NO.016

The NATSEM report released today by Ann Harding and Neil Warren (Distributional

Impact of Possible Tax Reform Packages) reaffirms the benefits of the

Government’s tax package.

The non-Government members of the Committee asked NATSEM to model the distributional

effects of the tax package using a range of adverse assumptions regarding inflation,

household specific price impacts, dissaving by lower income groups and the exclusion of

food. In all, ten options were modelled for 29 cameo groups.

In the first option, NATSEM replicated the methodological assumptions as set out in the

Government’s policy A New Tax System (ANTS). Harding and Warren endorsed the

Treasury estimate of a 1.9% CPI impact from the tax package and stated, “Generally

speaking, our estimates of the net distributional effects for particular types of

households of the Option 1 package are very close to the Government’s

estimates.”

That is, the analysis confirmed no category of person worse off from the

Government’s tax reform. In fact, pensioners and low-income earners are better off

from tax reform than without it.

Options 2 to 6 are based on a higher CPI impact of the GST because the Committee

instructed the modellers to include in the CPI effect the expected impact of the tax

package on tobacco and new home prices. Harding and Warren disagree with this approach:

It should be noted that we do not endorse using this measure as the appropriate

indicator of the likely change in prices facing households. There are strong arguments for

not compensating smokers for the likely increase in prices facing them under the ANTS tax

reform package. In addition, we have not been able to model the distributional impact of

the proposed First Home Owners Scheme, so that the adverse distributional effect of the

GST on house prices is included within this measure but not the positive effect of the

new scheme specifically designed to overcome this adverse effect (my emphasis).

Notwithstanding this adverse CPI assumption,

Under the assumptions implicit in Option 2, however, on average there are still

no losers expected from the tax reform package for the cameo households modelled.

Option 3 uses the higher CPI estimate, and also uses household specific price effects

(based on HES data) and an arbitrary dissaving assumption for low-income earners. The

authors themselves disclaim the validity of Option 3 results because of their concerns

about the higher CPI estimate.

We do not support this as the most appropriate measure of the impact of the tax

reform package on prices, preferring instead a measure of price change which excludes the

likely impact of tobacco and new house price changes.

After excluding such impact the report finds there is no category of person worse off

under Option3B.

Option 4 builds on Option 3, with its attendant errors on tobacco, house prices and

dissaving, and incorporates a 70% pass through of indirect tax cuts in the first year but

100% of increased costs arising from GST passed through. The authors again discount the

usefulness of this option, stating

It is important to recognize that this 70 per cent scenario should not be viewed

as the standard case. A strong defense can be mounted for the ANTS assumption of 100 per

cent shifting forward. In particular, one could cite the powers being given to the

Australian Competition and Consumer Commission (ACCC) to pursue businesses who do not

fully pass on their tax related price changes.

…This aggressive strategy is likely to ensure 100 per cent shifting of the

indirect tax changes does act to offset the typical economic argument that the market will

take some time for the tax-related price increase to flow through. Therefore, in the case

of the ANTS reforms, 100 per cent shifting is probably the most reasonable assumption in

the medium term. As a result, the 70 per cent WST and Stamp Duties shifting assumption

should be viewed as at the extreme of the range of possibilities.

It is only by making unreasonable assumptions that the report can find categories of

persons worse off and even then not very many.

Option 5 and 6 model the removal of food from the package and funding the revenue

shortfall by reducing tax cuts (Option 5) or increasing the GST rate (Option 6). Warren

and Harding note, however, with respect to removing food that what hasn’t been modelled,

but should be

…is the increased complexity of a GST with food made GST-free, both for the

Australian Taxation Office and the over 20 per cent of businesses who will be collecting

GST. These increased compliance and administrative costs must mean a greater burden on

households than we have been able to estimate in this study. This will manifest itself as

reduced GST revenue (net of administrative costs) and the prices of goods and services

increasing by more than we have estimated in this report.

In addition to the concerns of Warren and Harding, the Government does not support

these options because they remove tax cuts principally from taxpayers in the $20 000 to

$50 000 bracket and the GST rate would have to increase to 12%.

In Options 1 to 6, NATSEM assume that the Government would increase pensions by 3.4 per

cent, notwithstanding introducing assumptions which produce a higher CPI then in ANTS

and the Government’s commitment to compensate pensioners above the CPI effect by a

margin of 1.5 per cent. The results based on these cameos attempt to thus show what the

likely impact of the tax reform package would be if the price effect of the tax reform

package was different to that anticipated by the Government but the planned increase in

pensions as per ANTS went ahead anyway.

However, because NATSEM assume a fixed 3.4% increase in pensions independent of what

the CPI outcomes are, the These cameo results arethefore clearly not correct.based on

false assumptions.

Because Warren and Harding reject the validity of the higher CPI assumption which was

directed by the Committee, they modelled Options 3, 4 and 5 with tobacco and house price

effects removed from the CPI as used in ANTS.

In these scenarios (the “B” options in NATSEM’s report), Warren and Harding

maintain the Government’s actual compensation approach by assuming that pensions are

increased by 1.5 per cent more than whatever the estimate of the CPI effect is for each

option. The cameos in tThhese “B” options are the only cameos which correctly

incorporate the government’s compensation commitment..

Option 3B is stated by the authors to be “probably the most appropriate.”

Option 3B shows the outcomes using the lower CPI assumption and the compensation rate for

pensions and allowances is 3.5 per cent (equal to NATSEM’s estimated CPI of 2 per cent

plus the Government’s buffer of 1.5 per cent). Under Option 3B, every single group

modelled is better off under the ANTS package.

It is clear from the report that Harding and Warren do not favour the removal of food

from the GST base. The Australian Democrats were the driving force behind setting up the

Senate Committee with the intention of mounting a case to exclude food. The Committee

commissioned the work of Harding and Warren which finds against such an outcome. Indeed

not one of the Committee’s consultants supports excluding food.

The additional options modelled on the basis of adverse assumptions, many of which

Harding and Warren were clearly uncomfortable with, resulted in only 85 observations out

of the 6090 modelled where particular households were not beneficiaries from tax reform.

If the 70% pass through option, which is considered unrealistic by Harding and Warren,

is set aside then only 15 observations, mostly as a result of the arbitrary dissavings

assumption, do not show a net benefit from tax reform.

This modelling was the last hope of Labor and the Democrats to undermine the

Government’s tax package. They have, however, been severely disappointed because of the

professionalism of the modellers.

It is now the responsibility of the Senate to accept the weight of evidence in support

of the benefits of the Government’s tax package and pass the legislation.

8 April 1999

Contact: Niki Savva

02 6277 7340