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Dave Grimmond says it's time to change the way GST is applied to exports and imports, to give service exporting industries like tourism and education fair treatment

Dave Grimmond says it's time to change the way GST is applied to exports and imports, to give service exporting industries like tourism and education fair treatment

By Dave Grimmond*

Trying to plug the holes in the current goods and service tax (GST) system is likely to be an expensive failure that will have the perverse impact of encouraging a culture of tax avoidance. 

As I have noted previously, there is a fundamental flaw in the design of New Zealand’s GST, which the current review of cross-border transactions ignores. While the current review is aimed at plugging revenue gaps that are developing because of technology and social changes to retail patterns, it ignores the more important economic efficiency consequences of shortcomings in the design of GST. 

This perspective may come as a surprise to many.

New Zealand’s GST is normally held up as being a soundly designed value added tax system, and indeed compared to systems in many other countries it is.

But it has a fundamental flaw that means that it promotes a sub-optimal allocation of our resources that has harmed and will continue to harm wealth creation.  As a pleasant positive side effect, my proposed change will more effectively address the revenue gaps that the government is currently so concerned about.

A value added tax, like GST, is almost, but not entirely equivalent to a tax on consumption. Rather than taxing final consumption it taxes each stage of production, but allows GST registered entities to claim back the GST they have paid on their purchases. What this means is that although GST is added on at each stage of the productive process, it is the final consumer of the good or service that ends up paying the full liability of the GST.

The advantages of the value added tax design hinge on the ability for companies that are not the final consumers of the product to claim back the tax they have paid:

• This ensures that tax on intermediate goods and services are kept to a minimum,

• It allows simple rules for enforcement – all purchasers must pay the tax.  Although registered traders can claim back their tax payments, one does not have the problem of defining who retailers are.  This means that actions by tax evaders have a minimal impact on the amount of tax paid – it only effects the tax liable on the stage of production or delivery that was missed. 

• There is little incentive for producers or service deliverers to avoid the tax – indeed the incentive is for them to register with the IRD, as only registered traders can claim back their tax paid.

• This incentive to register for GST purposes has the added advantage of reducing the size of the black economy – registering brings entities to the awareness of the IRD, and therefore will require them to submit income tax returns.  And if entities choose to remain underground, the IRD at least manages to claim some tax off them, as they will not be able to claim back any GST that they pay.

The design of the New Zealand GST adheres to the “destination principle”.  The destination principle is used as a means of arbitrating on any jurisdictional issues with regards to taxing decisions.

Effectively the destination principle implies that if a good or service is purchased (or rendered) in New Zealand it should be liable for GST. In principle this means that imports should be subject to GST, as the goods and services will be purchased (or rendered) in New Zealand.  Exports on the other hand are zero rated (ie exempt) as final consumption will be offshore. 

Application of the destination principle in the design of value added taxes is a logical progression from the Diamond-Mirrlees conclusion that aggregate production should be efficient.  This means that just as no taxes should be raised between firms, no taxes should be imposed on transactions between countries, and international trade would then take place at producer prices (Kay 1990). 

The problems with GST

Although, the aim of the destination principle is to ensure that taxes are not imposed on the transaction between countries and so ensure that international trade takes place at producer price, the actual application of GST in New Zealand does not ensure this.  Indeed it places a significant wedge between the earning power of different activities (eg between farming or running a home-stay) and the costs to consumers of different activities (eg holidaying on the Gold Coast or at Taupo).  In this way it encourages a misallocation of resources that must be detrimental to the economy’s performance.  The destination principle implies that rather than taxing either value added created in New Zealand, or the genuine consumption of New Zealand residents, GST has effectively become a tax on consumption that takes place within New Zealand. 

The GST raises the relative returns of exporting goods above that of exporting services provided onshore.  It also encourages consumers to spend their money on trips abroad ahead of travel within New Zealand or indeed on any other product available within New Zealand. Although the misapplication of GST looks like a tax on overseas tourists it is in reality a tax on the incomes of those in the tourist industry and other traded services industries.

For example, if a tourist arrives in New Zealand with a budget of NZ$1000, the tourist industry is likely at most to receive $869.57 of this while the remainder is collected as GST by the Government (ignoring other duties such as excise and tariffs).  If the same person spent their money on sheepskin products (either overseas or at a duty free store) the export sector (including associated services) would receive the entire NZ$1000. 

By lowering the relative returns from tourism and other service exports such as education, GST reduces incentives to invest in service export industries and so hampers their ability to grow.  Instead the application of the tax encourages resources into other (primarily export good) sectors that have a lower potential for growth – except through the advantage provided by the unfair application of GST.

In addition, as the current review highlights, the expansion of cyber commerce has made it more difficult to police domestic tax systems.  Irrespective of tax considerations there are obvious market led reasons for this expansion.  Internet shopping and on-line streaming of services both expands consumer choice and on-line services can be far more convenient than traditional shop-based service provision.  The complication for the tax system is that these markets go beyond normal national tax jurisdictions.  It is one thing to ask domestic-based businesses to register and regularly file GST returns, it is far more difficult to expect foreign based organisations to comply.  Without necessarily any New Zealand-based costs there are perhaps only compliance costs and no financial incentive for them to file a return. 

The other approach is to better police New Zealand consumers.  But many of the imports come in ways that are both difficult and expensive for traditional regulatory agencies like Customs to police.  As much as one may disapprove of tax avoidance and tax evasion, it is important to note that the incidence of tax avoidance and evasion says more about problems in the tax system, than the social system (Kay 1990).  A poorly designed tax system places the pressures on individuals to yield to temptations of tax avoidance.

The current review is blinkered in trying to create fixes for the existing system.  There has not been sufficient critical analysis of the current system nor does it seem an adequate assessment of the root causes of the problems.  In particular the review only appears to be interested in revenue collection and not on the impact of the tax on economic efficiency.

The fix

There is in fact a surprisingly simple solution to both the allocative efficiency issues and the shrinking tax base issues that GST faces: convert the application of GST from being destination based to origin based.

That is rather than attempt the exceedingly complex task of removing the unfair tax on the tourism industry, simply remove the dispensation currently provided to other exporters.  Similarly instead of attempting the impossible task of taxing all imports of on-line goods and services, simply remove all taxes on imports. 

By taxing all exports and exempting all imports, all trade is moved to the same side of the expenditure tax filter, thus removing distortions between different types of economic activity and preserving the aim of not taxing transaction between countries.

Although it might not seem immediately obvious, as long as a country does not attempt to tax both exports and imports, but only one or the other, then the country is not actually taxing the transactions of another country.  A pure origins based system taxes value added (ie production within New Zealand) while a pure destination based system would effectively tax consumption (ie the spending of New Zealanders).  In both cases only New Zealand transactions are being taxed.

An obvious objection that many might have to this approach is to question what the impact of applying GST to our exports will do to the competitiveness of the export sector.  The short answer is probably nothing.

In the presence of a flexible exchange rate, one would expect the introduction of an origins based GST system to trigger a one-off compensating reduction in the nominal exchange rate.  Indeed Lockwood, de Meza and Myles (1995) demonstrate that a unilateral switch to an origins based system will have neutral inter-country impacts under virtually all circumstances.

Unlike the complexities involved in attempting to clean up the destination approach, a move to an origin approach is actually likely to reduce the administration burden faced by IRD and the government.  The taxing of exports would end IRD or Customs’ role in administering and policing the zero rating of exports.  Customs would also not be required to apply GST to imports. 

Diamond P A and Mirrlees J A (1971) “Optimal taxation and public production I: production efficiency and II: tax rules”, American Economic Review, Vol 61, pp8-27 and pp 261-278

Kay J A (1990) “Tax Policy: A Survey”, Economic Journal, 100, March, pp18-75

Lockwood B, de Meza D and Myles G (1995) “On the European Union VAT Proposals: The Superiority of Origin over Destination Taxation”, Fiscal Studies, Vol 16, No 1, pp1-17

David Grimmond is an Associate Economist at Infometrics. You can contact him here »   This article originally appeared in Infometrics’ newsletter and has been republished here with permission.

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>>> An obvious objection that many might have to this approach is to question what the impact of applying GST to our exports will do to the competitiveness of the export sector. The short answer is probably nothing.

Really! You expect Europeans to be happy paying 15% to a govt they have no obligations to, in addition to the 20% import VAT they'll be hit by locally? Never mind the resulting price increases, why should foreign consumers be expected to pay a NZ tax - this is just a bizarre and unfair concept.

>>> In the presence of a flexible exchange rate, one would expect the introduction of an origins based GST system to trigger a one-off compensating reduction in the nominal exchange rate.

And that's okay is it? I mean I'm all for normalizing the NZD but I'm not sure I'd vote for impoverishing all NZ'ers domestic financial holdings to the tune of 15% overnight.

>>> Indeed Lockwood, de Meza and Myles (1995) demonstrate that a unilateral switch to an origins based system will have neutral inter-country impacts under virtually all circumstances.

I think more than a passing reference was necessary to show how this burdening of exporters, overseas markets, and massive hit to the NZD will have zero international impacts, and what exactly is meant by "virtually all circumstances". And never mind that, what about the domestic impacts...


Why cant we drop GST? that would surely save costs?


So one thing I have wondered on, why cant we do away with GST and all the costs associated with collecting it and just put up personal tax? GST can be dodged but personal tax is harder?


There may be all sorts of wacky ways of obtaining essential income to redistribute. We left very high marginal income tax behind and one way of helping was a consumption tax. Perhaps GST should have a difference in claim and claimed rates so that a little bit could be gathered at each step.
Or how about a payroll tax to effectively collect extra tax on incomes above a flat income tax at employee level. Something like that would severely hit the company that pays its CEO megabucks.
My point is, it is time to review the whole tax system to make this country competitive. No need to penalise exports if the exchange rate is kept low. Countries like China have held their exchange rate low to gather custom. We may not have that power but we can screw some feet to the floor using tax.
And while I am on about tax, try taxing debt instead of giving relief. Tax part of every landlords debt and give partial relief to owner occupiers to assist in balancing the horrendous competitive position between home owners and investors.


All to what end? For what purpose? What is the end objective?
Is it simply to re-arrange the deck-chairs?

Puzzling how so much academic and intellectual thought goes into fiddling with the rats and mice of the tax system while the big end of town - the multi-nationals - rape the system - and as time-goes-by they will make greater inroads into the tax-system - debasing it to such a degree that every-man and his dog will be doing a Dave Grimmond, wondering why we don't re-arrange the GST (again) and do it differently - to little effect - years will go by - then there will be calls to say that didn't work - lets try another way - meanwhile the big multi-nationals will be even bigger - the tax-system will be weaker - 60% personal tax rates will be re-introduced, but GST retained - genius - 40 wasted years - back to where we were in 1980

Observation:- this is a core-critical issue that gets no traction in the media - Why?
Are they too scared?


"the multi-nationals - rape the system" I agree it needs to be fixed. Effectivley we are punishing ourselves and our own local homegrown businesses who have to pay GST and more than needed because the Multis like google pay none.

" a core-critical issue that gets no traction in the media" that is an interesting Q, who pays for adverts?

When Google NZ has a revenue of $180million?? in NZ but pays no GST the system is clearly broken and needs fixing.

Overall GST only made sense when goods were only sold here, now they are not. So now there seems to be a punitive drive to stop internet imports and maintain the retail industries rentier pricing. I am buying more and more bits n pieces from overseas because its so much cheaper, even if I paid GST I would still save a packet.

Then there is the overhead of GST, so we collect tax via two different methods income tax and a spending tax I am scratching my head why we do so. To me GST should be done away with and put on rates or personal tax and that way we do away with one huge headache.


With both hands ties behind your back

our own local homegrown businesses who have to pay GST

and in addition

Our own businesses have to pay income-tax in full measure
While multi-nationals pay little if any

How do you compete against that? - it's like having both hands tied behind your back


Totally agree, its wrong taht NZ business suffers such a dis-advantage. Hence why I ask why do we need to have GST? what is so essential about its function that we and businesses have to pay for it? (ie it costs money to operate) On top of that we need to be looking at taxing business as a level playing field, just how that is achieved is I suspect complex and subject the evasion. personally I'd ramp up the penalties for evasion and put those onto the tax consultant. ie if there is jail time or fine for the client the tax consultant gets it in parallel.


They have our hands tied behind our back and they have shackled our feet as well !!! Oh yes and they give you shove periodically just to keep you off balance !!!


GST is classed as a regressive tax so hardly a way to help.


Example. Does Uber pay GST on its 20% commission and then income tax on that net income because it certainly has little or no expenses to run its NZ operation?
The tax system needs to be more certain on what it can and does collect. Surely assuming guilt and asking overseas entities to prove their "innocence" would prove a starter.


GST is a tax on labour added to goods and services!!

The price of goods or services have the labour component built in....e.g. $50 per hour charge out that includes the labour cost of say $25 per hour......or say a widget is for sale at $10 plus GST the labour component is already included into the $10 widget.

When you pay wages you don't add GST directly on for the simple reason the initial charge out price of the labour included it at the point of sale.....the people are told that wages are exempt which covers up the fact the labour cost has already been included......when you claim GST back on the inputs side you are not able to claim the portion that gets paid in wages or interest etc.......GST is a huge rort !!!