SENATE GST INQUIRY: LABOR FINDINGS

Executive Summary

Evidence presented to the committee contradicted all of the major claims made by the Government. Some of the major claims are detailed below.

Labor Senators do not necessarily accept the emphasise placed on particular evidence in the general report

Introduction

The scope of this first report of the Select Committee on a New Tax System (ANTS) involves an examination of the economic theories, assumptions, calculations, projections, estimates and modelling which underpin the Government's proposed tax changes.

This package of changes to the tax system (ANTS) involves the introduction of a new 10% GST, associated indirect tax changes, income tax cuts and changed social security measures.

The required reporting date for this first report means the committee has not had the opportunity to fully evaluate all of the tax proposal measures announced by the Government. Significant proposals have not yet been introduced into the Parliament and consequently have not been closely examined by the committee. Examples include the proposed Wine Equalisation Tax and the precise Commonwealth-State financial arrangements.

These omissions are major and do not allow a complete report on the full tax package at this stage. They complicate the task of reporting on the macroeconomic effects of ANTS. The final report of the committee will address these outstanding issues.

Is the Tax System Broken?

The Government's publicly stated rationale for the ANTS package is that the current taxation system is `broken' and consequently is in need of fundamental reform.

Whilst it is easy to make such claims, statements like that are meaningless.

In properly evaluating the current taxation system regard should be had to:

• The primary function of a tax system – namely raising sufficient revenue to meet public expenditure needs;
• The compliance and administrative costs of the current arrangements;
• The economic efficiency of the current arrangements; and
• The equity of the current arrangements.

The current system is providing adequate public revenues as the Commonwealth budget is in a position of underlying surplus, and the State and Territory budgets are in aggregate also in surplus.

As the evidence will demonstrate, the ANTS package will reduce the equity of the tax system, increase the compliance and administrative costs of the tax system and will yield negligible, if any, gains to economic efficiency.

Labor has always acknowledged that any tax system needs constant repair and maintenance to ensure:

• Tax avoidance is minimised to the maximum possible extent;
• That emerging technologies can be used to improve and simplify administration and compliance; and
• That industry development or other social objectives can be met, for example through tax concessions.

This position has been reinforced by the evidence provided to the committee.

Evaluation of the Evidence

Macroeconomic Modelling

The ANTS documents contain no results of the estimated macroeconomic effects of the tax reform proposals.

Both before and after the election on 3 October 1998 the Prime Minister, the Treasurer and other Government members constantly asserted that the ANTS package would increase economic growth and employment.

The committee's terms of reference required it to evaluate the results of any modelling undertaken, and the advice provided, by the Treasury which would substantiate these claims.

We were indeed surprised to hear evidence from Treasury that they had not undertaken any macroeconomic modelling. The only work commissioned by the Treasury was modelling undertaken by Mr Chris Murphy of Econtech. This modelling involved the impacts of a revenue switch between the Wholesale Sales Tax (WST) and a so-called realistic GST. This was not modelling of the ANTS package and was not mentioned in the ANTS document.

The inquiry consequently sought the quantitative advice generated by the Treasury to the Government on the macroeconomic outcomes of ANTS. It was astonishing to be informed that no such advice existed. In fact, Treasury revealed that the only macroeconomic advice provided involved “qualitative” assessments, rather than any detailed estimates of the effects on employment, unemployment and economic growth. Treasury further revealed that the GDP figures used in calculating the so-called “growth dividend” was simply an assumption [1].

Treasury essentially admitted that assumptions are in fact best guesses. [2]

In view of this evidence, the claims concerning the macroeconomic impacts of the ANTS package were unsubstantiated. The committee resolved to undertake independent macroeconomic modelling in order to test the assertions made in ANTS and to establish a foundation of independent data from which the macroeconomic effects could be assessed.

The committee was assisted in the choice of a suitable economic modeller by the expert evidence provided by Professor Ken Wallis of the University of Warwick who is the Director of the Macroeconomic Modelling Bureau of the Economic and Social Research Council in the United Kingdom.

Professor Wallis, an international economic modelling authority, advised the committee of suitably qualified Australian economists in the field of macroeconomic modelling. Professor Wallis said “…there is a world famous group in Australia at Monash. The intellectual leader is Alan Powell and Peter Dixon does it.” [3]

On the basis of this independent evidence, the high quality of Professor Dixon's initial submission and his competitive tender, the committee resolved to commission Professor Dixon to model the ANTS package under various scenarios. Professor Dixon's terms of reference appears in appendix VII of this report.

The Monash Findings (Dixon)

The modelling by Professor Dixon presented to the committee was released on 3 February 1999. It showed the Government's claims that the tax package is good for the economy are false.

In evidence to the inquiry, Professor Dixon described the GST as “job destroying”. [4]

The Monash modelling found:

1. Up to 100,000 jobs could be lost in the early years of the tax package if wages rise in response to the higher cost of living from the GST;
2. Any jobs that are created in the early years will be due entirely to the fiscal stimulus associated with the income tax cuts and not the GST;
3. A delay of just one year in passing on the full savings from reducing some indirect taxes will lead to an estimated 15,000 job losses;
4. Any economic efficiency gains from the tax package will be negligible even under the most favourable assumptions;
5. The package will cause a small decline in average Australian living standards; and
6. The existing tax system will collect revenue faster than growth in GDP, so the need for a GST to meet Australia's future revenue needs has not been proven by the Government.

These findings refute the Government's claims about the supposed economic benefits of the GST. Professor Dixon's summary of his results states,

“We find, as in our December paper, that the Government's proposed tax changes will have little effect on Australia's long-run macroeconomic performance…If wage earners refuse before-tax wage rates to fall relative to the CPI, then the package will cause job losses in the short run, despite the net reduction in taxation. Another short-run risk to employment is that increases in indirect taxes may be passed on more quickly than reductions. Finally we should emphasise that no consideration has been given in this report to the costs of implementation, compliance, administration and rent-seeking. These should be set against any benefits claimed for the package.” [5]

In addition, Professor Dixon's report produced the only long-run estimates of the revenue impacts of retaining the current tax system.

The report states:

“ANTS (eg P8) implies that a major change in indirect taxation is necessary because, without increases in tax rates, the present array of indirect taxes will raise insufficient revenue in relation to Australia's future public sector requirements. However ANTS includes no explicit forecasts. We find no evidence to support the ANTS proposition.” [6]

Professor Dixon's evidence is that the taxation system is not broken.

On receipt of this information Labor committee members sought advice from Treasury through the Senate estimates hearings, [7] about the results of formal long-term revenue modelling of the existing tax system undertaken by them. This information was sought in order to compare Professor Dixon's estimates with those of the Government.

Treasury revealed it had performed no such forecasting. Accordingly, no advice has been provided to the Treasurer on which his extravagant claims could reasonably be based. The absurdity of the Government's claims were referred to by Professor Dixon when he stated:

“I looked at that ANTS document, looking for a substantive argument. `Ramshackle', `1930s', `Botswana' - this is not economic argument. This is just some sort of lightweight rhetoric.” [8]

He continued,

“I listened carefully to the Prime Minister and other senior members of the government and I am still listening, still waiting for them to make their substantial arguments, to explain to me why the present system is going to fall apart…” [9]

The Murphy Critique

Mr Chris Murphy of Econtech was retained by the committee to critique Professor Dixon's work.

Mr Murphy appeared before the committee on 5 February 1999 and explained the results of his earlier modelling of the ANTS package. (Note: This modelling does not include the proposed business taxation changes contained within ANTS) [10]

On 29 January 1999 Mr Murphy received Professor Dixon's report. He was then scheduled to deliver his critique and appear before the committee on 12 February. As his critique was incomplete, his presentation on Professors Dixon's report was rescheduled for 15 February 1999.

Around 5pm on Friday 12 February the committee received a document from Mr Murphy which did not include the last four sections of the final report.

The committee did not receive a complete copy of the critique until Mr Murphy's presentation had commenced on Monday morning 15 February. The failure to receive the critique on time prevented adequate preparation for questioning and evaluation of the detail of Mr Murphy's evidence.

This process also meant that Professor Dixon, who received the Murphy critique very late on Sunday night, had very little time to absorb and respond to the points made by Mr Murphy.

These problems were further exacerbated by the unprecedented walkout by Coalition Senators, thus preventing detailed questioning of Mr Murphy by Labor committee members.

The Murphy Results

The modelling undertaken by Mr Murphy was of the long-term effects (5-10 years) and involved using the most favourable assumptions to support ANTS.

The key assumption is that there will be no increases in wages flowing from the introduction of a 10% GST. Mr Murphy maintained that no wage consequences would arise as a result of the GST, even where price increases considerably exceed the 1.9% inflation estimate contained in ANTS. His position was not altered by evidence from the ACTU [11] and the Shops and Distributive Allied Employees Association (SDAEA)- [12] that they would pursue wage claims to maintain the living standards of their (predominantly low income) members.

The key finding of Mr Murphy's work, agreed to by Professor Dixon, was that their respective results were consistent. Any economic gains, which only arise from optimistic assumptions, were negligible.

Unlike Professor Dixon, Mr Murphy did not model differing wage-response scenarios although he was commissioned to do so, preferring instead to only consider the optimistic scenario contained in ANTS.

Estimated Change in Living Standards

Mr Murphy's model (known as MM303) estimated the total welfare gain (ie increased living standards) from the ANTS package at $607m.

This represents a 40% reduction from the $1 billion estimate provided by Mr Murphy prior to the election. This reduction was not acknowledged in Mr Murphy's report and was only bought to public attention after questioning by Labor members. Further exploration of this important revelation was prevented by the walkout of Coalition Senators.

The claimed $607m welfare gain represents only 0.2% (or 1/500th) of consumption expenditure, an insignificant figure as confirmed to the committee by Professor Dixon. In fact this best case scenario represents a minuscule 65c per person per week. Furthermore, even if achieved, this would not be evenly distributed amongst all Australians.

Labor members further note that this is the only figure expressed by Mr Murphy in dollar terms as opposed to a proportionate measure. The method of presentation is clearly designed to give the impression of significant benefits from the ANTS package.

Due to the limitations discussed previously, the committee cannot provide detailed comments on many issues raised by Mr Murphy's evidence. Accordingly, the committee will seek to explore these issues further and incorporate the conclusions in the committee's final report.

We note Professor Dixon's observation that “Now, Chris (Murphy) talked about how he had a chat with the mining council and that moved him from $1,000m to $600m. I suggest that he go and have a chat with a few other industries.” [13]

Employment Outcomes

Evidence from the Treasury, Professor Dixon and Mr Murphy confirms that the GST will not create any jobs. However, significant job shifting between industries is predicted. Jobs will be lost in the services sector, mainly in the tourism, agricultural and forestry, housing, personal and other services and culture and recreational services.

See Chris Murphy's paper p27, CHART 3.

As the chart shows, even under Mr Murphy's optimistic assumptions, jobs are lost in 10 out of 17 industry sectors.

The notion that all workers who lose their jobs because of the GST will find alternative employment in other industries and/or other regions is not credible.

It is unrealistic to assume that those who lose their jobs in the services sector (eg tourism), will pick up work in the mining or manufacturing sectors. The absence of any resources in the tax package for re-skilling or other retraining initiatives, relocation assistance or regional development initiatives to assist dislocated workers, their families or their communities demonstrates that this assumption is totally implausible.

The committee notes that these real world considerations are ignored by the long-term modelling undertaken by Mr Murphy. His report contrasts the Monash model with his own MM303 model. As he states, “The most important way in which the Monash model extends the original ORANI model is by introducing a time dimension. Instead of making the long-term assumption that capital stocks and the labour market are in equilibrium, the Monash model aims to track the year-by-year adjustment of capital stocks and wages towards equilibrium.” Mr Murphy continued, “By showing estimates of the adjustment process, they may provide a guide to the transitional costs in moving from the existing tax system to ANTS.” [14]

By contrast Mr Murphy admits that his MM303 “…estimates how ANTS changes the shape of the economy in the long run, but does not explicitly model the time path over which these changes develop.” [15]

The committee considers that any realistic assessment of the likely impacts of the GST must focus on the plausible real world impacts, rather than the theoretical long-term results which ignore the social and economic costs which will eventuate.

Labor members totally reject the justification for not considering the transitional costs of ANTS provided by Mr Murphy “Transitional costs are not one of the three principles for the good design of a tax system…” [16]

In addition, significant aggregate job losses will occur if any wage increases occur in response to the inequity of the tax package.

The job losses will not be evenly distributed throughout Australia. Queensland, Tasmania and the ACT will lose jobs. [17]

Tasmania, which already suffers from the highest unemployment rate in Australia, will be particularly hard hit. The loss of 1000 jobs, as predicted by Mr Murphy, will have a devastating effect on the Tasmanian economy.

Given the geographical distribution of jobs, particularly in the tourism and agricultural and forestry industries, other regional areas of Australia will be similarly disadvantaged. No amount of so-called `compensation' will be adequate to offset these severe regional impacts.

Committee members completely reject Mr Murphy's view that “… the fact that employment is marginally lower in some states is hardly even relevant in assessing whether a policy is good or bad.” [18]

Mr Murphy's report criticises Professor Dixon because he “..adopts the misplaced popularist notion that there are winners and losers from ANTS.” [19] The committee is perplexed by this comment as Mr Murphy's own modelling identifies 47,000 job losses across various industry sectors [20], thereby demonstrating there are many losers from the ANTS package.

Inflation Impact

The ANTS document claims an inflation impact of 1.9%. This is a misleading figure. Evidence provided to the committee by Treasury revealed that the true Treasury estimate of the initial inflation effect of the GST is 3.1%. Even this figure significantly understates the real effect that will occur in year one of the GST as it assume that all of the proposed indirect tax cuts will be immediately and fully passed on to consumers.

The real inflation effect in year one will be at least 4-5% based on the evidence provided to the committee. No credible witness seriously argued that an immediate full pass-on of all the indirect tax cuts will occur. The National Farmer's Federation (NFF) response to the question as to whether its' members will pocket some of the gains was typical of most industry comment. As Mr Donges of the NFF stated, “Farmers are no different to any other businessmen. If there is a possibility that they can claim some of the profits in the system, then no doubt they will.” [21]

Treasury admitted that the pass-through will not be immediate and will vary between industries. [22] Mr Murphy confirmed that the cost savings from capital replacement will only flow through to consumers as the capital stock is replaced over many years. As he said, “With respect to capital business inputs, as you point out, they will only realise the cost savings over time as equipment is replaced.”. [23]

The Road Transport Forum also agreed that some of their members would seek to retain some cost savings. [24] In addition, Mr Claugton of the Australian Society of CPA's stated “I do think anyone could guarantee 100% pass on.” [25]

Mr Hank Spier of the ACCC, the expert body that monitors actual business practices in the real world, testified that he could not name one perfectly competitive industry. By contrast, Mr Spier was able to name a litany of industries that have been involved in anti-competitive behaviour. [26] This real world evidence refutes the absurd Government assumption that all cost savings will be reflected in lower consumer prices immediately.

Indeed, Dr Ken Henry, chairman of the Treasury Taskforce that developed ANTS, when asked whether some of the reduction in WST will be taken as profit said, “I am not saying that will not happen.” [27]

The second reason why the inflation impact will be higher than officially claimed arises because the economic models relied upon by the Government (PRISMOD, MM303) also assume that there will be no compliance costs to business either in establishment costs in preparing for the GST or for its ongoing administration.

The extent of the establishment costs is not estimated by the Government, but will amount to several billion dollars. The $500m allocated by the Government to offset this is manifestly inadequate.

In addition, the Government's own Regulation Impact Statement on the GST legislation admits that the estimated second-year GST compliance cost to business will be $2 billion. Canadian experience suggests year two costs will be 25% lower than year one costs. [28] This implies year one costs for Australian business of around $2.7 billion.

These real world costs will either be passed onto consumers, thereby increasing the estimated inflation effect, or they will reduce business margins leading to job losses.

Another reason why the actual inflation outcome will be higher than the Government's estimate is because the transitional provisions relating to cars and trucks deny business a GST credit for vehicles purchased in year one. Only half of the GST will be available as an input credit for purchases made in year two. This means that much of the estimated reduction in transport costs will not occur in the short term.

Furthermore, no inflationary impact was factored in by Treasury arising from the fiscal stimulus provided by the package. [29] Access Economics, has estimated that this effect will add around 0.5% to inflation in year one. [30]

All the evidence provided to the committee disproves the Government's claim that the inflation effect will only be 1.9%. The real impact will be at least 4-5%.

Impact on National Savings

The committee also notes evidence provided by Treasury to the Senate Estimates committee on 11 Feb 1999 confirmed that no modelling of the effect of ANTS on national savings has been undertaken. This continues the disturbing trend and failure by the Government to adequately investigate the economic effects of the tax package.

The Complexity of the GST

The Australian Society of CPA's, indisputable expert in the area of taxation compliance and administration, admitted “Even a `simple' GST such as that in New Zealand is relatively complex…- see the GST guide from New Zealand as an example.” [31]

Labor members conclude the proposed GST legislation before the committee has more items subject to zero rating and input taxing and is consequently more complex than the New Zealand law.

Summary of Findings

Because of the tight reporting timeframe, the committee was unable to thoroughly examine the underpinnings of the economic theories, assumptions, calculations, projections, estimates and modelling which relating to the Government's proposed taxation reforms.

As well, Hansards of evidence given up to ten days before the deadline for this report were not available at the time of writing. This has hampered a comprehensive tabulation of all of the evidence and therefore the writing of this analysis and conclusions. However, what is presented is properly substantiated.

The substantial evidence provided to the committee leads to the inevitable conclusion that the Government's claims concerning the tax package:

• Are not sustained by any research undertaken by the Treasury;
• Have not been independently verified;
• Do not take into account the real world transitional social and economic effects;
• Involve unrealistic assumptions about the competitiveness of the Australian economy leading to the assumption that all proposed indirect tax reductions will be immediately passed on to consumers;
• Assume no wage pressure in the economy despite the true inflationary impact of the GST being at least 4-5% rather than 1.9% contained in the ANTS document; and
• Are incorrect in claiming no short-term job losses despite the evidence to the contrary from independent economic modelling.

Put simply these claims are not credible, and have been shown to be so.

Senator Peter Cook Senator Stephen Conroy Senator Nick Sherry

ALP ALP ALP

Footnotes

[1] Treasury, Hansard, 17 Dec 98, P11

[2] Treasury Op.cit P18-19

[3] Professor Wallis, Hansard, 7 Dec 98, P6

[4] Dixon, Hansard, 3 Feb 99 P527

[5] Dixon Report to Select Committee, 25 Jan 1999, P24

[6] ibid, P22

[7] Senate Economics Legislation Committee, 11 Feb 99

[8] Dixon, Hansard, 3 Feb 99, P551

[9] Loc.cit

[10] Murphy, Hansard, % Feb 99 (Hansard 1st strike P16)

[11] ACTU, Hansard, 4 Feb 99, P667-688

[12] SDAEA, Hansard, 2 Feb 99, P394-413

[13] The Australian, 16 Feb 99, P2

[14] Murphy critique, P9

[15] Loc.cit

[16] Murphy critique P9

[17] Murphy Op.cit, Chart 5 P 32

[18] Murphy, Hansard, 5 Feb 99

[19] Murphy critique P24

[20] Murphy Op.cit P27,28

[21] Donges, Hansard 28 Jan 99, P248

[22] Treasury, Hansard 17 Dec 98, P66

[23] Murphy, Hansard, 5 Feb 99, (Hansard 1st strike P43)

[24] Higginson, Hansard, 28 Jan 99, P349

[25] ASCPA's, Hansard, 3 Feb 99, P580

[26] Hansard of 11 Feb 99, as yet unavailable

[27] Treasury, Op.cit 17 Dec 98, P65.

[28] Treasury, Regulation Impact Statement P7

[29] Treasury, Hansard, 28 Jan 1999, P367

[30] AAP Report, 22 Jan 99, 18.05PM

[31] Submission No 205, P1