Cut GST for fruit and veg?

Posted by: Matt Nolan on: December 2, 2007

• In: Microeconomics | New Zealand Economics
• Comment!

Over at Kiwiblog, Mr Farrar noticed a newspaper article on removing the GST tax from fruit and veg. I agree with him on both his points,

1) that the response of consumers to a 12.5% reduction in the price of fruit and veg will likely be small (items that only take up a small part of your household budget are inherently price-inelastic), and

2) that it is better to have a flat GST rate, as you are ensuring that the relative price of goods remains the same and minimise the cost of implementing the policy

However, the Massey Researchers also have a point (there is something I never thought I’d say ), and it has to do with situations where the second point doesn’t hold, specifically when we don’t want the relative price of the goods to stay the same. This occurs if we have an externality.

The externality that the Massey researchers are talking about is interesting, they say that if we eat more fruit, we will be less of a burden on society, and so their is a positive externality. In this case we want to subsidise the eating of fruit, as at market prices consumers are consuming less than is socially optimal.

Ok, so this idea makes sense, but should we be cutting GST to do it? From what I remember about fiscal policy, one instrument for one problem. GST should be flat, as it is a way of raising government revenue. If we make exceptions then we create inefficiencies in the market place, which worsen the dead weight loss problem of the tax. However, in this case the market is already inefficient, and the change in price actually improves welfare. In accounting terms I would prefer any ‘subsidy’ to make fruit and veg more popular to be separate from the GST rate, so that the policy goals of the given policies remain clear, and can be adjusted optimally by the creaking government bureaucracy.