Food expenditure and GST in New Zealand

Abstract

This paper investigates the welfare effects on New Zealand households of zero-rating food in a goods and services tax (GST). The detailed effects, for a range of household types, are investigated using Household Economic Survey data. Demand responses to consumer price changes are estimated and welfare changes, in terms of equivalent variations, are obtained. Comparisons are also made across clusters, consisting of groups of households with similar characteristics. A tax change is found to produce a very small amount of progressivity in the GST. Redistribution is from households without children and with high total expenditure to households with children and low total expenditure, and towards older households.

Keywords:

• goods and services tax
• tax progressivity
• budget shares
• welfare changes

JEL Classifications:

• H31
• I3
• D11

Acknowledgements

Access to data used in this paper was provided by Statistics New Zealand under conditions designed to give effect to the security and confidentiality provisions of the Statistics Act 1975. The graphs presented in this report are the work of staff at the New Zealand Treasury and not Statistics New Zealand. The views, opinions, findings and conclusions are strictly those of the authors and do not necessarily reflect the views of the New Zealand Treasury. We are grateful to Matt Benge, Angela Mellish, Alastair Thomas, Martin Wong and two referees for their comments on earlier drafts of this paper.

Notes

1. A distinction needs to be made between exemptions from GST and zero-rating. With zero-rating, registered firms can claim tax credits on inputs purchased. With exemptions, such credits cannot be claimed. For a detailed analysis of zero-rating of food from a legal and administrative point of view, see van Klink (2012).

2. For international comparisons, using the concept of ‘C-efficiency’ (reflecting departure from a uniform system), see Keen (2013). He decomposes the efficiency measure into a ‘policy gap’ and a ‘compliance gap’.

3. Indeed, the configuration of tax rates is irrelevant only if judges are indifferent to the distribution of welfare and, in addition, if all own-price and cross-price elasticities of demand are zero. This is essentially a second-best problem in view of the impossibility of taxing endowments. For example, with identical preferences, a fixed wage rate distribution and a linear income tax, uniformity is optimal if Engel curves are linear and the marginal rate of substitution between goods is independent of leisure; see Stern (1990).

4. An argument for zero-rating certain food items considered to be healthy has been made, but the emphasis here is on the general redistributive case made in all countries where food is exempt (though the question of what constitutes food is not always clear, and problems arise in defining food consumed outside the home).

5. Although only the single tax is being examined rather than a tax and transfer system, the term ‘redistribution’ is used here, following the public finance convention.

6. If all households have identical tastes, additivity implies that optimal indirect tax rates are uniform. However, this does not arise in the present context because of the allowance for heterogeneity of expenditure patterns between groups.

7. On the revenue elasticity of indirect taxes in New Zealand, see Creedy and Gemmell (2004).

8. This is consistent with the elasticities converging towards unity, though the convergence may not be uniform. The budget shares are also affected by the tax structure, since where is the cross-price elasticity of demand for good with respect to a change in the price of good

9. On reranking arising from indirect taxes in Australia, see Creedy (2002).

10. This policy effectively ignores any consequences arising from increased debt or reduced government expenditure as a result of the revenue reduction.

11. The unit is the household: that is, 10% of households are in the lower decile of household expenditure per adult equivalent.

12. All values reported are averages within the designated groups, obtained as weighted averages using the Household Economic Survey sample weights used to aggregate to population values. In the case of the budget shares, these are obtained as the ratio of the (weighted) average household expenditure on food, divided by weighted average total expenditure. This is in line with Statistics New Zealand calculations of budget shares (though of course the ratio of averages is not the same as the average of ratios).

13. It could be argued that, since food may enter as an intermediate input into some goods and services which are still subject to GST, those other goods will not have constant prices. This kind of effect cannot be considered here but can reasonably be expected to be small.

14. There is an exception in that the average ratio for decile 4 is slightly higher than that for decile 3.

15. Values for ‘Other households’ are omitted from the table. These two groups (with and without children) are extremely heterogeneous, and in the case of those without children the EV is negligible, making the ratio of the change in tax to the equivalent variation extremely high.

16. The larger values of Tax/EV observed for expenditure decile number 6 and renting households arise because the equivalent variations for these groups are in fact very small.

17. Since and defining it can be shown that and