting it right the first time, by simplicity in structure and operation, stability and certainty in legislation and rulings, the timely dissemination of information, convenience in payment arrangements, and, it should be added, by administrative integration with the business income tax. [18]

Dr Pope's paper provides additional important evidence with respect to comparing international experience with compliance costs. At the outset he points out

It is essential that research findings are not only accurately quoted but placed in context. In short, in a rush to score 'political points' there is a danger of a simplistic and erroneous correlation of factors being made, or data being presented in a misleading way. [19]

His paper goes on to explain that a range of factors have an impact on compliance costs and then demolishes the proposition that there is no impact on compliance costs from making food GST-free.

There is no evidence to show that zero-rating food, as in the UK and Canada, leads to lower compliance costs than in New Zealand, which includes food. Rather, the apparent lower GST compliance costs in the UK and Canada – which applies only to small business and not large business – are entirely explained by other factors. These include, in particular, the GST registration threshold level (for the UK) and research methodology, previous experience with a retail sales tax and the level of computerisation (for Canada). [20]

To the best of this author's knowledge, there is no compliance cost research in the world that supports the proposition that zero-rating (or excluding, in layman's terms) food from a GST leads to lower (gross) compliance costs to the country overall. [21]

... bringing the New Zealand threshold roughly in line with that of the UK's would probably reduce the gross compliance cost estimate for the country to a figure close to that of the UK's… [22]

To sum up, a detailed analysis of the compliance cost estimates from the UK and New Zealand show that, at a disaggregate level, UK compliance costs are only lower for smaller size business, and above US$500,000 annual turnover are actually higher than New Zealand's. Various factors, especially the much higher UK GST registration threshold, clearly account for the UK's relatively higher gross compliance costs overall. It is completely spurious and false to attempt to correlate the UK's zero-rating of food with lower compliance costs and New Zealand's inclusion of food for higher compliance costs. [23]

With respect to Canada

In short, Canada's GST compliance cost estimates have absolutely nothing to do with its zero-rating of food in its GST, and no compliance cost study (to this author's knowledge) has ever cited this as a possible reason. [24]

On the issue of the compliance cost estimates in the Regulation Impact Statement, Mr Pope made the following comments

Some commentators are questioning Government estimates of the compliance cost of the GST as contained in its Regulation Impact Statement (1998). One such critic is Tran-Nam…. There appear to be three main points made by Tran-Nam. These are briefly considered, but overall are not considered by this author to seriously bring into any doubt Government estimates. [25]

On the point about considering net and not gross compliance costs, Pope says

It is therefore reasonable for business to be primarily interested in, and for researchers to identify and estimate net compliance costs, which are the true cost to business. This aspect would only be an issue if the Government or other researchers ignored gross compliance costs; this is clearly not the case. [26]

In short, this is at best a non-issue or at worst mischief making.

Mr Pope concludes

Food should be included in the GST base at the full 10% rate.

This policy minimises administrative and compliance costs. Any arguments using compliance cost estimates from other countries in support of zero-rating food are erroneous and totally misleading. [27]

(c) Equity

The issue of the equity or fairness of the ANTS package was discussed at length during the hearings of the Select Committee. Many organisations commissioned research to determine what they considered to be the distributional impact of the package on their constituents. The outcome of all of the research commissioned was that when using reasonable assumptions no group of people were found to be worse off under the ANTS package.

ACOSS, for example, repeatedly claimed that the ANTS package was unfair, but repeatedly failed to show how. After the package was released in August 1998, ACOSS refused to believe the Treasury cameos which showed every group to be better off, and demanded that the Treasurer release Household Expenditure Survey (HES) based analysis. ACOSS claimed that this would show the true distributional impact of the package. The Treasurer released this analysis which, contrary to the ACOSS view, also showed that each household group would be better off, with the cost of living increase varying between 1.3 per cent and 2.5 per cent compared to the Government's commitment of an up-front 4% increase in benefits.

ACOSS, in their continuing quest to find losers, then commissioned modelling from the Melbourne Institute. The results of this modelling were discussed in the Government Senators' first Select Committee report:

ACOSS asked the Melbourne Institute to model the price effects for households whose primary income source is government income support payments, described by ACOSS as “households with the lowest incomes”. Four assumptions were then modelled, using the Treasury inflation figure of 1.9% as the most optimistic assumption, and then getting progressively more pessimistic (See ACOSS submission p.9.).

The results of this modelling showed that even under the most pessimistic assumption used by the Melbourne Institute, every group modelled was better off under the tax package. [28]

Still not happy with the modelling results ACOSS further narrowed the scope of the model, finally claiming that they had at last found losers. However, the results of this modelling were in direct contrast to those of NATSEM, with NATSEM's Prof. Warren and Prof. Harding questioning the ACOSS methodology.

Senator FERGUSON— ...Your NATSEM results do not seem to support ACOSS's model which they released recently, which I can only presume you have had a chance to either see or read about. Have you got any comments as to the reasons for the apparent discrepancy between ACOSS's modelling and your own results?

Prof. Harding— ...On the part that we modelled, we felt that they had not modelled the family tax package. [29]

And

Prof. Harding— ...It is difficult for us to tell, in some cases, exactly what they have done, because the methodology is not fully spelt out in the document that they put out. But we believe that they did not model the benefits of the family tax package.

Senator FERGUSON—You believe, from your observations, that they have done their modelling without taking into account any of the effects of the family tax package?

Prof. Harding—We believe that is one issue. There are some others.

Senator FERGUSON—And you do not want to share those others with us?

Prof. Warren—There are some concerns about how they got to July 2000 from the Melbourne Institute numbers. Again, like Ann, I have a concern about the methodology, but that is really seeking an explanation more from ACOSS as to how they got to those of July 2000. They are quite important in terms of how the price effects move and then how people lie each side of the four per cent. It is from there that they generate the concern about the losers.

...They used a technique which essentially takes the 2001-02 numbers and adjusts them for the information that the Treasury indicated as being the expected July 2000 number versus the 2001-02. The 2001-02 number is 1.9 per cent; the July 2000 number is 2.5 per cent. So they adjusted the Melbourne Institute numbers by 2.5 over 1.9 times the 2001-02 numbers. That is the methodology they use to get to July 2000. We had difficulties with some of that, which begins to explain why we do not get the same order of magnitude of the losers as they get. [30]

ACOSS evidence given later at the same day's hearing did not clearly respond to any of the methodological concerns raised earlier by NATSEM. Mr Davidson focused his responses on conclusions relating to pensioners rather than explaining why price impacts for families with children were estimated without including reference to the Government's increased family assistance.

The issue of durability of compensation was raised at this hearing as well as in earlier evidence from Mr Geoff Carmody. The claims made were that while the Government committed to compensate for the one-off price impact of tax reform, the pension link to 25 per cent of MTAWE could overtake this compensation over time if wages were rising faster than prices. This overlooks the fact that the GST works on prices and compensation for GST therefore must be compensation against price rises.

In response, Government Senators note that the ANTS package set out explicitly that the Government legislated guarantee of pensions being at least 25 per cent of MTAWE will continue to protect pensions in this scenario.

What this means is that when the GST is introduced, pensions will increase by an up-front 4 per cent and be maintained at 1.5 per cent more than the CPI level. If, in the future, 25 per cent of MTAWE is higher, then pensions will rise again and rise further in excess of prices. In this scenario pensioners get higher real increases.

The two promises provide double protection.

NATSEM Modelling

The non-Government members of the Select Committee asked NATSEM to model the distributional effects of the tax package using a range of adverse assumptions regarding inflation, household specific price impacts, dissaving by lower income groups and the exclusion of food. In all, ten options were modelled for 29 cameo groups.

The key assumptions fed to NATSEM by Labor and Democrat were:

• including housing and tobacco in the price effect of the GST;
• using a hypothetical dissavings ratio; and
• a 70 per cent pass through of indirect tax cuts in the first year but with 100 per cent of increased costs passed through in one year.

In the first option, NATSEM replicated the methodological assumptions set out in ANTS.

Harding and Warren endorsed the Treasury estimate of a 1.9% CPI impact from the tax package and stated,

…estimates of the distributional impact of the package are extremely close to the Treasury's in almost all cases [31]

And

Some variation has to be expected, as we are using more recent projections of likely changes in average weekly earnings and the CPI than were available to the Treasury at the time that they undertook the modelling. [32]

That is, the analysis confirmed no category of person worse off from the Government's tax reform. In fact, pensioners and low-income earners are better off from tax reform than without it.

Options 2 to 6 were based on a higher CPI impact of the GST because the Select Committee instructed the modellers to include in the CPI effect the expected impact of the tax package on tobacco and new home prices. Harding and Warren disagreed with this approach:

It should be noted that we do not endorse using this measure as the appropriate indicator of the likely change in prices facing households. There are strong arguments for not compensating smokers for the likely increase in prices facing them under the ANTS tax reform package. In addition, we have not been able to model the distributional impact of the proposed First Home Owners Scheme, so that the adverse distributional effect of the GST on house prices is included within this measure but not the positive effect of the new scheme specifically designed to overcome this adverse effect. [33]

Notwithstanding this adverse CPI assumption,

Under the assumptions implicit in Option 2, however, on average there are still no losers expected from the tax reform package for the cameo households modelled. [34]

Option 3 used the higher CPI estimate, and also used household specific price effects (based on HES data) and an arbitrary dissaving assumption for low-income earners. The authors themselves disclaim the validity of Option 3 results because of their concerns about the higher CPI estimate.

We do not support this as the most appropriate measure of the impact of the tax reform package on prices, preferring instead a measure of price change which excludes the likely impact of tobacco and new house price changes. [35]

NATSEM also questioned the reliability of their measure of “dissaving”, saying:

Given the very tight time frame in which this report has had to be completed, it has not been possible to undertake a comprehensive analysis of the comparative dissavings rates revealed in the HES. As a result, we have simply imposed completely arbitrary dissavings rate assumptions upon different types of households [36]

A word of caution was also given by NATSEM in relation to their use of the HES data

The estimates should be regarded as broadly indicative, rather than definitive — particularly for those small population sub-groups where the HES sample contains only a limited number of survey respondents. [37]

And

This underlines the need for caution when using these household-specific price effects, as it seems likely that some component of the apparent difference between different household types is a result of sampling error. In other words, if the entire population had been sampled, different price effects might have emerged for each of these household types. [38]

Option 4 built on Option 3, with its attendant errors on tobacco, house prices and dissaving, and incorporated a 70% pass through of indirect tax cuts in the first year but 100% of increased costs arising from GST passed through. The authors again discounted the usefulness of this option, stating

It is important to recognize that this 70 per cent scenario should not be viewed as the standard case. A strong defense can be mounted for the ANTS assumption of 100 per cent shifting forward.

In particular, one could cite the powers being given to the Australian Competition and Consumer Commission (ACCC) to pursue businesses who do not fully pass on their tax related price changes. [39]

…This aggressive strategy is likely to ensure 100 per cent shifting of the indirect tax changes does act to offset the typical economic argument that the market will take some time for the tax-related price increase to flow through. Therefore, in the case of the ANTS reforms, 100 per cent shifting is probably the most reasonable assumption in the medium term. As a result, the 70 per cent WST and Stamp Duties shifting assumption should be viewed as at the extreme of the range of possibilities. [40]

It is only by using unreasonable assumptions that the report can find categories of persons worse off and even then very few.

Option 5 and 6 modelled the removal of food from the package, with the revenue shortfall funded by reducing tax cuts (Option 5) or increasing the GST rate (Option 6). With respect to removing food, however, Warren and Harding noted that what hadn't been modelled, but should be was

…the increased complexity of a GST with food made GST-free, both for the Australian Taxation Office and the over 20 per cent of businesses who will be collecting GST. These increased compliance and administrative costs must mean a greater burden on households than we have been able to estimate in this study. This will manifest itself as reduced GST revenue (net of administrative costs) and the prices of goods and services increasing by more than we have estimated in this report. [41]

In addition to the concerns of Warren and Harding, Government Senators note that these options reduce tax cuts principally from taxpayers in the $20 000 to $50 000 bracket or increase the GST rate to 12%.

Government Senators note that in Options 1 to 6, NATSEM assumed that the Government would increase pensions by only 3.4 per cent, notwithstanding unreasonable CPI assumptions which NATSEM were directed to model and the Government's commitment to compensate pensioners above the actual CPI effect by a margin of 1.5 per cent.

Because Warren and Harding rejected the validity of the higher CPI assumptions imposed on them by the Committee, they modelled Options 3, 4 and 5 with tobacco and house price effects removed from the CPI as used in ANTS.

In these "B" scenarios, Warren and Harding approximated the Government's actual compensation approach by assuming that pensions are increased by 1.5 per cent more than the corresponding CPI effect for each option.

Option 3B was stated by the authors to be “probably the most appropriate.” Option 3B shows what the tax package is worth using the lower CPI assumption, with the compensation rate for pensions and allowances being 3.5 per cent (equal to NATSEM's estimated CPI of 2 per cent plus the Government's buffer of 1.5 per cent). Under Option 3B, every single group modelled is better off under the ANTS package.

However, Option 3B understates what the Government's tax package is worth because it discounts the price effects of tobacco and housing from the CPI, whereas the Government's commitment is to provide a 1.5 per cent buffer above the actual CPI.

It is clear from the report that Harding and Warren do not favour the removal of food from the GST base. The Australian Democrats were the driving force behind setting up the Senate Committee with the express intention of mounting a case to exclude food. The Committee commissioned the work of Harding and Warren which found against such an outcome. Indeed not one of the Committee's consultants supported the exclusion of food.

The additional options modelled on the basis of adverse assumptions, many of which Harding and Warren were clearly uncomfortable with, resulted in only 85 observations out of the 6090 modelled where particular household types were not beneficiaries from tax reform.

If the 70% pass through option, which is considered unrealistic by Harding and Warren, is set aside then only 15 observations, mostly as a result of the higher CPI and arbitrary dissavings assumption, do not show a net benefit from tax reform.

Given that the Government's compensation commitments were not modelled correctly, the validity of these observations must be called into question.

Fairness and food

The issue of exempting food for equity reasons was canvassed in the first Select Committee report.

In the first report a paper presented by Professor Warren was used, which pointed out that rather than being a progressive equity measure, zero-rating food would benefit the wealthy to a much greater extent than the poor:

… zero-rating food benefits most in nominal terms, those in the highest income groups. In fact, the top 20% benefit twice as much in terms of dollars and cents from zero-rating food, as does the bottom 20% [42]

Ms Angela Ryan from the ACPAs also presented evidence in support of Prof. Warren's assessment:

If you are looking at the dollar amounts of GST that you are going to lose if you take out something like food, it is the high income earners that will do best out of that system by a proportion of about two to one if you compare the top 20 per cent of households with the bottom 20 per cent. [43]

The evidence provided by Professor Warren and Ms Ryan undermines the argument presented by the Democrats that the Government's tax reform package provides too much benefit to the wealthy. The Democrats propose to solve this by exempting food from the GST, and taking away tax cuts from average earners and above to fund it.

The irony of such a move would be that by exempting food from the GST they would be providing additional benefits to the wealthy over the poor at a ratio of 5 to 1.

Internationally acknowledged expert on value added taxation, Professor Sijbren Cnossen, also dispelled the myth that removing food from the tax base would lead to greater equity:

In high-income countries, it is increasingly being realised that VAT-rate differentiation makes little sense on equity and administrative grounds. [44]

Professor Cnossen also went on to explain that there was somewhat of a rethink going on in Europe on the issue of levying value added tax at lower than standard rates on certain necessities.

There is also a growing consensus in high-income countries – albeit more on paper than in practice – that lower-than-standard rates are not really an effective way of alleviating the tax on the poor. Because the consumption patterns of low and high income groups have converged, rate differentiation changes the impact of the VAT less than might be expected when necessities are zero rated (as, for example, in the United Kingdom), taxed at a lower rate (as in the Netherlands), or taxed at the standard rate (as in Denmark and Sweden). Other instruments, such as the income tax and income-support systems, are clearly much more effective in financially assisting the poor. Differentiated VAT rate structures, moreover, greatly increase administrative and compliance costs, particularly of small businesses. [45]

(d) Revenue Sustainability

One of the reasons advocated by the Government for the need for comprehensive tax reform was that the current tax system is failing Australia. The following extract from the ANTS document refers:

The current tax system is ineffective. It provides a crumbling base from which to derive the necessary revenue to fund essential government services, including those provided to rural and regional areas as well as those provided through the social security system.

It is totally inconsistent to be committed to maintaining or increasing current levels of expenditure on social security but to be opposed to fair and systemic reform of a crumbling tax base.

In the absence of comprehensive reform, the existing tax system will only become even more ineffective. The Commonwealth will become increasingly reliant on income taxation directly levied on individuals and companies if it is to maintain funding for government services. Tax rates would rise and the system become even more unfair as those individuals and companies who had the opportunity to avoid or minimise their tax increasingly did so. The indirect tax base would continue to decline, rates would need to be increased again, and this debilitating cycle would continue.

Furthermore, under the current system the tax base of the States will become even more inadequate and more inefficient in terms of funding necessary services. [46]

While Professor Dixon did not support the proposition that the current tax base was eroding, his view was an isolated one.

In particular, Access Economics, which has over ten years' experience in projecting Federal and State revenues, disagreed with Professor Dixon's position.

In a paper released on 17 February 1999, Access made the following comments

The Federal indirect tax system

In the ten years to 1997-98, and despite rate increases to stem revenue losses, Federal indirect taxes fell from 6.40% of national income (GDP) to 5.55%. Another fall is expected in 1998-99. In the decade to 2008-09, Federal indirect taxes are projected to fall from 5.34% of GDP to 4.49%. In today's dollars, that is a shortfall of $5.33 billion a year compared to 1999-00 collections. Losses may be expected to mount thereafter. Weakness in the tax take is due to:

• Improved fuel efficiency and the trend to smaller cars.
• A falling impact of the penalty duty on leaded petrol, as more cars use unleaded.
• Falls in tobacco usage and modest growth in the consumption of spirits.
• Already announced falls in tariff rates, notably in 2005.
• New cars sold continuing to decline as a share of total consumer spending, with people spending relatively more on the likes of travel and restaurants instead.
• Growth in the value of services outstripping that in the value of goods – and therefore undercutting other sales tax collections.
• The fall in the next decade (as a share of GDP) is expected to be the same as last decade. But last decade's fall would have been worse, had not rate hikes in sales and excise taxes overwhelmed the impact of tariff cuts (see the Table). The reason Access Economics does not project a more rapid decline next decade is we are deliberately conservative in our assumptions. In particular, we assume the relative decline in the value of the tax base for the likes of cars, petrol, cigarettes and alcohol is less fast in the future than it has been in the past.
• Impact of the 93/4 Federal Budget ($m)

1. Source: 1993-94 Budget Paper No. 1, page 4.6
2. The State indirect tax system
3. In the ten years to 1997-98 the States raised franchise fees, notably on tobacco, and financial transactions taxes. As a result, State indirect taxes rose from 5.34% of national income to 5.78%, up 0.44 percentage points. A fall is expected in 1998-99. In the ten years to 2008-09, State indirect taxes are projected to fall from 5.62% of GDP to 5.36%, down 0.26 percentage points. In today's dollars, that is a shortfall of $1.61 billion a year compared to 1999-00 collections. The fall is expected across several key taxes:
   • Stamp duties are cyclical, and they are riding current good growth in the economy. However, as asset prices ease from cyclical highs, and as ageing of Australia's population base crimps growth in new housing starts, the growth in stamp duty collections is not expected to keep pace with growth in the wider economy.
   • For payroll tax, States such as WA and Queensland have lower rates of payroll tax (and more exemptions) than do the other States. With those two States expected to see the fastest job growth in the next decade (as they did last decade), the regional composition of growth will lead to a relative fall in payroll tax revenues.
   • For franchise fees and other taxes, weakness in the petrol, tobacco and liquor tax bases is projected to slightly outweigh the strength in the gambling tax base. As with payroll tax, the low tax States of Queensland and WA are expected to grow a little faster than other regions. That will also hold back collections.

The big picture

That leaves the following big picture. The Dixon/Rimmer modelling suggests the indirect tax system will generate revenues rising faster than the overall economic cake without rate increases. Access Economics expects indirect tax revenue to decline, unless rates rise or the base is widened. In times past the decline has been delayed mainly via rate rises.

This analysis suggests problems ahead. To keep revenue at its current share of the national cake would require increases in tax rates over the next decade. Examples include the Federal excise on petrol (which would have to rise by more than 6 cents a litre over and above the usual indexation), and the standard rate of sales tax on cars (up from 22% to 26.5%). In total, and measured in today's dollars, the shortfall a decade down the track from keeping the current indirect tax system is projected to total $7 billion a year. It would rise thereafter, as growth in services continues to outstrip that in goods, ensuring the indirect tax base continues to erode. [47]

This independent analysis puts an end to Labor's claims that Australia's indirect tax base is not shrinking. Government Senators do not agree with Labor or Professor Dixon and maintain that tax reform is essential to maintain sufficient government funding to provide services expected by the community.

A further matter which comes under the effectiveness of a tax proposal is its ability to deliver revenue, including from the black economy.

A central element of the Government's tax package is its integrated nature. This was noted in ANTS:

The whole package of tax reform will enhance community confidence in the fairness of the tax system. The combined effect of the various measures will be greater fairness, transparency and certainty, resulting in increased compliance. Some specific measures will assist the Tax Office to make greater in-roads into the cash economy. The GST, the alignment of business tax payments, the establishment of the ABN and the new withholding arrangements will, together, result in more timely receipt of better information and a more comprehensive matching capability for the Tax Office to act upon. The level of integration of the GST into the tax system as a whole will be a key feature of the Government's approach.

The introduction of the ABN will make it much more difficult for those operating in the cash economy to avoid their tax responsibilities. It will also put a stop to people opting out of employment relationships to avoid withholding taxes and thereby slipping into the cash economy.

Those within the community who continue to flout our tax laws and place an unfair burden upon others, will no longer get away with it. More scrutiny will also be given to the tax-driven activities of high wealth individuals, tax manoeuvring of international groups and artificial end-of-year tax planning. A special focus will be given to activities aimed at exploiting any of the new measures foreshadowed in this package.

The Commissioner of Taxation has estimated that $3.5 billion over three years in additional income tax revenue will be generated as a result of these collective impacts. [48]

Professor Cnossen draws together enforcement and administration issues:

The level of administrative costs should also be influenced by the extent to which the control of the VAT is integrated with that of the business income tax, since many aspects that enter into the control of the income tax are relevant to the control of the VAT and vice versa. Thus, the sales receipts and cost of purchases figures in the profit and loss account submitted for income tax purposes should provide a useful cross-check on gross and net VAT liabilities. Similarly, a check on cash receipts as part of a VAT audit may uncover undeclared sales and hence income that should have been reported for income tax purposes. Clearly, since VAT is an accounts-based tax, VAT enforcement should benefit from joint controls and audits with the income tax. [49]

This is an important issue which the Opposition has ignored in making false claims about tax reform having an impact on the black economy in Australia.

ISSUES(a) Food

Why food should be in the GST

There has been some debate over exactly how broad the base for the GST should be, and this has particularly focussed on the Democrats' proposition that food should be exempt. The Democrats have not, however, provided a definition of food.

Witness after witness appeared before the Committee, urging on grounds of good tax design and good policy, that food be included in the base, culminating in the Australian Tax Commissioner declaring that exempting food would be “a recipe for disaster.” [50]

Why a recipe for disaster?

Because we could have a situation like that in Canada where the sale of five or less doughnuts is taxable, but the sale of six or more doughnuts is GST-free provided the doughnuts are not for immediate consumption at the establishment. This has apparently led to the formation of ad hoc consumer “doughnut clubs” at the door of take away outlets in order to take advantage of the bulk buy rule.

Because we could have a situation like that in the UK, where a hot meat pie is generally taxable but bakeries successfully argued that they heat their pies mainly to create freshly cooked food and an enticing smell. Consequently, hot pies sold from bakeries are GST-free unless they –

• are specifically heated at a customer's request;
• are thrown out once they have been kept hot for a period of time; or
• have been reheated from cold (as opposed to being cooked from raw).
• A more recent UK ruling is that a meat pie sold in a bakery before 3pm is taxable as a snack food, but if sold after 3pm it becomes a grocery and is tax-free.
• The UK VAT information indicates biscuits are standard rated if they are covered or partly covered in chocolate or some other product similar in taste and appearance to chocolate. This includes:
• all fully and semi-coated biscuits including biscuits decorated in a pattern with chocolate or some similar product;
• chocolate shortbread;
• gingerbread men decorated with chocolate unless this amounts to no more than a couple of dots for eyes; and
• ice cream wafers partly covered in chocolate.
• It does not include:
• chocolate chip biscuits where the chips are either included in the dough or pressed into the surface before baking;
• bourbon and other biscuits where the chocolate or similar product forms a sandwich layer between two biscuit halves and is not continued onto the outer surface;
• jaffa cakes; and
• biscuits in a coating of caramel or some other product that does not resemble chocolate in taste and appearance.

All of the economic modellers, including Chris Murphy, Peter Dixon, Geoff Carmody, Ann Harding, Neil Warren, and even the academic who did ACOSS's research, Dr David Johnson, argue that it is best to leave food in the tax base.

A very wide group of business groups, tax experts, accountants, community groups, and other witnesses were adamant that food should remain in the base. The reasons that they give all conform to the general principles of good tax design outlined earlier; efficiency, simplicity, and equity.

On efficiency, evidence from both Econtech and Peter Dixon, showed that excluding food from the tax base would lead to a reduction in economic welfare.

On simplicity, excluding food from the base would make the tax system immeasurably more complex, would place an enormous burden on businesses to comply, and would lead to endless disputation over definitions. There was a clear message from the Commissioner of Taxation:

I would like to put before the Parliament some of the issues that, from an administrative perspective and a cost perspective, I think it is important be shared so that as you come to your decisions they are understood.

The point that I want to make most directly is that in attempting to draw a line around food we have long experience from the operation of the wholesale sales tax that attempting to draw that line will inevitably lead to significant disputation. It will lead to a tax system that has more aggravation rather than less. The cost to business will inevitably increase, as will the costs of administration, if we are to achieve reasonable levels of compliance. And it does raise compliance issues. Overseas experience and our own experience with the wholesale sales tax says that there will be attempts around those lines to move things into GST-free areas and so on. [51]

He went on to say

I do believe strongly that when you have a tax system that becomes subject to ridicule— which some of these rules can lead to, with stories like the formation of doughnut clubs outside doughnut shops so that individuals wanting one will get together and one will go in and buy six—it sounds funny, but you are almost promoting a sense in people of a comfort with not complying with the law. They become significant issues for administration of any system. [52]

Equity is most effectively achieved by leaving food in the base and working on compensation through the income tax and welfare systems, as the Government has done. This allows for better and more generous targetting, without the wasteful “free kick” to the wealthy that a food exemption would entail. Professor Cnossen referred to

…a study in Sweden which shows that the main beneficiaries of a zero rate on food would be yuppies – single people with dual incomes living together. These people buy more expensive varieties of food, eat out more often, and tend to throw food away more easily. [53]

Professor Cnossen also stated

Research and experience in other countries proves that the best GST is a GST with a single rate applicable to all goods and services. A zero rate on food is largely ineffective in mitigating the GST burden on the poor. Zero rating food is like giving stones for bread to the poor, because they continue to pay the GST on other items of consumption. The poor are helped more effectively through changes in income-support systems and, to some extent, the income tax. [54]

While the position of Government senators is that food should remain in the GST base, the views of witnesses are outlined below:

National Seniors Association (representing 151 000 members)

The NSA said that they were broadly supportive of the proposed legislation and that it was “best for the whole community if food was not excluded from the GST.” – David Deans, Chief Executive. [55]

“Provided an adequate compensation package is implemented, excluding food would only serve to complicate the GST and reduce the size of personal income tax cuts.”

“It is time parochial sectional interests stopped muddying the waters by seeking short-term deals which are not in the best interests of all Australians.”

National Association of Retail Grocers (representing 10 000 small & independent grocers)

The Chairman Mr Ian Baldock recently travelled to New Zealand meeting with business people and consumers, who “reacted with a combination of absolute horror through to derision that we would even be remotely considering the removal of food from the GST.” [56] He said that exempting food would be an “administrative nightmare” of “enormous complexity,” would “result in higher prices,” and “create a competitive advantage for large retailers over small retailers.”

Mr Baldock said that up to half of its members would be forced to close if food is excluded [57]

Baking Industry Association of Australia (representing over 100 000 people in the bread and baking industry) support a GST on food, including bread.

“Whether big or small, we are of the very clear view that every business in the industry will be detrimentally affected if food is exempt from the GST. We are yet to see any definition of food for exemption from the GST which we consider would not be heavily detrimental to the industry. We believe the cost of compliance would be substantial, but falling particularly harshly on small businesses,” Marcin Firek, Executive Director. [58]

Council of Small Business Organisations of Australia (representing 150 000 small businesses)

“It is our very strong belief that to exempt food would be a disaster.” Rob Bastian, Chief Executive. [59]

“Without question, small business wants food included.”

After travelling to NZ and meeting with counterparts, Mr Bastian said that “the response from New Zealanders was perfectly clear – `For Heaven's sake, you are nuts if you exclude food.'”

“I can't overemphasise the strength of the feedback from the New Zealanders to include food in the tax.”

Australian Chamber of Commerce and Industry (representing 350 000 businesses)

“The potential exemption of food would be a critical blow to the fundamental attraction of a single rate, broad-based GST. All the key advantages in terms of lower compliance burden, high level of voluntary compliance, ease of administration and improved competitiveness would be seriously eroded if food were to be exempt.” [60]

“It is difficult to exaggerate the compliance nightmare which an exclusion, or partial exclusion of food would cause for small businesses in the retailing and distribution sectors.”

National Farmers Federation

“Once you start zero-rating things and having things so that every invoice has to be dissected, the compliance costs go up exponentially,” Bob Douglas, Director Rural Policy. [61]

“A decision not to tax basic food, but to tax restaurant meals and and take-away foods, adds mind-numbing complexity to the tax system,” NFF Submission to Senate Select Committee. [62]

Australian Food and Grocery Council

“Excluding food from the GST base will only serve to render the system more complex, more administratively difficult, and more costly to comply with.” Mitch Hooke, Executive Director. [63]

“It is just not an efficient way of ensuring that the social objectives of tax reform are met – equity, progressiveness and responsibility for the poor and disadvantaged.”

“There is simply no desire on our part to support a piecemeal approach to the reform of Australia's taxation system. It is neither in the nation's interests nor our industry's.”

Australian Small Business Association

“We must make the system as simple as possible. In our view part of the simplification is to make the system all embracing with no exclusions and no exemptions. Canada's system was full of exemptions, it failed. New Zealand had few exemptions and it worked. Should a GST be imposed which includes exemptions Small Business would have to question its support for such a system.” – Peter Siekman, Federal President. [64]

“We would like to see food included in the GST, overall, completely”. [65]

Woolworths (Australia's largest supermarket group) & Coles Myer

Woolworths Chief Executive, Roger Corbett, told The Age that “the GST should be introduced as structured by the Federal Government.” [66]

“The retail industry supports the GST including food across the whole range. We believe the GST will improve the economy, and a better economy is a better retail environment.”

Australian Tax Office

“The critical point I want to inject into the public debate is that any attempt to draw a line around food will lead to costly disputation and greatly increased costs for the community in administering the GST.” [67] Tax Commissioner, Michael Carmody.

“We estimate that up to 370 000 businesses will also be in the `business' of distinguishing between GST and non-GST purchases and sales.” [68]

GST-free food would would be “a recipe for disaster,” and it would cause the Tax Office to introduce rules “that inevitably will be subject to ridicule and that almost encourage people to become comfortable with entering into arrangements to exploit them.” [69]

Australian Society of Certified Practising Accountants

“Approximately 300 000 business operators will face a massive increase in compliance costs as a result of making food GST-free. This is a deadweight on the economy and one that will inevitably be recouped through increased prices.” [70] Angela Ryan, Tax Director.

“If food is made GST-free it would cost the economy over $100 million annually in compliance costs.

Financial Planning Association of Australia (Professional Association for Financial Planners 10 000 members)

“If the integrity of the Government's tax reform package, including the GST, was not kept intact it would make a mockery of the reform package.” Michael McKenna, CEO. [71]

“The new tax system was designed to work in its entirety. Exempting food from the GST will increase the level of GST on other goods and services and distort the reforms."

Tricon (Company which controls Pizza Hut, KFC, and Taco Bell)

Want either all food out or all food in, estimate that if supermarket food is exempt and restaurants are not then they will lose 7000 jobs in their industry. [72]

New Zealanders

The former head of New Zealand's GST Co-ordinating Office, Marylin Goddard, said that her country's acceptance of a flat rate for all goods and services was the key factor to its success, and that Australia must stand firm in its rejection of exemptions to the GST. [73]

“That was accepted in New Zealand. It was not an issue, it was certainly accepted by small business,” said Ms Goddard.

Business Coalition for Tax Reform (representing almost 40 industry bodies)

“Excluding food would add significant compliance costs, particularly for small business; tend towards creating a culture of non-compliance and activity that seeks tax avoidance; increase the administrative costs and the time spent by tax administrators and the courts in deciding what is and what is not food for the purpose of tax; and reduce the general competitive advantages of a single rate, broad based indirect tax.” Fergus Ryan, Chairman. [74]

Mr Ryan said that GST-free food would be “a nightmare,” [75] saying that “to make such an exemption would call into question the value of the whole tax reform package.” [76]

Corporate Tax Association (representing over 100 major companies on tax matters)

“Exemptions from the broad-based single tax rate will add exponentially to compliance costs. To us it would appear to be an unnecessarily wasteful and costly option to the extent that benefits would flow indiscriminately to those not sought to be advantaged by the measures.” – Mr Romano Nenna, President. [77]

Setting up systems to deal with different rates would cost “tens of millions for large retailers, and proportionately so for smaller retailers. Our main concern is compliance costs as far as the exemption of food is concerned.”

Commonwealth Treasury

In the absence of other changes, the exclusion of food, clothing and shelter from a GST would result in less taxation revenue and higher disposable income across the community than would be the case if these goods were taxed. However, this would mean that the package was unsustainable as a whole, with likely highly adverse economic effects on the fiscal balance, monetary policy settings, growth and employment. [78]

The Irresponsibility of the Democrats' Position

One disappointing aspect of the debate has been the propensity of the Democrats to claim the support of people whose views do not actually support them. For example, they attempt to conscript the modellers Peter Dixon and Chris Murphy to their side, as evidenced in the Press Release “Economists agree – GST-free food won't hurt the economy”. In actual fact, Dixon and Murphy agree on exactly the opposite (to different extents), and both support food being included in the base.

They also attempt to conscript Treasury to their side with a press Release entitled “Treasury figures support Democrat arguments: Zero rated food slashes inflation & compensation costs.” In actual fact, Treasury support the inclusion of food in the base on the grounds of good tax design.

Another example is the expert on compliance costs, Professor Walpole, whom the Democrats claimed backed up their case, but who explicitly endorses food being in the GST base and who felt compelled to write to the AFR to refute the Democrat portrayal.

The repeated refusal by the Democrats to accept the evidence from the expert witnesses on this issue elicited this response from Geoff Carmody of Access Economics, “There are none so blind as those who won't see.” [79]

The Democrats often claim that if 23 out of 27 OECD countries exempt food, why can't Australia.

There are several points to make regarding this claim. When it comes to public policy, Australia ought to follow world's best practice, not common or outdated practice. World's best practice is universally considered by tax experts to mean the fewer exemptions the better. As Professor Cnossen notes

Early converts to the GST (which they call VAT) generally have dual rate structures, including most member states of the European Union. The reason is that in the late 1960s and early 1970s food still weighed heavily in consumer baskets and income-support systems were not well developed. Moreover, the original EU member states wanted the burden distribution of the new tax to be as close as possible to that of the previously existing turnover taxes. The intention was to avoid complicating discussion of the VAT's merits – at that time, a very novel idea – with debate about the proper distribution of the tax burden under the new levy. Even these countries do tax food, however, albeit at a reduced rate. And even in these countries it is now widely recognized that a single rate would be best on grounds of fairness, efficiency and simplicity.

Later converts to the GST and countries with modern tax systems have single-rate GSTs. These countries include Denmark, Norway, Sweden and Iceland, as well as New Zealand, Switzerland, Japan and Singapore. (Canada is a notable exception.) These countries realize that the poor are better taken care of through the income tax and income-support system. [80]

The Democrats themselves are divided over the crucial question of how much food should be exempt. Leader Senator Meg Lees supports a narrow definition [81] which excludes restaurants, but this is contradicted by the Economics Spokesperson Senator Andrew Murray, who favours a wide definition including restaurants because “if you make it too narrow, you make it too complex.” [82]

(b) Families with children

Government Senators refute the claims of Professor Peter McDonald in particular, that the tax reform package does not give due regard to families with children.

Much of Professor McDonald's critique appears to be predicated on an assumption that the impact of tax reform will be higher for families with dependent children than for all other households – regardless of household income.

NATSEM's report to the Select Committee however, provides information which undermines Professor McDonald's assumption.

The experience for single age pensioners outlined above provides a reasonable guide to how the estimated distributional impact of the package varies for other low income groups as the Treasury's assumptions about dissaving and price effects are changed. But the precise effect depends upon the estimated increase in prices facing each particular type of household. Based on the estimates of price changes shown in Table 5, it does not seem possible to conclude that families with children generally face higher potential price increases than families without children. For example, the estimated increase in prices from Option 3 for single income couples without children is 3.1 per cent. This is higher than the estimated price increases facing any of the other single income couples with children. Similarly, the estimated price increase from Option 3 for two income couples without children is 2.6 per cent. This is higher than the estimated impact for a two income couple with two children, one of whom is aged less than five years. But it is marginally lower than the estimated impact for a couple with two children, both of whom are aged 5 to 12 years.

Does removing tobacco and housing make any difference to the conclusion above that families with children do not appear to face higher price increases than the average or than families without children? The relevant price effects are shown in the column of Table 6, headed `Option 3B'. This column shows household-specific price effects, but with the impact of tobacco and housing price changes removed. If anything, these results appear to more strongly reinforce the earlier conclusion that families with children are expected to face lower price increases than both the average and than families without children. Given an estimated average CPI movement of 2.0 per cent, the only household groups with children expected to face price increases above this average are two income couples with income equally split between them and with one child aged five to 12 years and self employed couples with children.

Even given that families with children do not seem likely to face above average price increases from the tax reform package, are they still net winners from the package if the impact of tobacco and housing prices is included and, at very low income levels, they are assumed to be dissaving? Suppose for the moment we take the `worst-case' dissaving assumption of 10 per cent used by Treasury in the Draft White Paper (1985, p. 259). This can probably be regarded as providing an upper bound to any likely medium term dissaving by households.

Looking first at families with no private income, who are fully dependent on the social security system, Table 11 indicates that most social security dependent households seem likely to make small gains from the tax reform package under the Option 3 assumptions. Recall that the estimate of the price increase facing each of these types of households varies depending upon what type of household they live in — and it also includes the impact of tobacco and housing. In this sense it is a worst case estimate. As Table 11 suggests, if social security households are not dissaving then they do relatively better from the tax package. However, even at an assumed dissavings rate of 10 per cent, they are not on average net losers.

Treasury analysis of HES data corroborated the NATSEM findings, as evidenced in the following exchange during the hearing on 8 April:

Senator GIBSON—Mr Smith, I would like to basically repeat a question I put this morning to Professors Harding and Warren. This is to do with the effect of the tax package on families …

Mr Smith—The broad answer is that I think we have previously indicated that we felt that our own analysis comes up with similar results, and our own analysis comes from Mr Gallagher.

Mr Gallagher—In the indicative analysis that we have done using the HES data, if you look at households with and without children, the price effects for those households are indistinguishable, given the nature of the analysis. Like that of Professors Harding and Warren, there is a very slightly smaller price effect on families with children, but you would not want to make too much of that. As the number of children increase within the limits of the sample, it is still the case that the price affects the families with children. If you look at the expenditure patterns of households with children and with dependants under the age of 17, you can see that the broad expenditure patterns of those households are in fact very similar across the 17 categories on which the ABS published its information. So we have two thoughts. One is that the modelling says this. Then, if we go back to the information in the original ABS HES data set, it says that the expenditure patterns are fairly similar at a broad level. So it is not surprising that we do not think there is any additional price effect for families with children in the design of this package.

Senator GIBSON—Thank you, Mr Gallagher.

While both NATSEM and Treasury have strong misgivings about the reliability of HES data, it is the only household specific database available. The data, therefore do not appear to support Professor McDonald's central proposition around which his assertions are based.

A further claim raised by Professor McDonald is that price rises associated with children are estimated in ANTS at 30 cents per week. The 30 cents per week figure is a fundamental mathematical truism related to the level of the current per child family payment added to the expected value in July 2000 of the current Family Tax Initiative. That is, the impact of a 1.9 per cent price increase on a minimum family payment per child of an expected $632 plus $200 for the FTI is $15.80 per annum or 30 cents per week.

What Professor McDonald should be looking at is the real cash gain (ie benefits after taking into account the GST and its impact on prices) to different family types as it shows the total benefits to families from tax cuts and increased family benefits.

For example, in the case of a dual income couple on $30,000, both a childless and with-child couple will receive an income tax cut of $14.96 per week from which the impact of GST is subtracted ($9.33 for the childless couple and $9.63 for the with child couple). The childless couple therefore receives a real cash gain of $5.63 from the tax cuts whereas the with-child couple receives a real cash gain of $5.33 from the tax cuts plus a further $30.25 in increased family tax benefit.

This clearly shows that concentrating on the 30 cents figure as Professor McDonald does is a red herring when trying to look at the benefits of the tax package to families with children and demonstrates, at best, a lack of understanding of the ANTS cameo tables.

Another claim from Professor McDonald was that families with dependent children between the ages of 17 and 24 are not recognised in the compensation package.

This is not correct. Under the families package, there is no change to the age limits for receipt of the Family Tax Benefit; the maximum age for payment will continue to be 18 years. As with other income support payments, a 4 per cent increase will apply to the Youth Allowance which includes a 1.5 per cent real increase. Youth Allowance is available to eligible children between the ages of 16 and 24.

(c) International Food Price Comparisons

One of the claims made by the Democrats in support of making food GST-free is that some OECD countries either tax food at a concessional rate or make it GST-free. The corollary is that food is more affordable under such arrangements.

Government Senators have obtained some data comparing international food prices. In 1996, the latest year in which information was available shows the following:

Comparative price levels for food, 1996

(Australia = 100) [83]

If the Australian figure was inflated by the expected average price rise of 4.4% for food (ie to 104.4), it is obvious from the table that food prices in Australia still remain very much at the lower end of the scale. It also shows that factors other than taxation treatment determine food prices (including protection levels).

Government Senators conclude it is a fallacy to argue that food has to be concessionally taxed to ensure low food prices.

CONCLUDING REMARKS

The 1998 election saw the Coalition Government go to the people with a detailed comprehensive tax reform plan – breaking Labor's cycle of electoral deceit and broken tax promises. This bold course of action sets this Government apart from the failed attempts of previous Governments to reform the tax system.

For over twenty years, both major political parties have understood the need for comprehensive tax reform, and have held inquiries.

In 1985, a broad-based consumption tax was proposed in the Draft White Paper. The Labor Government took its preferred Option C (a 12½% broad-based consumption tax) to the Tax Summit and then in the face of pressure did nothing.

In 1993, the Coalition in opposition proposed a GST but was not elected. The Labor Government, which campaigned on the basis of no tax increases, then funded their election promises by increasing all wholesale sales tax rates and excises and withdrawing the L-A-W tax cuts. These tax increases went ahead because the Democrats supported the legislation in the Senate without demanding any compensation for the higher prices which resulted.

In 1998, the Coalition developed the most detailed and comprehensive tax reform policy and put it before the people prior to the election. The election was won by the Coalition. A mandate was received to proceed with the tax reform proposals and Government Senators consider the Senate should respect this mandate and pass the ANTS legislation.

The Senate Inquiry process on A New Tax System has been used as a political device by non-Government Senators to undermine the Coalition's mandate for tax reform.

The Inquiries have focussed solely on the GST, and have ignored the rest of the tax package which includes:

• Lower marginal income tax rates for 95% of taxpayers resulting in $13 billion of tax cuts
• Increases to pensions and to family benefits to make people better off after GST
• Lower costs for industry because of the removal of $10 billion a year of embedded taxes on business
• Increased competitiveness for Australian exporters because of $4.5 billion reduced costs.

Government Senators Conclude:

1. The Inquiry process produced no information that was not already in the public domain or had not been considered by the Government when putting the tax reform plans together and debated during the election campaign.

2. The Inquiries by the Senate were poorly focused and mis-used by Labor and Democrat Senators who manipulated the Inquiries in an attempt to re-argue their political positions which were defeated in the last election. The Democrats ignored and misrepresented evidence which did not support their position with respect to food and GST.

3. Many witnesses and submissions relied on false assertions and anecdotes – many of which were irresponsibly perpetuated by the Labor Senators rather than primary source material, such as the legislation and explanatory memoranda, which have been public since December 1998. Government Senators therefore do not place any credit on the claims and conclusions of the Labor Senators which are willingly based on misleading and inaccurate evidence.

4. The Government's tax package entirely meets the criteria by which tax reform should be assessed

• it is efficient
  1. a single rate GST and few exemptions means minimum distortion to allocation of resources and prices and economic welfare increases by the greatest amount
• it is simple
  1. least compliance effort by business and ATO and no wasteful tax rate re-classification (eg frozen yoghurt) court battles
• it is equitable
  1. GST effects are offset by compensation - either increased pensions or benefits or tax cuts and compensation is targetted to those in need
• it increases the sustainabilty of the tax base and therefore governments' ability to continue to provide services.

5. There was no credible evidence to demonstrate, on reasonable assumptions, that any modelled household type would be worse-off as a result of the Government's tax reform package.

6. The reasoned evidence to the Inquiries overwhelmingly supported food remaining in the GST base on efficiency, simplicity and equity grounds. The Democrats refused to acknowledge that when informed witnesses addressed issues of equity and fairness they supported the use of direct compensation rather than narrowing the broad-based design of the GST.

Appendix A

MEMBERSHIP OF THE COMMITTEES:

Senate Select Committee on A New Tax System

Senator Cook, ALP (Chair)

Senator Ferguson, LP (Deputy Chair)

Senator Conroy, ALP

Senator Gibson, LP

Senator Murray, AD

Senator O'Chee, NP

Senator Sherry, ALP

References Committees:

Footnotes

[1] Terms of reference, paragraph 3.

[2] Government senator's report for the Community Affairs References Committee, Inquiry into A New Tax System, p.180

[3] Evidence, Community Affairs Committee, p.614

[4] Evidence, p.2306

[5] Evidence, p.2307

[6] The Australian, 11 March 1999, p.4

[7] Terms of reference, paragraph 4

[8] Access Economics, AEM Model Forecast Report, 7 December 1998.

[9] ECONTECH, (Murphy Model MM2), Australian Economic Outlook, 13 December 1998.

[10] Murphy C, Modelling A New Tax System (ANTS) - Comparing Monash and MM303, Commissioned by the Senate Select Committee on a New Tax System, 1999, p.3

[11] Asprey, Full Report of the Taxation Review Committee, 1975, p.16

[12] Warren N, GST: The long, winding road, 1996, p.11

[13] Evidence, p.1799

[14] Evidence, p.1906

[15] ASCPA, Media Release, 10 February 1999

[16] Evidence, pp 1780-81

[17] Murray, Senator Andrew, Media Release 16 March 1999

[18] Cnossen Sijbren, Administrative and Compliance Costs of the VAT: A Review of The Evidence, Tax Notes International, 20 June 1994

[19] Pope, Dr Jeff, The Compliance Costs of the Goods and Services Tax: A Comment on Current Major Issues 1999, p.2

[20] Ibid, p.1

[21] Ibid, p.3

[22] Ibid, p.4

[23] Ibid, p.6

[24] Ibid, p.8

[25] Ibid, p.10

[26] Ibid, p.12

[27] Ibid, p.15

[28] Government senator's report, Senate Select Committee on a New Tax System First Report, February 1999, p.59

[29] Evidence, p.2345

[30] Evidence, pp 2345-6

[31] NATSEM, p.1

[32] NATSEM, p.20

[33] NATSEM, p.1

[34] NATSEM, p.21

[35] NATSEM, p.2

[36] NATSEM, p.13

[37] NATSEM, p.21

[38] NATSEM, p.22

[39] NATSEM, p.14

[40] NATSEM, pp 14-15

[41] NATSEM, p. 37

[42] Warren, op cit. p.7

[43] Evidence, pp 567-8

[44] Cnossen, Sijbren, Global Trends and Issues in Value Added Taxation, Economic Faculty, Erasmus University, 1998, p.409

[45] Cnossen, opcit. pp 409-10

[46] ANTS, p.8

[47] Access Economics, Is the existing indirect tax system broken?, February 1999, p.i-ii

[48] ANTS, p.150

[49] Cnossen, op cit, p.1653

[50] The Age, 25 March 1999

[51] Evidence, pp 2231-32

[52] Ibid

[53] Cnossen Sijbren, What rate structure for Australia's GST? Canberra, 24 March 1999 p.2

[54] Ibid p.1

[55] National Seniors Association Media Release, 31 January 1999

[56] Evidence, EWRSBE, p.278

[57] The Australian, 24 February 1999

[58] Submission, Senate Select Committee on ANTS, 29 February 1999.

[59] Evidence, p.2207

[60] ACCI Submission, Senate Select Committee on ANTS, 1 February 1999

[61] Evidence, p.250

[62] NFF Submission, Senate Select Committee on ANTS, 27 January 1999

[63] AFGC Media Release, 4 February 1999

[64] ASBA Submission, Senate Select Committee on ANTS, 23 February 1999

[65] Evidence, p.1103

[66] The Age, 26/3/99

[67] Tax Commissioner Michael Carmody, Speech, Hobart, 24/3/99

[68] ibid

[69] The Age, 25/3/99

[70] Aust. Society of Certified Practising Accountants, Media Release, 10/2/99.

[71] Financial Planning Asociation of Aust., Media Release, 26/3/99

[72] Evidence, EWRSBE, p.232

[73] AAP Report, “Exemption-free GST crucial says head of NZ Task Force,” 10 February 1999

[74] Evidence, p.608

[75] Sydney Morning Herald, 28 January 1999

[76] BCTR Media Release, 4 March 1999

[77] Evidence, p.413

[78] Submissions, Vol 3, p.783

[79] Financial Review, 12 April 1999

[80] Cnossen, op cit, p.1

[81] The Australian Democrats Taxation Policy Response, 18 September 1998

[82] Senator Andrew Murray, “Meet the Press”, 4/4/99

[83] Source, OECD

Non-government (bold)