Saturday, December 24, 2011

macro impacts of gst

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The 18 election by the Liberal party led by John Howard initiated tax reform in Australia. After many years of the rejection of a goods and service tax (GST) this was now an opportunity for the government to apply tax reform which included a GST. The new tax system introduced in July of 000 initiated major modifications to the old tax system including a 10 per cent sales tax replacing the now abolished wholesales tax, reform to company tax, the deregulation of the market along with changes to individual income tax brackets.

The impact of the new tax system will be closely analyzed with the assistance of the aggregate supply (AS) - aggregate demand (AD) model.

Probably the most evident change of the tax system was the replacement of some ten hidden taxes with the fixed 10 percent GST. Wholesale taxes, FID, debits tax, ‘bed taxes’ and stamp duties were all replaced. The wholesales tax was a rate varying between 0 per cent up to 45 per cent in certain circumstances. This change from varying tax percentages to one flat rate of 10 per cent has had a large impact on the Australian economy. Direct and indirect taxes were altered within the change, both of which have different effects on the market. The lowering of direct taxes (personal income taxes) discourages the supply of labour and savings while encouraging consumption. Whereas the increase of indirect taxes (the GST) appears to discourage consumption, encourage savings and have no impact on the supply of labour.

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If we first look at the abolishment of wholesales tax this would lead to a direct impact on aggregate demand. This decrease in taxes would therefore lead to an increase in both consumption and investment. These two increases would directly impact aggregate demand shifting the curve to the right.

Figure 1.1 Figure 1.

As we can see in Figure 1.1 the economy is in long run equilibrium where actual price levels equal expected price levels; quantity supplied is equal to potential output which equals quantity demanded. A decrease in taxes, as explained, would cause a rightward shift of the AD line to AD1, shown in Figure 1.. This would then cause the equilibrium point A to move along the SRAS line to point B. The price of goods would increase as the quantity demanded also increases. This would eventually lead to a shift in the SRAS curve back to SRAS1 in order to once again achieve full equilibrium output, although an increase in AD leads to inflation leading to a higher price level for the same quantity amount shown in Figure 1. from P to P1.

Figure 1.

The introduction of the 10 per cent goods and services tax is an indirect tax and therefore does not impact the demand side of the market. It has directly affected the price of a product no matter what income is being earned.

Figure .1 Figure .

Figure .1 displays that this increase in price causes a shift in the SRAS curve to the left. This has then moved equilibrium from point A to the new position at point B. The market is again in disequilibrium and can be returned to equilibrium by both expansionary fiscal and monetary policies. Shown in figure . the expansionary policies will shift AD to AD1 and therefore B to the new point of equilibrium at C.

The price goods and services, however do affect the demand of goods. Consumer demand varies inversely with price level. That is if the price of a good goes up generally the demand for that good will go down. The 10 per cent GST has exclusions in place for example in the food industry. This leads to more problems in the demand for goods. Firstly, the demand for certain goods are more sensitive to price change than others. So certain goods demanded will depend on consumer wants and need. The idea of complementary goods and substitute goods also affect demand due to price change as not all goods are incurred with the 10 per cent increase.

Reform to company tax did not have much of an impact on the supply and demand market of the economy. The figure was a reduction of approximately per cent in total. This reduction would lead to a demand side shift as prices wouldn’t drop due to this small reduction. Known as the wealth effect, households whom have shares in companies would therefore enjoy an increase in dividends paid due to the tax reduction and therefore increasing consumption and investment. Figure 1. again displays the increase of consumption and investment which shifts AD to AD1 causing equilibrium to move from A to B and then to C as in Figure 1..

The deregulation of the market by the government allows more price competition between firms for goods and services. This action would lead to higher expectations of price drops in the future as higher competition should lead to a more open market. This expectation for the future encourages household to increase their consumption and investment as the economy is expected to become stronger. Again this leads to increased aggregate demand shifting the AD curve in Figure 1. to AD1 and its after effects as previously discussed.

These changes to the tax system have been analyzed as separate entities. The goods and service tax replaced the wholesales taxes leading to an immediate increase on prices of certain goods at 10 per cent. The other decreases of company and income tax, abolishment of sales tax and the deregulation of the market, as discussed, should eventually lead to an increase in the level of real wages, therefore a process of adding and eliminating of taxes would balance the movements in both the AD curve and the SRAS curve. It was assumed that after the all the movement in the AS � AD model there would be a total increase of approximately 1. per cent in total living costs.( Commonwealth of Australia, Tax Reform; not a new tax system, pp 5)

Ultimately the Australian economy has had many impacts due to the introduction of the GST. These impacts have been distinctly visible as prices of goods increased; income tax was reduced, government handouts increased including family assistance and pension. Overall the introduction of the new tax system has lead to a fairer tax system and more open economy. The aggregate supply aggregate demand model displays certain impacts of the GST on the economy however it is only one view with impacts being much broader than the one model.

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