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For those of you who don't know, there has been discussion recently about reducing the import tax on guns and diamonds because we have run short of production on weapons and we have lost our high diamond states of NT and WA during the Brazil invasion.

IMPORT TAX

The proposal before the Senate (or in the case of weapons unilaterally passed by the Cabinet without reference to the Senate) is to reduce the import tax on weapons and diamonds to enable our military and private militia to keep resisting Brazil. So what is the economic effect of making these changes and what are the alternatives?

Without a doubt it is a priority to make weapons and gifts as affordable as possible for our citizens but it is a fallacy that high protectionism in times without war is good for the economy. I will use the example of a total demand for weapons equal to 1000 Q1 weapons. If the normal price of a Q1 weapon is $AU6 and another country can produce a Q1 weapon for equivalent $AU4, then based on the normal import tax of 99% levied by the government the imported weapon would cost close enough to $AU8 and there would be no basis to export to Australia because the foreign manufacturer could never compete. As an aside there would be zero revenue generated from the import tax because there would be zero foreign units coming into the country to attract the tax.

The consequence of this is that if eAustralia total demand for weapons was equivalent to $AU6,000, however this is because the country's economy is protected from competition and as such the domestic economy has been free to dictate prices regardless of what is going in the rest of the world. eAus is living inside a bubble and as a result the country is $2,000 poorer for it.

All of a sudden the eAus government has mandated the import tax be reduced to 1% because the Australian weapons cupboard is bare. Two things have happened as a result: foreign manufacturers start sending their weapons to Australia for $AU4 and weapons manufacturers have to compete for sales with the foreigners. Two more things then happen as a flow on: weapons manufacturers start to drop wages, and eAustralians have more money to either buy more weapons or buy a better quality weapon or buy other goods as well.

As a result of reducing the import tax the government has achieved one main thing: for the $6,000 of original weapons demand Australians are now getting more value for money. Wages will be driven to a more realistic level on an international scale and Australia on a world stage will perform most efficiently in those industries with which it has high resources.

But the moral of the story is that import taxes only ever hurt the consumer who is forced to pay more basic consumer items due to protectionism of inefficient industries. For those who are worried about employment, fear not. With high resource industries Australia will always be able to supply best price and quality product in some sector and this is where the job and profits and investment will flow to.

VAT

Value added tax is like Australia's real life GST. It is a consumption tax levied on all products generally at the same rate. As such, the more the country consumes the more tax it collects.

In the example above total demand for weapons was $6,000. Now if the total demand for goods in Australia was $50,000 and the VAT is 5% then we know two things. Total VAT will be 5% of total consumption or $2,500 and secondly Australia will have have $44,000 of demand for other goods. Now if the import tax on weapons is reduced to 1% then the total cost for those same weapons is $4,000 and Australians can either spend on more weapons, buy something different or save the difference. But on an individual scale all the consumer will see is that a $6 weapon now costs $4 (both including VAT) Now if the Aus government were to increase VAT hypothetically to 10% across the board for manufactured items it will do two more things: it will increase government revenue and encourage saving. The consumer is taxed and the saver is rewarded. As such the person who saves has less money taken by the government and can invest in other endeavours. Either way the imported $4 weapon ($3.80 ex-VAT) is now $4.18 - a massive saving to the consumer from $6 and the government has doubled its tax take on weapons as a % of value. The remaining money saved from lower costs of weapons is then spent through the economy and also collects VAT at the higher rate but all the time goods are falling in price because foreign manufacturers can now bring their goods in without penalty and consumers can enjoy their consumption at the most efficient price possible.

All the time more and more goods are being bought instead of consumption being hampered by an import tax which keeps Australia's goods prices artificially high and suddenly the power of the VAt starts to multiply as gross domestic product begins to increase in size. The benefit of low import taxes means more volume of goods at cheaper prices for everyone.

An alternative middle of the road outcome is to implement minimal import taxes like what is done in the RL Australian car industry e.g.5 or 10% and so that marginal industries that have trouble competing can share the turnover with foreigners who seems to produce their products more cheaply for some reason by making the end price of the import similar to its Australian competitor. But for every dollar extra the Australian consumer pays, remember they are worse off overall.

Conclusion

The bottom line is that import taxes are inefficient and hurt the consumer in the end. A VAT is broad-based tax on all consumption and as such is a great way to gather revenue in a less invasive way while at the same time rewarding people who choose to save rather than consume. I would always urge the government to cut import taxes and increase VAT for health of the Australian economy and steady revenue for the government's activities.