When the government plays with hidden taxes, we all lose

When the government plays with hidden taxes, we all lose

Stephen King
March 30, 2014

Governments like to play the political equivalent of a magician ‘pulling a rabbit out of the hat’. They get something for nothing, whether it is national uniform price for telecommunications and postal services or, more recently, cheap gas for Australian industry or a uniform price for national broadband. Cheap gas helps some Australian businesses. The NBN provides broadband services to areas that would not get these services in the marketplace. Apparently, the government makes some people better off without making others worse off.

However, as the saying goes, “you don’t get nuthin for nuthin”. While the government appears to be pulling free benefits out of its hat, the schemes involve hidden taxes and subsidies. So uniform national pricing for the government’s National Broadband Network (NBN) involves a subsidy to rural and regional Australia funded by taxes on broadband services sold in Australia’s cities. A ‘gas reservation scheme’ that forces gas producers to sell some of their product in Australia below the world price, might provide cheap gas to high-energy-using industries. But it is paid for by a tax on gas producers.

How does this work? Let’s use ‘snail mail’ as a long-term example. Australia Post (under a variety of names) has been delivering standard letters throughout Australia at a uniform price since before federation. It currently costs 60 cents to send a standard letter from Melbourne city to Carlton, Melbourne to Sydney, or Oodnadatta to Dampier. But the costs of these services differ greatly. For letter deliveries on high volume or short routes – like our first two examples – 60 cents per letter is likely to be well above the marginal cost of delivering the letter. But the marginal cost of delivering a letter between two remote regional locations – like our third example – will be well above 60 cents.

Australia Post uses the profits that it makes on the short and high volume services to cover the losses that it makes on services to the bush. This hides the fact that the services to regional Australia are being provided below cost and has, at least until recently, allowed Australia Post to cover all its costs.

What does this cross-subsidy scheme mean in terms of economics? We can break the scheme into two parts. First it involves a subsidy to rural and regional Australia so that they receive mail services cheaper than if they faced the full cost. Second, it involves a product specific tax on city-dwellers who want to post letters.

A subsidy to reduce the price of mail deliveries in the bush may or may not be desirable. Personally, I think it has been a good policy for the last century. It has helped social cohesion. Australia is a large and diverse country. It is important to make sure that rural and regional Australia is not left behind because of the difficulties in supplying services over vast distances.

A tax on a specific product, such as mail delivery, in urban Australia however makes no economic sense. To fund a subsidy to rural and regional Australia, we want to raise revenue in the most efficient way. We want a broad-based tax, like an income tax or a goods and services tax, that minimises distortion from raising the revenue that the government needs. In contrast, a tax on a specific product, like standard letters, simply provides an incentive for consumers to switch to something else. And that is what has happened in recent years as the internet has driven down mail volumes. As a result, Australia Post now makes a large, growing loss.

While this type of tax-subsidy scheme makes no economic sense, it can make political sense. A subsidy to the bush may or may not be a good idea. But telling city dwellers that they have to pay higher taxes to pay for these subsidies is bad politics. So the government’s version of the magician’s trick is to raise taxes in the city without telling the city residents, and transfer the money to the bush through an implicit subsidy. The politicians get the praise from rural Australia without the political harm of higher taxes.

Unfortunately, the tax-and-subsidise policy cannot stop there. Because the tax is hidden in a price paid by city dwellers, and is not charged on all suppliers of the relevant product, the government’s scheme is vulnerable to competition. If Australia Post’s price of 60 cents includes an (unstated) 20 cents tax, a private company has an incentive to come in and provide city letter services in competition to Australia Post. The competitor can undercut Australia Post by, say, 5 cents and still make 15 cents profit, because it is not subject to the hidden tax. To stop this, laws exist so it is (effectively) illegal to compete in delivery of standard letters against Australia Post.

More worryingly, the same holds true for the NBN. If the NBN charges city dwellers more than the cost of delivering high-speed broadband, then this will encourage private competitors. For example, let’s say the NBN uniform national price is $150. But the true cost in the city is $100 per service. A private competitor will be keen to come in and compete against the NBN in the city. After all, it could provide high-speed internet at a price of $110, undercut the NBN by $40 and still make $10 profit per household. So part of the NBN rollout has been a ban on private competition in the city. That is why the NBN is buying the existing fixed-line internet infrastructure from Telstra and Optus: not to use it, but to prevent competition. It is why earlier in the NBN process, there were attempts to limit mobile broadband. And it is why TPG and other companies are looking at ways around the rules to provide ‘fibre-to-the-basement’ for inner-city apartment buildings.

Because the NBN is being built under a hidden tax-subsidy scheme, it will only work if it stamps out competition in the areas paying the tax. This was relatively easy for a low-technology product like letters, but is almost impossible for rapidly changing technology like the internet. Someone will always work out a way to invent around the rules. So for the NBN to work, the government will have to adopt evermore draconian rules against competition.

Further, destroying internet competition harms all Australians in the long term. Under the NBN, the government has to ‘pick a technology winner’ and prevent private business from using alternatives that might be better. So the NBN will stifle internet innovation in Australia. Unless the government has picked the exact right technology, new innovation in the next decade will lead to better systems that other countries will adopt, leaving Australia behind.

Finally, we have to ask why the government would want to put a product specific tax on a key input to Australia’s economic development. Could there be a worse good or service to use to raise taxes than internet services? While the NBN rhetoric is all about lowering internet costs to improve productivity, the reality for most Australians is the exact opposite. For urban Australia, the NBN is an internet tax.

The government currently has an NBN review. Others, including the ACCC, Australia’s main competition regulator, have pointed out these problems. We can only hope the government is listening. By all means build a Rural and Regional Broadband Network. But basic economics tells us that this should be funded by broad-based taxes, not a city internet tax.

The ‘gas reservation scheme’ is another example. It involves two policies, a tax on gas exporters and a subsidy to high-energy-using businesses. While an extra tax on gas exporters may or may not be a good idea, it is bizarre to use the tax revenue to subsidise our biggest greenhouse polluters, instead of using it to pay for hospitals, schools, roads and other valuable government services. Fortunately, the federal government has fought back against the vested interests that support a gas reservation scheme, although the scheme is in place in Western Australia.

The general lesson is to be wary. If the government is offering something for nothing, then you know there is a hidden tax. From an economic perspective, a hidden tax is much worse than a transparent tax. It often focuses on one product, rather than ‘spreading’ the tax distortion. And it often has to be accompanied by rules to limit competition that harm long-term innovation. Of course, it may be good politics!

Some other things to read:

For other articles by Stephen (and other economists) see the CoRE Economics Blog at www.economics.com.au and Stephen’s articles at the Conversation, https://theconversation.com/profiles/stephen-king-1374/articles