The Implementing GST in New Zealand - Essay Example

Economic 100 Table of Contents Executive Summary 3 Introduction 4 Analysis 4 Conclusion 9 References 11 Executive Summary The project speaks of the impact of implementing GST in New Zealand. Firstly it brings forth the extent of rise in GST in the country and consequently the amount of rise in the prices of food items. The overall impact of the rise in tax on the food sector has been presented in this project. Then, an analysis has been provided to study the impact of GST for different kind of food products. The project explains how the impact of GST differs between the elastic and inelastic food products. Lastly, the project explains how the system is preferred in comparison to the income tax. As GST has a broader base, it leaves more money in the hands of consumers than the income tax. Thus consumers have greater incentive to buy the goods and services. Introduction According to the 2010 budget, the goods and services tax (GST) rose from 12.5% to 15% from October 1st 20101. However to neutralize the budget revenue of the Government, a number of tax cuts were imposed. This rise in GST influenced the businesses in a number of ways. Entities having businesses in New Zealand and consequent transactions with the customers and suppliers should keep themselves aware of the impact of change on their customers and suppliers. The rise in GST rate was passed on to the customers, which reflected in the increased prices of goods and services. The rise in GST rate affected the food prices significantly. Price of food rose by 2.2% in October. The project makes a study of the situation and provides reasons for the same. Graphs have been provided to represent the causes behind this increase. Analysis The impact of rise in GST was reflected in the rise in food prices in New Zealand. However, this rise is sure to have an impact on the consumers. Since food items are regularly used by consumers, the consumption of these items would undergo a change in the households. The price of cakes and biscuits rose by 4%. The price of cheese rose by 4.6% while that of milk rose by 2%2. The overall demand of food items in the economy fell because of price rise. This caused a fall in demand of food products in the economy. According to the law of demand, “the consumer demands more of good at a lower price and vice versa”3. Wheat has been taken as an example in this case. The following graph shows the fall in the demand of wheat due to the rise in price. Figure 1: Fall in demand of wheat due to rise in price (Source: IMS, (2002), “The law of demand”) The effects of the rise in GST can be presented by using the demand and supply diagram. Before the implementation of tax, the equilibrium price is at Pe and the equilibrium quantity is Qe. After the imposition of tax, the price paid by consumers shifted to Pc. Thus the price received by producers also shifted to Pc. The price paid by consumers is equal to the price received by the producers as well as the tax. Since the consumption of consumers fall at a higher price, the producers also sell off the products at low prices. Thus the quantity sold fell from Qe to Qt. This is represented in the diagram below. Figure 2: Effect of tax on demand and supply equilibrium Generally food products are considered to be inelastic. “If the change in demand is proportionately less than the change in price then the good is considered to be price inelastic”4. In case of good grains which form a part of the staple diet in New Zealand, the effect of tax rise would not have a significant impact on the demand. In such cases, since the consumers do not remain much responsive to the price changes, the tax burden is passed easily to the consumers by the producers. This is represented in the following diagram. Here the quantity demanded by the consumers falls by a small amount but the price rises by a large amount. This is common for the food products consumed regularly by the consumers. If the good was perfectly inelastic, the entire burden of the tax would be passed on to the consumers. Figure 3: Impact of GST on inelastic products For elastic commodities the situation is entirely different. In case of elastic food products, like that of cheese, the demand for the good changes rapidly with the change in price. Elastic commodities are very sensitive to price changes. In such cases, when the tax is imposed the price of the commodity increases by a much greater than the amount of the tax. But the quantity demanded falls substantially after imposition of the tax. This is represented in the diagram below. It is evident from the above diagram that the price increases by a very small amount as compared to the amount of the tax. That is why the primary burden of the tax is absorbed by the producers. The firm has to bear the entire burden of the tax but it is not compensated entirely by a sufficient rise in price. The burden of the tax to be borne by the consumers is little. Initially he had to pay P1 price for the commodity but now he has to pay P2 price for the commodity. The distance between P1 and P2 is not very large. Thus it is evident that the GST imposed on elastic commodities would have lesser impact on the consumers and greater impact on the producers. Figure 4: Impact of GST on elastic commodities The next figure shows how GST is a better substitute in comparison to income tax. Although the price of the commodity increases, the amount received by the producer falls. This is shown in the figure below. This is known as the tax wedge or the tax revenue of the government. The tax revenue of the government is the amount that the producer pays. The tax is then distributed among the public. Consumer surplus is represented by the area above the equilibrium line. The producer surplus is represented by the area below the line of equilibrium. The reduction in producer and consumer surplus is bad for the welfare but the tax revenue collected is good for the society as it is distributed among the public. This tax system is better in comparison to the income tax as it leaves more money in the pockets of consumers and provides them incentives to buy more5. Figure 5: Why GST system is preferred to income taxes (Source: Monash University, (2009), “Assignment topic Question 3”) Conclusion During the course of the project it was found that implementation of GST in New Zealand caused the price of goods and services to rise considerably. However, the demand for food products does not change substantially. This is because generally the food products are inelastic in nature. Their demand does not change rapidly with price. There are certain food products which are price sensitive. An example of these is cheese. A little price change can cause the demand to change quickly and to a large extent. But the system of GST is preferred more in comparison to income taxes. This is because they would leave more money in the hands of consumers encouraging them to buy more. However the tax revenue collected is distributed in society. References IMS. (2002). General Economicas for CA Common Proficiencey Test. Tata McGraw-Hill. Monash University. (2009). Assignment topic Question 3. Rebeccas sample assignment. Retrieved December 3, 2010 from http://www.monash.edu.au/lls/llonline/writing/business-economics/economics/3.1.2.xml. NZherald. (November 11, 2010). Food prices up 2.2pc - fruit and veg climb. Business. Retrieved December 3, 2010 from http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10686863. Pitcher Partners. (June 1, 2010). New Zealand 2010 budget – Important tax changes. Tax Bulletin. Retrieved December 3, 2010 from http://www.pitcher.com.au/Uploads/Tax%20Bulletins/1%20June%202010%20-%20NZ%20Federal%20Budget.pdf. Spot Colorado. (No Date). Introduction to Unit 4: Elasticity. Retrieved December 3 from http://spot.colorado.edu/~kaplan/econ2010/section4/section4.html. Read More