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Harmonized sales levy is the lesser of tax evils

Gwyn Morgan, Globe and Mail – Aug 17, 2009

It isn't often that political leaders take policy actions they know will be highly
unpopular. The decisions by Ontario Premier Dalton McGuinty and B.C.
Premier Gordon Campbell to harmonize the provincial sales tax with the
federal goods and services tax are rare shows of political courage.

The unpopularity of harmonized sales tax (HST) arises almost entirely


because the PST has a long list of exempted items that will now have the PST
added to the existing GST.

Here in B.C., the most vocal opposition comes from the tourism and
restaurant sectors, already hard hit by the recession and higher dollar.
Accommodation will be protected by an offsetting elimination of the hotel
tax, but services such as domestic air travel, hair care, dry cleaning,
accounting and even funerals will be subject to the additional 7 per cent.
New-home buyers will pay the tax on purchases over $400,000 and all
homeowners will see the HST applied to cable, telephone, gardening, repairs,
renovations and heating fuels.

A recent headline in the Victoria Times Colonist captured the public's


reaction: "HST slams into wall of opposition." An Ipsos Reid survey found that
85 per cent of respondents opposed the July 1, 2010, HST implementation.
And critics' mischievous portrayal of the move as bailing out big business on
the backs of consumers seems to be a dream wedge issue for the Opposition
New Democrats.

It's not that Liberal Premier Campbell couldn't have anticipated the reaction:
Mr. McGuinty has endured similar opposition since Ontario announced sales
tax harmonization in May. What could be so compelling about moving to the
HST that these politically savvy premiers would take such a risk? Part of the
answer lies in the reason the move is so unpopular - the dog's breakfast of
complex and different exemptions between the PST and the GST. A second
part of the answer lies in the investment and job-killing structure of the PST.

First, the dog's breakfast: Separate sales taxes require two costly
administrative bureaucracies, taking a big bite out of the money needed for
programs such as health care and education. The federal government will
foot all of the HST's administrative costs, saving B.C. hundreds of millions of
dollars. As a further incentive, Ottawa is providing a $1.6-billion one-time
transition payment.

Second, creating jobs and encouraging investment: Unlike the GST, the PST
hits at every step in the production chain. In the struggling forestry sector,
for example, PST is paid on everything from raw lumber to transportation to
delivery. This multiple, cascading PST is recovered in the cost of the finished
product paid by Canadian consumers, but isn't possible in the case of exports
because the price is set by competition from U.S. producers.

The export-oriented mining sector faces a similar difficulty. The B.C. forestry
and mining sectors directly employ more than 116,000 people, even after
province-wide layoffs because of low prices and cutthroat international
competition. Many other sectors are hurt by the cascading PST structure.

Making matters worse, its complexity adds to administrative costs. B.C.


government officials estimate that the HST will remove more than $2-billion
from business operating cost. In addition, the HST will lower the tax rate on
new capital investment to 16 per cent from 27 per cent.

B.C. Finance Minister Colin Hansen summarizes the province's motivation:


"Introducing the HST remains the single biggest thing we can do to stimulate
the economy. ... As we come out of recession, investors around the world will
be making significant decisions about where to put their investment dollars
and where to create jobs. ... While it's the right public policy and good
economic policy, it's a tough sell."

One of the things that makes it a tough sell is that the cascading PST
structure hides a lot of the tax in the overall price paid by consumers, while
the HST is clearly visible. But even for exempt items such as house
construction and restaurant meals, consumers pay substantial hidden,
cascading PST on input costs.

Opponents of the HST say there is no guarantee that businesses will pass on
the tax savings to consumers. There are two answers to this. First, almost
every business lives in a highly competitive world where pricing leverage is
extremely limited. Margins have become so tight for most sectors that the
issue is survival, not excessive pricing.

And then there is the experience with the 1997 HST implementation in the
Atlantic provinces. Bank of Nova Scotia economist Mary Webb found that
manufacturers quickly passed on savings when sales tax was removed from
the production process; and a C.D. Howe Institute report found that dropping
the tax rate on capital substantially increased machinery and equipment
investment.

Prime Minister Stephen Harper recently stated: "There is no such thing as a


good tax," and the furor in British Columbia and Ontario bear this out.
Canadian governments have taken on big-time public program obligations -
too big, in my opinion. But the reality is that every province is bleeding red
ink as health care and other costs rise. Structures that minimize
administrative costs mean more of the taxpayers' money actually gets to
where it's needed.

The other reality is that cascading hidden taxes hold back Canadian business
in the fiercely competitive environment that will follow global economic
recovery. When it comes to either retaining an antiquated and
counterproductive tax structure, or helping to create jobs, Gordon Campbell
and Dalton McGuinty are making wise and courageous choices.