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Political realities of reduced GST rates

It remains to be seen whether the local body election results in the weekend represent a shift to the left in New Zealand. Certainly some commentators are suggesting Phil Goff can take heart from the Auckland result especially.

What would a change of government next year mean for GST?

The Labour Party has said they will remove GST from fresh fruit and vegetables. A policy which probably owes its existence to National’s increase of the standard GST rate to 15%.

Labour had 9 years in office to reduce GST on food if they felt 12.5% was too high and the health benefits demanded it, but they didn’t. In fact their GST policy was the same as National’s in that time, i.e. no exceptions. So it seems clear it’s this latest increase which has prompted their GST u-turn.

If Labour gets the chance and implements this policy, overseas experience suggests it could be politically very difficult for subsequent governments to overturn it.

Last year the German Government commissioned a special report on the multitude of reduced VAT rates in Germany’s tax system. Over the years Germany’s reduced rate of 7% has been applied to around 50 different product groups after originally applying to a narrow range of goods such as books, magazines and food. When the 7% rate was recently applied to hotel accommodation there were calls for a review because the system had become unwieldy and illogical.

The review’s aim was to come up with a consistent approach to determining reduced VAT rates which took into account business compliance costs, social, economic and budgetary requirements.

The report was published a few days ago and concluded that apart from the reduced rate for food there was no adequate justification for maintaining existing or introducing new reduced rates for other goods and services. In essence it recommended a major realignment of Germany’s VAT rates.

The reported response from Germany’s Finance Minister Wolfgang Schauble has been swift. Apparently he is opposed to reforming VAT rates because the additional revenue raised would be minimal and the change would merely provoke anger and opposition at increased VAT rates. The reports I’ve read put the potential revenue gain at EUR25b, clearly in this case not enough to overcome the perceived political cost of such a rationalisation.

Phil Goff reckons Labour’s policy of removing GST from fresh fruit and vegetables will cost $250m and save the average family $6 per week. Any future government seeking to overturn Labour’s move would be faced with similar political realities to those mentioned by the German Finance Minister. They’ll ask themselves whether it’s worth it and I suspect the answer will be, no it isn’t. It may be politically preferable to increase GST on something else less controversial.

The German experience shows that once you have exceptions in your GST system political pressure comes on for more as every lobby group presents their case for special treatment. And, when the number of exceptions gets out of hand it can be extremely difficult politically to turn the clock back.

Very careful thought is needed before we embark on this policy route. Is it really the best way to deliver $6 a week to the average family?

Iain

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