More winners and losers from GST

So, us New Zealander’s are switching some income tax to consumption tax.  Good for us.  In order to think about whether this is a good thing we need to discuss costs and benefits.

It turns out this switch is also a “transfer” of resources between two groups, relatively speaking.  These groups are people that HAVE borrowed and people that HAVE saved.

When we increase GST and lower income tax we are saying “we will tax future consumption more and future income less”.

If people have borrowed this implies that they purchased consumption when it was relatively “cheaper”, and are now going to be taxed at a lower rate on the income they are making to pay it back – as a result, borrowers win.

If people have saved, this implies that they have deferred consumption when it was cheap – and will buy things when they are more expensive.  As a result, savers lose out from the change in relative taxes.

Since it is “true” that people on low incomes borrow relatively more of their income, then in a static sense this switch could be seen as more “progressive” right?  I don’t really like static definitions, but if people are complaining about the poor and saying that the poor borrow more then it is important to keep this initial transfer in mind …

Personally, I think borrowing and saving  is based more strongly on lifetime income, impatience (which I think is income neutral) and the lumpiness of consumption – as a result, I’m don’t see to much progressivity here.  However, this does tell us that people with a stock of liabilities will benefit and people with a stock of assets will lose.

5 replies
  1. Dismal Soyanz
    Dismal Soyanz says:

    Underpinning this view though, Matt, is the stark consumption choice – current or future. This really only applies to highly discrete consumption e.g. buying a car or some other type of durable good other than housing (which for owner occupiers has no GST).

  2. Matt Nolan
    Matt Nolan says:

    @Dismal Soyanz

    “This really only applies to highly discrete consumption”

    Or discretionary spending, or spending that is time dependent (preferences do change over time after all). In fact, I would say it accounts for the majority of spending.

    Now, what is fundamentally driving the initial above is the lifetime budget constraint – if we think that is satisfied then the trade-off is between borrowing and saving is as stated.

    When it comes to the last two paragraphs I am assuming some consumption smoothing. The data does indicate that the young borrow more than the old, and that the old are more asset rich – so the conclusion seems fair.

  3. Dismal Soyanz
    Dismal Soyanz says:

    I agree that it’s hard to imagine spending that cannot be shifted to some degree further into the future. However, the two periods under comparison are before and after the tax change. Consumption of non-durables is unlikely to be significantly affected except right at the change over. So the question that springs to my mind is just how much spending is switchable between these two periods. Even time dependent spending may not be – for example someone who will retire in the post tax change period might not bring forward consumption ahead of retirement, regardless of the tax rate.

  4. Matt Nolan
    Matt Nolan says:

    @Dismal Soyanz

    But Dismal, even if demand is highly inelastic we know that this still constitutes a “income transfer” between borrowers and savers – as the real buying power of savings will decline, and the real buying power of future income has risen.

    Even if the allocation of resources is completely unchanged, there is a welfare relevant transfer.

  5. John
    John says:

    Interesting article and nice comment you got there. I can’t say more but I totally agreed with you Matt Nolan!

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