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The Impact of Sales Tax HarmonizationSeptember 18, 20091
TD Economics
THE IMPACT OF SALES TAX HARMONIZATION IN ONTARIOAND B.C. ON CANADIAN INFLATION
September 18, 2009
Special Report
The Government of Ontario and B.C. announced thateffective July 1, 2010, the provinces will harmonize the provincial sales tax (RST) with the federal goods and ser-vices tax (GST). We estimate that the move to a harmonizedsales tax (HST) will reduce the amount of taxes paid oninputs by business by a combined $6.9 billion in BritishColumbia and Ontario, along with an additional $650million by reducing compliance costs under the currentseparate provincial and federal tax systems. By reducingthe cost of doing business in the two provinces, the aim of the reform is to make businesses more competitive and toencourage business investment and future income growthfor their economies, yet the policy has taken a lot of heatfrom critics for its impact on consumer prices.In response to consumer concerns, we thought it would be worthwhile to highlight what implications the reform
will have on Canadian households and ination. In the past,
consumers ultimately bore the burden of a large chunk of the $6.9 billion tax bill as businesses likely passed the ma- jority of this tax to consumers in the form of higher prices.As such, previous experience tells us that businesses won’t pocket the $6.9 billion in cost savings, but rather competi-tive pressures will cause them to pass along the bulk of those savings to consumers via lower prices. However,for the tax to be revenue neutral for governments, the tax burden will shift to consumers and apply to a broader baseof goods and services. Yes it is true that the policy will havea positive permanent impact on overall consumer prices, but it will not be as much as many fear. We estimate thatthe reduction in prices will not be enough to fully offset therise in the effective tax rate on consumption, and the neteffect will be a permanent 0.7% increase in the consumer  price index in Ontario and British Columbia. The com-
HIGHLIGHTS
•BothOntarioandB.C.willharmonizetheGST
and RST with a single HST, as part of an effortto make businesses in these provinces morecompetitive by lowering the effective tax rate onbusiness inputs
•Weestimatethatthemovetoaharmonizedsales
tax (HST) will reduce the cost of doing businessby a total of $6.9 billion in Ontario and BritishColumbia
•Themajorityofthecostsavingswillpassonto
consumers in the form of lower prices, and con-sumers in both provinces could witness a 0.8%-0.9% drop in the pre-tax ticket prices on thepurchase of goods and services
•However,thetaxburdenwillshiftfrombusi
-
nessestoconsumers,whowillnowpaytheat
HST on a broader array of goods and servicesthan before, and the effective tax rate on con-sumption will increase by 1.5 percentage pointsOntario and B.C. , and the overall price level willincrease by 0.7 percentage points in both prov-inces
•Thecombinedimpactwillleadtoapermanent
0.4% increase in Canada’s average annual con-sumer price level relative to where it would havebeen without harmonization.
 bined provincial impacts will lead to a 0.4% increase inCanada’s average annual consumer price level relative towhere it would have been had harmonization not occurred.
 
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The Impact of Sales Tax HarmonizationSeptember 18, 20092Understanding Harmonization
Before delving into the details of the policy, it is worth-
while to take some time to dene harmonization and some
of the key policy changes that come with it. Harmonizationis the process in which the rules that govern the provincialretail sales tax (currently the RST) will be integrated withthose of the federal goods and service tax (GST) to cre-
ate one nal tax – the HST. In Ontario, the HST will be
13%, and in B.C. it will be 12%. The provincial portionsof the tax will be 8% and 7% respectively. Moreover, the provincial tax base will be broadened to include the samegoods and services taxed by the GST (the federal tax baseis currently much larger than that of the RST). Table 1 provides a detailed list of the goods and services that will be affected by the policy. Since services are much more broadly taxed under the GST than they are under the RST,the table shows that the largest impact of the policy will bea higher effective tax rate on services. This includes some
nancial services, all professional services and personal
services consumed by households and businesses alike.
The Motivation for Harmonization
The HST is a value-added tax, which ensures that onlythe value added by the business providing the good or services is taxed. Thus, it attempts to avoid the situation
where a product may have been taxed multiple times – atdifferent stages of production – and in some cases earlier 
taxes may have been compounded by applying tax upon tax before ultimately being taxed one last time when purchased by the consumer. This process is commonly referred toas tax cascading. To prevent this, businesses can claima tax credit for much of the HST they pay on non labour inputs, effectively reducing the amount of tax on many
inputs to zero, with the tax just being paid on the nal
sale of the good or service. This makes a value added tax
more efcient than a retail sales tax because it avoids the
cascading tax effect, which is ultimately passed along ashigher prices to consumers. To understand this in practice,Table 2 provides an example of how the RST creates tax
cascading. Consider a rm that uses $1000 of inputs, and
has a price mark up of 30%. A good for which 100% of itsinputs are currently subject to the RST, such as a renovationtechnician, for whom the majority of input costs includetools and supplies bought at the local hardware store, thetotal provincial tax paid is $192. But, after the switch tothe HST, the total provincial tax paid would be $104 and
the nal cost to consumers is 7.4% below what it would be
↔
↓
ONBC
Basic Groceries
↔ ↔
Prepared foods purchased atstores
↔
↑
Restaurant Food
↔
Natural Gas
↔
Gasoline
↔
Fuel Oil and Other fuels
↔
Water 
↔ ↔
Clothing/footwear and accessories
↔ ↔
Children's clothing and footwear 
↔ ↔
Household appliances
↔ ↔
Other household furnishings andequipment
↔ ↔
Recreational Equipment
↔ ↔
Autos/recreational vehicles
↔ ↔
Healthcare goods
↔ ↔
Personal Care supplies
↔ ↔
Tobacco and Tobacco products
↔
Alcohol
↔ ↔
Rent/mortgage interestcosts/insurance
↔ ↔
Maintenance and Repair 
↔ ↔
Credit Application/Account Fees
↔ ↔
Purchase/Selling of Investments
↔ ↔
Portfolio Management Fees
↑ ↑
Advisory Fees
↑ ↑
Mergers and Acquisition Fees
↑ ↑
Fees related to RRSPs, RRIFs,RESPs, TFSAs
↑ ↑
Telephone and Cable
↔
↑
Internet Acess Fees
↔
Postal Services
↔ ↔
Child care Services
↔ ↔
Other (cleaning, landscaping etc)
↑ ↑
Services related to installation of household equipment andfurnishings
↔ ↔
Health care and EducationServices
↔ ↔
Personal Care Services (eg. hair cuts, manicures/pedicures,andfacials)
↑ ↑
Recreational ServicesAdmission Charges
↔
Professional ServicesRegistration ,drivers liscences,and auto insurance
↔ ↔
TaxisOther Public transportation
↔ ↔
Note the table is meant to capture the general direction of changes for eachcategory, however there may be different treatment for certain goods withineach categories.
Source: TD Economics, produced with information provided byCanada Revenue Agenecy, the Ontario Ministry of Finance and theB.C. Ministry of Finance
Expenditure Category
   F   o   o   d   E   n   e   r   g  y   G   o   o   d   s   e  x .   F   o   o   d   a   n   d   E   n   e   r   g  y
=decrease in tax rate
Table 1: List of Goods and Services for which the Tax Rate willbe Affected By Harmonization (does not include the passthrough of business cost savings)
   S   h   e   l   t   e   r   /   O   f   f   i   c   e   S   e   r  v   i   c   e   s   F   i   n   a   n   c   i   a   l   S   e   r  v   i   c   e   s   G   o   o   d   s   S   e   r  v   i   c   e   s   T   r   a   n   s   p   o   r   t   S   e   r  v   i   c   e   s   O   t   h   e   r   N   o   n  -   S   h   e   l   t   e   r   S   e   r  v   i   c   e   s
= no change= increase in tax rate
 
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The Impact of Sales Tax HarmonizationSeptember 18, 20093
under the RST. Now imagine the amount of tax cascading
that goes on in manufacturing – an industry which has mul
-tiple stages of production. The manufacturing of a tire alonehas up to 8 stages. Depending on whether these stages aredone in-house or contracted out, there is the potential tohave the RST cascading through all 8 stages, before the
tire is taxed one last time as part of the nal purchase of a
motor vehicle. Moreover each stage uses inputs likely pur-
chased from an outside supplier such as, bolts, and ofce
equipment. But manufactured goods are not the only areawhere input tax credits will help ease the cost to consumers.
A signicant amount of tax cascading also goes on in the
service sector as they pay the retail sales tax on may of their inputs
 –
both operating and capital – such as machineryand equipment, mobiles, computers and software, ofceequipment, and ofce supplies. Many service providers
such as personal care services and professional services(such as lawyers, accountants, and investment managers)will now be able to claim an input tax credit for the 8% provincial portion of the harmonized sales tax paid on these items.More importantly, Table 2 also shows that
a move to a value added tax is more efcient
 because it avoids distortions. What this meansis that certain goods and services are moreheavily taxed simply because they use moreinputs that are taxable at the retail sales taxlevel. As a majority of tax is passed through toconsumers, they end up paying more tax (hid-den and direct) on these products. Under theHST, most goods and services will be treatedfairly, in that consumers will pay the exactsame amount of tax per dollar consumed.However, there is a small portion of goods
and services that will not benet from the
reform. Namely, goods and services that aretax exempt for the consumer, but for which businesses have already paid a value addedtax on the inputs. Because the business is the
nal taxpayer (no one after them is required to
 pay the GST), they cannot claim the input taxcredit. Table 2 shows that a good or service for which a large chunk of its inputs are alreadyGST taxable, but not RST taxable (0% RST,
100% GST), will experience a signicant risein taxes – as the 5% GST becomes a 13%
HST for many of its inputs in Ontario and a12% HST in B.C. For example, much of the
services provided by nancial and insurance institutions are
GST exempt. But, 22% of the inputs are services that will
CONSUMER PRICE INDEX VS. INDUSTRIALPRODUCT PRICE INDEX
-15-10-505101519801986199219982004-1-0.8-0.6-0.4-0.200.20.40.60.81
Correlation between CPI and IPPI(right scale)Goods CPI (left scale)IPPI (left scale)Source: Statistics Canada, Haver Analytics
year over year % change
Close tocompletepass through
level
RST100%50%25%0%50%25%0%GST0%50%75%100%50%75%100%
Cost of Inputs before Tax 1,0001,0001,0001,0001,0001,0001,000  RST paid on Inputs804020-4020-  GST paid on inputs-253850253850  Federal Input Tax Credit -253850---  Total Cost of Inputs 1,0801,0401,0201,0001,0651,0581,050  Ticket Price to Consumers1,4041,3521,3261,3001,3851,3751,365  RST112108106104---  GST70686665---  Final Price to Consumers1,5871,5281,4981,4691,3851,3751,365  Total Tax paid 263216192169655850  Cost of Inputs before Tax 1,0001,0001,0001,0001,0001,0001,000  Provincial HST paid on inputs-406080406080  Federal HST paid on inputs-253850253850  HST Input Tax Credit -6598130---  Total Cost of Inputs 1,0001,0001,0001,0001,0651,0981,130  Ticket Price to Consumers1,3001,3001,3001,3001,3851,4271,469  Provincial HST104104104104---  Federal HST65656565---  Final Price to Consumers if taxed 1,4691,4691,4691,4691,3851,4271,469  Total Tax paid 1691691691696598130  Final Cost to Consumer if Zero RatedGood1,3001,3001,3001,300---  % Change in final price paid byconsumers-7.4-3.8-2.0003.87.6Source: TD Economics*Note the example does not take into account the embedded retail sales tax in the purchase of the inputs
TABLE 2: EXAMPLE OF POTENTIAL TAX SAVINGS
Example of a Firm with $1000 in inputs and a 30% mark-up in Ontario
Current Tax SystemAfter Harmonization
Proportion of Taxable Business InputsFor Goods and Services Taxable tothe Consumer For Goods and Services notTaxable to the Consumer 
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