Opinion: GST treats services exports unfairly; Apply it to all exports

By Infometrics economist David Grimmond Treasury has put forward the idea of rebalancing the tax system by raising the emphasis on consumption taxes and lowering the emphasis on direct income taxes. This view has merit, but it also needs to be accompanied by a redesign of the Goods and Service Tax (GST), for if the tax is raised, the current discrimination against service exports embedded in GST will be accentuated. The GST is on the whole a well designed value-added-type tax:

• It is broad-based
• It is based on real transactions and so easy to enforce and apply
• It does not interfere with production efficiency by taxing intermediate consumption
• It is, broadly speaking, self-policed
• There is just one uniform tax rate, which simplifies collection and enforcement

The design of the New Zealand GST adheres to the "destination principle". The destination principle implies that if a good or service is purchased in New Zealand it should be liable for GST. In principle this means that imports should be subject to GST, as the goods and services will be purchased in New Zealand. Exports on the other hand are exempt as final consumption will be offshore. However, GST does not operate in this pure way in practice. This is because of the difficulty in applying the destination principle to services such as tourism or educating foreign students. The national accounts rightly treat the expenditure by New Zealanders abroad as an import and the expenditure of foreigners visiting New Zealand as an export. However, the way that the destination principle is applied by the New Zealand GST means that the expenditure of New Zealanders abroad escapes having to pay GST. It also means that tourists who visit New Zealand are liable to pay GST and other expenditure taxes during their stay in New Zealand. As a result, GST raises the relative returns of exporting goods above that of exporting services. It also encourages consumers to spend their money on trips abroad ahead of travel within New Zealand or indeed on any other product available within New Zealand. Although the misapplication of GST looks like a tax on overseas tourists, it is in reality a tax on the incomes of those in the tourist industry and other traded services industries. By lowering the relative returns from exporting services, like tourism and education, GST lowers incentives to invest in the service export industries and so constrains their pace of growth. For example, if a tourist arrives in New Zealand with a budget of $NZ1000, the tourist industry is likely at most to receive $888.89 of this while the remainder is collected as GST by the government (ignoring other duties such as excise and tariffs). If the same person spent their money on sheepskin products (either overseas or at a duty-free store) the export sector (including associated services) would receive the entire $NZ1000. By artificially lowering the relative returns from these service exports, the distortion created by GST artificially creates winners and losers, and so misallocates our investment resources. This lowers New Zealand's overall pace of growth, incomes and living standards. Attempting to correct this distortion using the current destination principle will simply generate excessive administrative and compliance costs. Instead a paradigm shift is required. And there is a remarkably simple solution "“ the GST design should shift from using the destination principle to the origin principle in determining who should pay GST. A GST designed using the origin principle would exempt all imports from GST, but would tax all exports (including the service exports already taxed). That is, rather than attempt the exceedingly complex task of removing the unfair tax on the tourism industry, simply remove the dispensation currently provided to other exporters. Similarly, instead of attempting the impossible task of taxing New Zealanders who travel abroad, simply remove all taxes on imports. An obvious objection that many might have to this approach is to question what the impact of applying GST to our exports will do to the competitiveness of the export sector. The short answer is very little. In the presence of a flexible exchange rate, the shift to an origins-based GST will trigger a one-off exchange rate depreciation, so the taxation of exports will have no lasting impact on the competitiveness of exports. This exchange rate depreciation will neutralise the effect of raising GST on the exports that currently do not pay GST, and at the same time will provide a corrective stimulation to the service exports that are already paying GST. The advantages of this approach are that it:

• Restores the principle that transactions between countries should not be taxed
• Treats all exports uniformly and also all imports uniformly
• Greatly simplifies the administration of GST
• Does not penalise exporting

________________ * Infometrics is an economic information and forecasting company based in Wellington. To find out more, see its website here. This piece first appeared in the Dominion Post.