Consumption Tax Or GST

de minimis stirred up some dust on GST with the help of walla; I here contribute a speck or two.

Q: What is the purpose of imposing a consumption tax?
A: To reduce consumption and to increase tax collection.

Q: Whose consumption will be reduced?
A: Those at the margin.

That is, those who have a very tight and they have to decide whether they want to buy A or B because now they cannot afford it because of the GST when they could buy both A and B before. They may forego B and left with A and have some cash to spare.

But if A is rice and B is milk, then obviously there is a problem for the consumer which the government may wish to step in to help if it wants to stay in power.

If A is a watch and B is a phone, then probably the problem isn't that severe and the government is happy to reduce that consumption.

Q: What is the reason for reducing consumption?
A: There is no particular good reason. In fact, it goes against the latest craze over stimulating demand by reducing the EPF contribution and putting money into the pockets of consumers.

But if you insist, then we have to go back to the textbook which says that it is better to impose a consumption tax to discourage consumption and to reduce income tax in order to encourage work and production.

Q: So will there be a reduction in the income tax with the impostion of the GST?
A: The answer is probably no, and the justification is probably that there has been a cut in the income tax already in the last budget.

Q: Why is it that the GST will be 4% when the last income tax cut was 1%? Is it fair?
A: The probable answer is yes because the objective is to raise taxes. But this answer is not healthy.

The GST will hit the total turnover or revenue as this is what final consumers will pay. Income comprising profit and wages and fees are at best a fraction of the total turnover of the economy. If profit and wages are 30% of the final sale price, then the income tax may need to be cut 3% to be equivalent to a 1% imposition of the consumption tax.

Since the expressed objective of the government is to increase tax collection, we may accept a 1% consumption tax to the 1% income tax cut.

Q: Will the consumption tax stimulate work and production?
A: No, if there is no or no significant cut in the income tax. The government then cannot claim to be stimulating work and production when it is imposing the consumption tax which will discourage consumption.

Q: Will there be inflation?
A: No, because it's objective is to reduce consumption. When retailers expect a reduction in their sales, they are likely to absorb the consumption tax.

Q: Will there be a reduction in consumption?
A: No, if the retailers are absorbing the consumption tax.

Q: Will it put marginal retailers at risk?
A: If no reduction in income tax, yes. If there is sufficient income tax reduction, consumption may even rise. This then defeats of discouraging consumption (and encouraging savings) and increasing the incentive for work.

Q: Will a consumption tax increase savings?
A: Not necessarily, if there are insufficient savings instruments.

Q: Will the consumption tax stimulate the economy?
A: Not necessarily. The consumption tax will increase the tax collection for the government. Somebody has to pay for it. If it is the local consumers, then there is a net reduction of the welfare of the local people. The only time when an increase in tax does not impair the welfare of the people is when the economy is growing and that growth comes from investment.

The trick for the government in trying to solve its fiscal problem is not to raise more taxes but to spend less and at the same time trying to encourage more investments by pulling up its socks!