Changes in the tax mix from income taxation to GST: Revenue and redistribution

Abstract

This paper examines the conditions under which a partial shift from a multi-step personal income tax structure towards a general consumption tax can be both revenue-neutral and distribution-neutral, in a cross-sectional context. In the absence of a tax-free-threshold, this can be achieved with a broad-based consumption tax, or one in which, at each income level, the proportion of taxed expenditure is independent of total expenditure. Such a change, involving a smaller percentage reduction in the higher marginal tax rates, is also shown to increase labour supply in a simple continuous-hours model.

Keywords:

• income taxation
• goods and services tax
• tax revenue
• income distribution

Acknowledgements

The authors are grateful to a referee for detailed helpful comments on earlier versions of this paper. The views, opinions, findings, and conclusions or recommendations expressed in this paper are strictly those of the authors. They do not necessarily reflect the views of the New Zealand Treasury or the New Zealand Government.

Notes

 1. A wide range of issues relating to changes in the tax mix are examined in the volumes edited by Head (1986, 1993) and Head and Krever (1997).

 2. On the effects on lifetime inequality and progressivity, and the timing of a tax shift, see Creedy (1998). On the lifetime incidence of taxation, see also Fullerton and Rogers (1993).

 3. The conditions for revenue and distribution neutrality in a stylised structure with a single income tax rate above a threshold and a general indirect tax structure, allowing for varying degrees of exemptions, are considered in Creedy (1992). In general, the two conditions cannot be achieved with only changes in the tax rates.

 4. Some countries have more than one GST rate (other than zero), but the present analysis is confined to single positive rate systems.

 5. A rate of g/(1 + g) applied to the consumer price produces the same revenue as g applied to the producer, or tax-exclusive, price.

 6. The simplest case arises where GST applies to all goods and services at a fixed rate, so that θ = 1 and .

 7. For details see: www.stats.govt.nz/browse_for_stats/corporate/corporate/corporatecommunications_mrimpact-of-gst-on-cpiimpact-of-gst-on-cpi.aspx

 8. Adjustments to thresholds would provide further degrees of freedom in policy choices, but it is seen that they are not required here.

 9. Compensation for those below a tax-free threshold may come in the form of adjustments to benefit levels.

10. The assumption that lending and borrowing rates are similar is also needed.

11. Alternatively, the various proportions of people and taxable income in each tax bracket may be available from actual data.