Canada - Cutting the GST: smart or silly?

"Bad move." "Not the most effective." "Far from a good policy choice." "Not needed." "Worst tax to cut."

These are just some of the responses of the 20 economists polled by the Globe and Mail on the federal government's plan to cut the goods and services tax again. Not everyone said it's a bad move — four economists said it was good or irrelevant — but there was one point that every single respondent agreed upon: cutting the GST should not be the government's top tax-cutting priority.

So what should the government be doing? Don Drummond, chief economist at Toronto-Dominion Bank, has plenty of suggestions. In his response to the survey, he pointed out that cutting the tax "does nothing to enhance the productivity capacity of the economy." Instead, it "simply increases demand and at a time when the Bank of Canada is legitimately telling us that demand is though the economy's capacity limit."

Mr. Drummond speaks with experience. The Victoria native spent almost 23 years at the Finance Department, where he held progressively more senior positions in economic analysis and forecasting, fiscal policy and tax policy.

As associate deputy minister there, he was responsible for economic analysis, fiscal policy, tax policy, social policy and federal-provincial relations, where he co-ordinated the planning of the annual federal budgets.

Mr. Drummond joined TD in 2000 as senior vice president and chief economist. He travels widely across Canada and the world, speaking to TD clients and various groups about the Canadian economy and its prospects.

Mr. Drummond took your questions on cutting the GST and where else the federal government should be focusing its attention.

Editor's Note: globeandmail.com editors will read and allow or reject each question/comment. Comments/questions may be edited for length or clarity. We will not publish questions/comments that include personal attacks on participants in these discussions, that make false or unsubstantiated allegations, that purport to quote people or reports where the purported quote or fact cannot be easily verified, or questions/comments that include vulgar language or libellous statements. Preference will be given to readers who submit questions/comments using their full name and home town, rather than a pseudonym.

Tavia Grant, globeandmail.com: Don, thanks very much for taking time out of your busy schedule to field questions. It's a hot-button issue and one that's already generated hundreds of comments this morning. Plenty of questions await you, but I wanted to start by asking you this: if cutting the GST shouldn't be the government's top priority, what should it focus on?

Don Drummond: The policy focus should be to raise to raise the economy's production capacity level. Personal and corporate income tax reductions, if properly structured, could do that. The real shame in following a path of GST rate reductions is in the opportunity cost. By the time the second point reduction of the GST rate has been implemented $12 billion will have been allocated.

Cutting the GST rate reduces the efficiency of the tax. One of its drawbacks is that it is expensive for small businesses to collect and remit it. But that cost is fixed so cutting the rate raises the cost per dollar raised.

Alternatively, every Canadians' marginal personal income tax rate could have been reduced 2 percentage points. That would increase the incentives to work, save and invest. Or Canada could have developed one of the most competitive corporate tax regimes in the world, encouraging our companies to expand and invest and drawing in foreign investment. In the modern, global economy, Canada has to do everything it can to make its workers and companies competitive.

The federal surpluses have offered a golden opportunity to move forward in a very decisive manner. The GST rate cuts don't move that agenda forward at all.

Tavia Grant, globeandmail.com: If you leave the GST alone, what should be done with the personal income tax?

Don Drummond: If I had a free hand, I would raise the GST rate and use every penny to lower income taxes (personal and corporate). We would end up with an overall tax system much more conducive to economic growth.

You don't pay the GST if you don't consume whereas there's no escaping PIT and in fact you pay it several times - once when you get the salary, then again if you manage to save any money (out of after-tax dollars) and earn investment income. Australia went this route - introduced a GST and used the proceeds to cut PIT - seemed to go over well politically. Quebec did a mini-version by raising their HST rate and using the proceeds to cut their PIT rates - again didn't cause a political backlash.

Knot a Liberal from Canada writes: The Conservative's objective is to get out of provincial jurisdictions in order to achieve more accountability. The provinces and cities will need more funding. Therefore shouldn't Ottawa's taxes go down and provincial taxes go up and maybe even leave some extra in my wallet? Wouldn't a reduction in GST and increase in PST do this? Then homogenize them for productivity gains?

Don Drummond: I absolutely agree that the only redeeming feature of a federal GST rate reduction is if it can be used as bait for the remaining provinces to harmonize with the GST. The provincial sales taxes such as in Ontario impede growth because they tax capital and become embedded in export prices. A GST rate reduction could in effect become a tax transfer to the provinces. But there is no guarantee the provinces will harmonize. No effort was made to achieve this with the first rate cut last year. As such the opportunity was squandered. I still would not favour a GST cut but if it achieved the provincial responded you suggest my opposition would be muted.

Andrea Meynell writes: The first 1% did not materially affect my life, but I am sure it made the Maseratis way cheaper. Why cut a tax that will have to be raised again when the economy is not generating as much revenue for the government and the demand for services grows with the aging population? Would it not be wiser to use the excess to improve infrastructure, apply it to environment projects or pay down debt?

Don Drummond: It is a question of balance. The federal government has been paying down debt since 1997-98. They have pumped billions into infrastructure. There have been some tax cuts but the burden on Canadians, particularly from personal income taxes, remains high. I am sympathetic to the notion of allocating some portion of the surpluses (which are projected to remain for several years because of the high tax burden) to tax relief. But I would far prefer to see the relief come from income taxes.

Joel Howe from Fredericton Canada writes: Is there an economic rationale for cutting the GST right now, or is this a purely political move (the GST is a popular tax to cut) at the expense of economic opportunity cost?

Don Drummond: I don't think there is ever an economic rationale to cut the GST. It will always be more compelling to cut income taxes. The rationale for a tax cut is that the tax burden is high on Canadians, the federal government is running large surpluses and the debt burden has shrunk to a tolerable level. But a tax cut should do more than save people money. It should improve economic performance. GST cuts just promote consumption and that could just provoke interest rate hikes. Income tax cuts cool raise incentives to work, save and invest.

Aaron Wong from Canada writes: Hi Don. Isn't the sales tax an extremely costly tax to implement, and if so, would we be better off eliminating it altogether? What other tax reform is needed to make Canada a better place for business and investments? Thanks, Aaron.

Don Drummond: The GST is expensive for small businesses to collect. But its beauty is it has the least economic distortion. It merely encourages people to save more. Income taxes reduce incentives to save, work and invest. So I believe the best approach is to keep the GST rate up (or even raise it) because this keeps the cost per dollar collected down. Then drive down personal and corporate income tax rates. The economy would benefit.

J H from Toronto Canada writes: Cutting the GST would help to correct a flaw in this tax that results in identical products being taxed differently depending on where they are purchased. For example, buy a carton of milk in a grocery store and it's GST-free. Buy a carton of milk at a restaurant and it's subject to GST. How else would you propose the government address this fundamental inequity?

Don Drummond: No doubt one of the flaws of the GST is that it doesn't apply evenly to all products. In practice this doesn't pose a huge problem. How many people would buy milk from a restaurant? Very few. You do get the silliness, however of five muffins taxable and six tax free. However, cutting the rate only lessens rather than eliminating the problem. My argument is that the high marginal tax rates on personal and corporate income and capital inflict far more serious economic distortions than the biases in the GST. Our income tax system impedes savings, work and investment and that lowers growth and welfare. So I would prefer cutting income tax rates.

Brian Smith from Ottawa Canada writes: Hi Don. What would you think if the federal government offered to cut the GST but only on condition that provinces raise provincial sales taxes to offset the cut, along with agreeing to harmonize sales taxes across the country? This would seem to fit in better with the Conservatives fiscal approach of giving provinces more fiscal control in areas of provincial jurisdiction.

Don Drummond: I agree the only silver lining of a federal GST cut is if it could be the bait to get the provinces still with retail sales taxes to harmonize. The retail sales taxes are very harmful because they tax capital and get embedded in export prices. But keep in mind only five provinces now have retail sales taxes. Of course, whether they raised their rate should be left to their discretion - the only mandatory part would be tax-base harmonization. Also keep in mind Alberta has no sales tax. No effort was made to get harmonization from the first point GST rate cut. So that $6-billion was squandered. If harmonization was achieved with a second point, my opposition would be muted. But I think we would be better off if the federal government attacked the distortionary income taxes.

tj wade from St Catharines Canada writes: What about taking that 1 cent GST ($5-billion) and using it as the federal share of a universal pharmacare program? This makes far more sense from a social-conservative perspective in (1) assisting ALL Canadians (2) improving the competitiveness of Canadian companies by removing the annual increasing company cost for this benefit, and (3) controlling annual increased health care costs by controlling the largest component responsible for this yearly increase through purchasing prescription meds via provincial/federal bulk buying.

Don Drummond: I agree a strong case can be made for a national pharmaceutical program. I would argue, however, that it should not be entirely funded by government. A component of co-payment (individuals, corporations) would address efficiency, contain public costs and could be designed to be equitable. At the same time, I think the Canadian tax burden is very high. But if that were to be cut, the GST would be my last resort. It would be much more beneficial to cut income tax rates.

garlick toast from Canada writes: Mr. Drummond, at one time there was a lot of talk about the "underground economy." Although rarely mentioned in the media, it still exists and would an increased GST fuel it further?

Don Drummond: You are absolutely right that public discourse of the underground economy has virtually disappeared. Stories of the underground economy being as much as 30 per cent of our GDP abounded around the turn of the decade. Reputable studies by Statistics Canada (and yours truly, if I could be so bold) however placed the underground economy at less than 5 per cent of GDP and likely much lower. You are also right that the GST is partly to blame for the underground economy, so raising the rate would exacerbate the situation. But I would argue this pales against the damage done by our very high marginal income tax rates - many families keep well less than half of any incremental income.

Tavia Grant, globeandmail.com Don, thanks again for joining us and I'm sure the debate will rage on. We couldn't get to all the questions, but any last burning thoughts?

Don Drummond: It's a small sample but I am intrigued by some common elements across the questions. First, most agree that cutting income tax rates is superior. Second, some good would come from cutting the GST rate if it was the catalyst to get the five remaining provinces with retail sales taxes to harmonize.

Finally, I have been impressed with the knowledge and thoughtfulness demonstrated by the questions.