Must be a very slow news day – Pauline Hanson is in the media describing what she would do as PM (for a start she is in the wrong house for that).
The One Nation leader said under her vision for a “better Australia,” she would, she was Prime Minister, also cut the number of politicians, limit migration, introduce an Australian identity card, and axe the GST and consider a flat two per cent tax rate.
This particular idea keeps raising its head:
… axe the GST and consider a flat two per cent tax rate.
Like a return to the gold standard and the evils of fractional reserve banking, so bad ideas just never die.
What Mrs Hanson has in mind is a cascading sales tax. The government would tax every transaction at two per cent. Now that may sound like an improvement on taxing every transaction at 10 per cent. But the fist thing to note is that the government does not tax every transaction at ten per cent – it taxes the value add of every transaction at 10 per cent with the consumer paying 10 per cent overall at the end. With a cascading tax very quickly we would be paying tax on tax.
We have covered the problems of a cascading tax before, but it well worth revisiting that coverage.
I often get asked about various proposals for tax reform – defined here as proposals for new and or different forms of taxation. The yardstick that I always apply is Adam Smith’s four criteria of a good tax:
- The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state.
- The tax which each individual is bound to pay ought to be certain, and not arbitrary.
- Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributor to pay it.
- Every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the state.
Recently I was asked about the idea of a cascading sales tax. By this the person meant a tax on each and every transaction in the economy. The basic idea is that a x% tax on every transaction would raise a lot of money very quickly and easily and if x is low enough (say 2%) the excess burden of taxation would be very low. This idea isn’t new – in Adam Smith’s day the Spanish had such a tax, called the alcavala.
This is how Adam Smith described that tax:
It was at first a tax of ten per cent, afterwards of fourteen per cent, and is at present of only six per cent upon the sale of every sort of property whether movable or immovable, and it is repeated every time the property is sold.1 The levying of this tax requires a multitude of revenue officers sufficient to guard the transportation of goods, not only from one province to another, but from one shop to another. It subjects not only the dealers in some sorts of goods, but those in all sorts, every farmer, every manufacturer, every merchant and shopkeeper, to the continual visits and examination of the tax-gatherers. Through the greater part of a country in which a tax of this kind is established nothing can be produced for distant sale. The produce of every part of the country must be proportioned to the consumption of the neighbourhood. It is to the alcavala, accordingly, that Ustaritz imputes the ruin of the manufactures of Spain. He might have imputed to it likewise the declension of agriculture, it being imposed not only upon manufactures, but upon the rude produce of the land.
I suspect it is fair to say he wasn’t a fan.
The criticism that Smith levies against the cascading sales tax is that it is arbitrary. While collecting a sales tax would have been a complex administrative task in those days the charge that a cascading sales tax is arbitrary remains the case today.
- The amount of tax paid on any good or service becomes a function of how long the production chain is. For any service with a short production chain the tax is lower, for goods with longer production chains the tax is higher. This is a violation of condition 2.
- Firms then have an incentive to either misrepresent the length of the production chain, or engage in pricing behaviour that minimises taxes. (See below for more detail). The tax becomes distortionary – a violation of condition 4.
- In practice the tax would manifest itself as a tax on turnover. Those firms with a lower profit margin would bear a higher burden than those with a higher profit margin. Tax considerations would drive many small businesses out of business. Again a violation of condition 4.
Okay – so what would happen? First tax avoidance schemes would include vertical integration and offshoring. Tax evasion would include mispricing and various kick-backs. The ATO would have to expand its transfer pricing division to include the domestic economy as well as the international economy. In short, the incentives to rort the tax would be massive compared to the value-added tax that we currently have.
Some US states have similar taxes and a Tax Foundation study is scathing.
In short, it’s not really a good idea.