Canada - Despite the benefits, B.C. drags its feet on better sales-tax system

The federal government might have won more support for its one-percentage point reduction in the Goods and Services Tax announced in the Oct. 30 fiscal update had it been linked to sales tax harmonization.

Finance Minister Jim Flaherty took some heat for fulfilling the Conservative campaign promise to cut the GST because slashing a sales tax doesn't stimulate investment or savings like a personal income tax reduction would. One can argue endlessly -- and economists do -- about whether a cut in the GST is better or worse than a drop in income tax rates, but it's hard to be against harmonization, which combines the GST and provincial sales taxes (PST) into a single tax.

The benefits of having one tax rate, one tax collector and one set of tax rules are obvious and proven.

Three Atlantic provinces -- New Brunswick, Newfoundland and Nova Scotia -- agreed in 1996 to create a new Harmonized Sales Tax (HST) of 15 per cent. It came into effect in April 1997, was lowered to 14 per cent in 2006 when the GST was cut from seven per cent to six per cent and will presumably fall further when the new five-per-cent GST rate applies in January. Quebec had earlier introduced the Quebec Sales Tax, a value-added tax with a base similar to that of the GST.

In a study released by the C.D. Howe Institute this summer, University of Toronto economist Michael Smart estimated that the annual investment in machinery and equipment in the harmonized provinces rose by more than 12 per cent above historical levels following the tax reform, which eliminated the provincial retail sales tax on business inputs -- tax that could approach 40 per cent of total provincial sales tax revenue. While the investment impact represents a short-term gain, the effect of new capital stock on productivity would be positive and permanent.

Concerns that harmonization would shift the tax burden from business to consumers proved unfounded. Indeed, after-tax consumer prices were slightly lower on average than before the reform. That's because the savings for business from lower taxes and reduced compliance costs were so substantial that they were shifted forward to consumers, a phenomenon economists call pass-through elasticity, offsetting new taxation on consumer goods and services previously exempt from the PST. The study also predicted that sales tax harmonization would not raise taxes on consumer services as much as is generally believed.

The hold-out provinces -- Ontario, British Columbia, Saskatchewan, Prince Edward Island and Manitoba -- fear that some consumer prices such as housing, heating and haircuts will rise and they will take the brunt of voter backlash. They are also resistant to giving up any jurisdictional authority to decree what goods and services are taxable. They also worry about a possible drop in their tax revenue. The federal government has indicated it would set aside a fund of $5 billion to help provinces through the harmonization transition. But Jonathan Kesselman, a professor at the Graduate School for Public Policy at Simon Fraser University, says the five provinces would lose $7.5-billion in tax revenues every year. So trying to persuade them to jump on the bandwagon with a $5-billion sweetener might be a tough sell.

But this might be a small price to pay for the competitive advantage harmonization gives to Canada. Federal Finance Minister Jim Flaherty hopes to make Canada the most tax competitive country in the G7. Harmonization would help him get there.

The gains in efficiency, productivity and competitiveness harmonization promises are too important to fall victim to internecine power struggles. The federal and provincial government should agree quickly to make harmonization happen.