Gavin R. Putland,  BE PhD

Thursday, May 30, 2013 (Comment)

Internal devaluation by tax reform

Contrary to conventional wisdom, it's possible to increase the GST without raising the cost of living. The trick is to use the extra GST to replace the PAYG component of personal income tax — that is, the component withheld from wages by employers. Employees continue to receive credit for the withheld PAYG tax (calculated on their “grossed-up” wages). But businesses, instead of forwarding the withheld PAYG tax to the ATO, pay a higher GST. In the aggregate, the withheld PAYG tax covers the additional GST, so there's no need to raise prices. And there's no reduction in after-tax wages or widening of after-tax wage inequalities.

This approach has three advantages. First, PAYG personal income tax is completely removed from the marginal cost of labour as seen by employers, creating more jobs, hence more domestic demand for Australian products. The reduction in the cost of labour is achieved by cutting taxes on labour, not by reducing take-home pay; it's WorkChoices without the worker-bashing. Second, the GST, unlike the cost of labour, does not feed into export prices, so there's more foreign demand for Australian products; it's “internal devaluation” without the worker-bashing. Third, because the extra jobs reduce welfare spending, not all of the lost revenue from PAYG tax needs to be replaced. So there's slight fall in prices of Australian products.

These advantages would be all the greater if the GST were high enough to replace not only PAYG personal income tax but also the superannuation guarantee...

Read the rest in the comments on “Australia slips down competitiveness rankings” at MacroBusinessP.S.: See also Maximalist ‘fiscal devaluations’ for Greece and Australia.

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