How the Left could learn to love a retail tax
(P.S.: See also Maximalist ‘fiscal devaluations’ for Greece and Australia.)
Conventional wisdom holds that replacing income tax with a consumption tax would be regressive, and that it would devalue past savings by raising prices. Both objections assume that gross wages and salaries would stay the same. If, instead, net wages and salaries stay the same, both objections disappear.*
- More exports, fewer imports, more jobs
- No losers
- What about housing affordability?
- Deemed residential rents
- Preserving net wages/salaries
- Anti-evasion provisions
- At what rate?
More exports, fewer imports, more jobs
The economic advantage of consumption taxes over income taxes is clear enough. Export income is income received by entities within the jurisdiction of the exporting country. But the exported goods and services are not consumed within that jurisdiction. Accordingly, under GATT/WTO rules, exemption of export income is prohibited for income taxes but permitted for consumption taxes (such as VAT/GST and retail taxes). Thus an income tax is a tax on exports (and local products consumed locally) but not on imports, whereas a consumption tax is a tax on imports (and local products consumed locally) but not on exports.
To replace an income tax with a consumption tax is therefore to shift a massive tax burden off exports and onto imports, increasing export sales (as protective tariffs cannot do) and increasing domestic demand for local products that compete with imports. The result is greater industrial self-reliance, more jobs in the domestic economy, hence a stronger bargaining position for workers relative to employers, hence better pay. All this should please the Left.
If income tax were abolished while gross wages and salaries remained constant, low-income workers would receive smaller tax cuts (expressed as percentages of income) than high-income workers. If the lost revenue were then replaced by imposing a retail tax, low-income workers, who need to spend greater fractions of their income on consumption than high-income workers, would suffer larger increases in their living expenses (again expressed as percentages of income). The net result would be a transfer of spending power from the poor, and from persons reliant on fixed incomes or savings, to the rich (and the Left would be greatly displeased).
But it doesn't have to be done that way. If income tax were abolished while net wages and salaries remained constant, there would be no change in take-home pay, hence no change in the relativities between high-income and low-income workers. And if the lost income-tax revenue were replaced by a retail tax, the amount of tax currently remitted by enterprises in the form of corporate income tax and employees' pay-as-you-earn income tax would instead be remitted by enterprises in the form of retail tax. As there would be no change in the total tax remitted on the way to the consumer, and no change in the net wage-salary expenses incurred on the way to the consumer, there would be no increase in the cost of living. In short, neither low-income workers nor persons reliant on fixed incomes or savings would be any worse off, and the Left would have no reason to complain.
The preceding paragraph applies to a closed economy. Recall, however, that replacing income tax with a retail tax would bring imports into the tax base and take exports out of it. This by itself would be expected to increase the cost of living, because import prices form part of the cost of living while export prices do not. But this tendency would be countered by two others. First, because a retail tax is much simpler than an income tax, there would be a saving in compliance costs, and competition would ensure that this would be passed on in lower prices, including more competitive export prices. Second, due to the improved balance of trade, the removal of tax and compliance costs from export prices would be partly offset by an appreciation of the currency, which in turn would reduce the cost of living as expressed in the local currency. Because exports and imports tend to be only small fractions of GDP, the reduction in compliance costs would probably be the dominant influence on prices. That should please the Left.
Let us enumerate some of the savings in compliance costs. With a retail tax there is no accounting burden for “consumers”, including wage/salary earners and ordinary home owners. If the retail tax is as broad-based as income tax, residential landlords must be treated as “enterprises”; but, as they are already outside the pay-as-you-earn system, their compliance costs do not increase, but fall because there is no longer any need to claim deductions for related expenses. Such expenses are business inputs and therefore already untaxed. For the same reason, there is no need for depreciation allowances; that need arises only when the assets are taxed, or purchased out of taxed income. Under a retail tax there is no case for special provisions concerning fringe benefits, inheritances, or gifts, because the recipients are taxed as they spend, not as they earn or receive. In particular, an heir who reinvests an inheritance or continues to manage an inherited business automatically escapes tax on the inheritance per se, whereas one who sells an inheritance and spends the proceeds will pay tax on the spending. The needs of superannuation are also automatically covered: superannuants are taxed only as they spend, and therefore automatically escape tax if they choose to “roll over” a payout. But there is no “double taxation” through “devaluation” of existing superannuation accounts because, for all the above reasons, the transition to a retail tax can be managed with no overall increase in prices.
One aspect of income tax not considered in the preceding paragraph is the treatment of capital gains. This is considered under the next heading.
What about housing affordability?
The application of a “consumption tax” to real property sales, although possible and indeed prevalent, is illogical. This is especially the case when the tax in question is called a “goods and services tax” (GST); real property does not fall within the common-law category of “goods”, and while the letting of a property can be construed as a “service”, the property itself cannot.Moreover, a large part of the price of a property is the price of space, which cannot be produced or “consumed”, but which, by reason of its scarcity and locational advantage, commands a rental value which can be capitalized as a sale price. Even a building is not “consumed” simply by being purchased, but tends to survive through multiple resales; indeed, the price of the property tends to increase with each resale because the depreciation of the building is outweighed by the appreciation of the space. (That we do not expect “goods” to behave this way is one reason for not classifying real property as “goods”.)
The tendency to appreciate, which makes property unsuitable for a “consumption tax” on sales, makes it an ideal target for a capital gains tax, which in turn is the only major aspect of the income-tax system that is not automatically handled by a retail tax. Logically, then, a retail tax replacing “income tax” should replace all aspects of income tax except capital gains tax. Capital gains would then be taxed while current income would not, so capital gains would be less attractive than current income.
This has two desirable consequences. First, the property market would be less likely to form speculative bubbles, which squeeze out first home buyers (and which subsequently burst, causing recessions). Second, property owners would be better motivated to generate income from their properties. So land approved for development would be developed (not hoarded), and vacant suburban lots would be built upon, and boarded-up buildings would be opened to tenants and buyers. All this would make housing more abundant, hence more affordable. That should please the Left.
Affordable housing is the key to economic justice. From the viewpoint of private entities, the overall supply of residential sites (space) is fixed, as is the supply within acceptable distance of any particular services, infrastructure, or job opportunities. Yet access to a suitably located site is a necessity of life. Therefore values of housing sites are competed upward until they absorb the capacity to pay. If wages and salaries rise, so does the cost of housing. If childcare or petrol or food gets cheaper, the cost of housing eats up the savings. What the rest of the economy giveth, the housing market taketh away. If this were not so, economic growth alone would have solved the housing problem. Therefore if a benefit for “working families” is not to be competed away in the housing market, it must be delivered through the housing market — by strengthening the bargain positions of renters and buyers relative to landlords and sellers.
Affordable housing is also a key to economic efficiency. Jobs cannot be created unless:
(a) the employer can pay the rent or mortgage on the business premises out of the proceeds of the business; and
(b) the workers can pay the rent or mortgage on housing within commuting distance of those jobs, out of wages that the employer can pay out of the proceeds of the business.
Unaffordable housing violates condition (b). In “bad” economic times, any such violation is a barrier to job creation. In “good” economic times, any such violation is a “capacity constraint”, raising prices and damaging international competitiveness. There is never a wrong time to do something about the housing problem.
Deemed residential rents
Under a retail tax, commercial and industrial rents would be exempt because they are not retail transactions. But residential rents could be construed as retail service transactions, in which case they would be taxable. This seems unfair, the more so because the tax burden would be at least partly shifted onto tenants; the landlord could avoid the tax simply by not offering the property “to let”, thereby reducing the supply of rental accommodation and pushing up rents. The effect on supply would be compounded because if absentee landowners are not going to offer houses “to let”, they might as well not build them in the first place.
However, the tax can easily be modified so that it reduces residential rents instead of raising them. The trick is to tax the absentee owner regardless of whether the property is let to a tenant, so that the owner cannot avoid tax by leaving the property vacant, but must find a paying tenant (or a buyer) in order to cover the tax bill. For example, every investment property could be deemed to be earning an annual rent of (say) 3% of the assessed site value — where the site value is the value of the associated ground and/or airspace, including any attached building rights, but excluding actual buildings so as not to discourage construction. (The nominated 3% per annum is the minimum rate at which the financial assets of Australian pensioners are deemed to be earning interest for the purpose of the income test.† If that's good enough for pensioners, it's good enough for property investors.) This would provide an incentive to develop “banked” land, build on vacant lots, and repair derelict buildings for prospective tenants or buyers. All this adds to the supply of housing and makes it more affordable. That should please the Left.
Preserving net wages/salaries
In Australia, preserving net wages and salaries while abolishing the Federal income tax has been made easier by the previous government's Federal takeover of workplace relations. But because the takeover was not complete, there would be some cases in which the cooperation of the States would still be needed.
The necessary legislation would involve a comprehensive no-disadvantage rule: no disadvantage for current workers who keep their present hours; no disadvantage for current workers who change their hours, compared with those who were already working the alternative hours; and no disadvantage for new workers compared with current workers on the same hours. By itself, however, the no-disadvantage rule would leave a loophole: under the present system, the “net” wage corresponding to given gross wage from a given employer depends on whether the worker is claiming the tax-free threshold from that employer. Hence employers might preferentially hire workers who do not claim the threshold and who therefore can be paid less. To limit such abuses, the no-disadvantage rule must be backed by a safety net. Furthermore, under the present income tax, a part-time worker keeps a greater fraction of his/her pay than a full-time worker employed under otherwise identical conditions, so that (for example) a half-time worker gets more than half the net pay of a full-time worker. To preserve this feature, the safety net should take the form of a minimum hourly rate (or piece rate) plus a shift bonus — that is, a separate payment for a completed shift or day's work.
Regardless of the present relativities between full-time and part-time workers, a mandatory shift bonus is several thousand years overdue. A shift bonus compensates workers of shorter shifts for the greater fraction of their wages that is consumed by travel costs, and the greater fraction by which their paid time is augmented by unpaid time, such as travel time and preparation time. That should please the Left.
Moreover, the proposed tax reform would be highly conducive to job-creation. The ensuing competition between employers would minimize the need for no-disadvantage rules and safety nets.
It is often alleged that a retail tax is more susceptible to evasion than an income tax or a value-added tax (VAT). Under an income tax, an item of income for a supplier is often an allowable deduction for a customer, in which case the customer's desire to claim the deduction will create a second record of the supplier's income and encourage the supplier to declare it. Similarly, under a VAT, the customer's desire to claim an input credit will create a second record of the sale and encourage the seller to declare it. But under a retail tax there are no deductions or input credits. How then are sellers to be kept honest?
One possibility is to provide all retail customers with a government rebate of (say) 1% of credit-card purchases and 2% of debit-card purchases from registered retailers, so that customers have an incentive to use cards, which of course produce an electronic record of every transaction. (Don't laugh. In South Korea, to keep retailers honest, there are substantial income tax deductions for the use of credit and debit cards! Where there is no income tax from which to claim a deduction, a rebate is the obvious alternative.) With so many customers wanting to use cards, any retailer that refused to accept cards would be highly conspicuous. And any customer using a card to buy from an unregistered retailer would not get the rebate. If only a small fraction of such customers became angry enough to complain to the tax authorities, life would be intolerably dangerous for “underground” retailers.
The proposed rebate could be paid using the same technology that has been used for many years to deduct financial institutions duty (FID) and bank account debits tax. Implementation would probably involve nothing more than programming.
At what rate?
Presumably the rate of the retail tax should be such as to make the overall package (including rebates) revenue-neutral, and therefore approximately price-neutral. Because income-tax rates are quoted for a tax-inclusive base, the quoted retail tax rate should also be tax-inclusive in order to avoid a misleading impression of an increase in taxation. Given those specifications, the Treasury should be able to crunch the numbers and come up with a rate.
Price-neutrality means that the new tax-inclusive prices would be about the same as the old prices. Therefore all displayed retail prices should be tax-inclusive, not only for the convenience of customers, but also for the convenience of the retailers; if displayed prices were tax-exclusive, retailers would have to reduce their their displayed prices by an average margin roughly equal to the tax rate.
Replacing income tax with a retail tax would greatly improve the balance of trade. Provided that net wages and salaries (not gross wages and salaries) were held constant, the reform would not be regressive and would not raise the cost of living. The alleged susceptibility of retail taxes to evasion can be overcome by appropriate use of existing technology. For optimum affordability of housing, the retail tax should replace all aspects of income tax except capital gains tax, and in the case of residential rents should apply not to the actual rent paid, but to a deemed rent proportional to the assessed site value.
* By Gavin R. Putland. First published Feb.11, 2008. Edited Feb.12, 2008. Edited (only to update the deeming rate) and included in the author's Federal Budget submission dated Jan.25, 2009. Relocated Apr.13, 2012. Cf. Prosper Australia's submission to the 2011 Tax Forum.
† P.S. (Oct.2, 2011): These “deemed” rents and interest rates are of course prospective, and are not to be confused with retrospective “anti-avoidance” provisions purporting to allow the tax office to deem past arrangements to be other than what they were. The former deeming arrangements provide legal certainty; the latter take it away. The former are compatible with the rule of law; the latter are not.