Goods and Services Tax Waiver for Basic Necessities – A Plausible Solution?

Workers’ Party had revived the argument on waiver for Goods and Services Tax (GST) waiver for basic necessities during the election. Though Mr. Low Thia Khiang was not able to out debate the articulate Christopher de Souza, it does not imply that the suggestion is flawed. Let us examine this proposition in details.

In a situation without any taxes, the invisible hand of the market would push the market to equilibrium, which happens to be the most efficient level the market is operating. Whenever the Government impose a tax, any economics students would be able to tell you that the tax would impact both the seller and the buyer regardless of whether it is a sales tax or purchase tax. However, who actually bears the burden of the tax and what is the deadweight loss of the tax to the economy?

Basically, taxation has a cost in the economy that is not so apparent to many who do not study economics. Taxation dulls market activities. Hypothetically, selling a cone of ice-cream at $1 would allow the shop to have 100 sales a day. If the Government impose a 20 cents tax on ice-cream, then the burden would be shared by both the consumer and the producer. The producer would have to charge more but receive less. They would not be able to charge the full 20 cents to the consumers as that would cause the demand of ice-cream to drop and hence they have to lower the price slight. In this example, there would be people who would normally do not mind paying extra 5 cents for the ice cream and shop do not mind selling the ice-cream for 5 cents less. Now the cost of the tax is 20 cents which means that either the shop must sell at a discount of more than 5 cents or the consumers must pay for more than 5 cents to make the revenue for the Government. Both the consumer and the shop ended not doing sales and the Government ends up not collecting taxes.

The above scenario is what we called a deadweight loss of taxation as the tax cause the market to generate fewer activities and hence people are worse off. The greater the size of the tax, the greater the deadweight losses are. In theory and practically, we cannot expect the Government to continue increasing GST as a method to raise revenue as the revenue from tax would decline after a while. In the above example, we can also examine who would bear the burden of the tax more. Looking at the illustration Exhibit 1 below, we can see that an inelastic demand, characterised by consumers not able to adjust their habits easily with the changes in prices, would mean that the consumers would bear the burden of the taxes more. Basic necessities such as rice, sugar or other items are considered inelastic as people would still need them to survive and their consumption pattern do not vary significantly with the change in prices. Hence, the cost of the taxes hit the consumers more in this case and hence the burden on our poor would be inevitable. However, when the demand is elastic, for luxury goods, as people normally would substitute them with inferior goods when taxes are high, then the burden would be more on the producers.

 

How elasticity of demand and supply shifts the burden of tax

Exhibit 1

We can see that reducing or waiving taxes for basic necessities do make some economic sense. Firstly, it reduces the deadweight loss of taxation especially on basic necessity and that would certainly increase the welfare of the people. Secondly, the taxation of other goods, which are consumed by people who have excesses, would still enable the Government to collect revenue and channel some of that revenue to the poor as debated by Christopher. This could be in fact, a win-win situation.

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Posted on June 21, 2011, in What's Happening?. Bookmark the permalink. Leave a comment.

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