Canada - How to fix the GST mistake

In his Economic Statement, the federal Minister of Finance, James Flaherty, should be commended for his broad-based tax relief, a sharp reversal of the past two budgets, which introduced many selective tax reductions for specific activities. Each of his budgets is getting better, with the "mini-budget" providing substantial tax relief to all Canadians.

Certainly, further corporate and personal tax reductions are welcome. Many Canadians will also celebrate the highly visible federal GST rate reduction from 6% to 5%, a fact known to the Conservatives from their own polling.

Nonetheless, despite all the good news on the tax front, the Conservatives should be slapped on their hands for a tax cut that does little to improve Canada's competitiveness position. Six billion dollars less in taxes due to the GST rate cut makes many Canadians happy, but a smarter tax policy could have been achieved. Here is a just a small list: - Personal income tax rates could have been sharply reduced for all brackets. - Corporate tax rate reductions could have been accelerated, rather than waiting until 2012 for the all the reductions to take place. - High personal tax rates that effectively eliminate inflation-adjusted returns on savings in taxable accounts could have received greater attention. - The dividend tax credit could have been made refundable, helping those with retirement savings who receive corporate and trust distributions that are subject to corporate tax. This would have removed the existing discrimination against the holding of equity in tax-exempt savings accounts.

The government could also have taken stronger actions to eliminate high marginal tax on low-income taxpayers who are subject to personal income taxes, payroll taxes and clawbacks of income-tested benefits, such as the GST and child benefit credits.

Although GST cuts are an inferior policy, the federal shift away from consumption taxes could be offset by smart provincial policies. Mr. Flaherty is rightly looking at the provinces to improve their tax structures and he has provided them with a unique opportunity to rebalance their tax system to shift from income to consumption taxes.

As he points out, the provinces could reduce their corporate income tax rates to Alberta's 10% rate. With a federal rate of 15%, the combined federal-provincial corporate tax rate would be 25%, which would bring Canada down to the forecasted OECD average by 2012. This will not only make Canada attractive for investments and job-creation, but help grow the corporate tax base as multinationals shift profits from high tax jurisdictions to Canada, where the corporate income tax rate would now be much more competitive. The provinces could also move to flatten personal income tax rates to reduce the impact of their tax policies on mobile taxpayers, especially those who can easily operate from any province in Canada to conduct their business or personal affairs.

However, provincial personal and corporate tax reductions cost money. Given the demands for health care, infrastructure and education, many provinces will be reluctant to aggressively reform their tax systems.

One option is to take advantage of the GST rate cuts by increasing consumption taxes at the provincial level, except for royalty-hiking sales-tax-free Alberta. Four provinces with modern value-added taxes --Quebec, New Brunswick, Newfoundland &Labrador and Nova Scotia--could easily adjust upward their provincial rates by one point so that combined federal-provincial rate would remain 14%. The additional revenue could be used to reduce substantially personal and corporate rates.

For five provinces with retail sales taxes -- British Columbia, Manitoba, Ontario, Prince Edward Island and Saskatchewan -- the options are more complicated.

For example, each province could increase their sales tax rate to pay for income tax reductions, but this would do little to improve their competitiveness. Since one-third of provincial sales taxes are levied on business intermediate and capital goods, raising the provincial sales tax rate would worsen competitiveness, thereby undermining gains from lowering personal and corporate tax rates.

Another is for provinces to reform their tax structures by adopting a value-added tax similar to the federal GST. The effect of this reform has always been criticized as shifting taxes on to consumers from businesses, even though the elimination of sales tax on business inputs would largely reduce prices faced by consumers. Compensating reductions in income taxes could help consumers cope with the sales tax increase and the federal offer to provide new funds to the provinces to fix up their retail sales tax could provide some an additional boost to meaningful tax reforms.

A third option is for provinces to increase their reliance on levies related to public consumption user fees for public services or taxes related to public benefits such as a good environment. Many provinces are already moving in this direction as they look at tolls for roads, charges for non-essential health care services, tobacco, alcohol, amusement and environmental levies. Such revenues could help pay for income tax reductions as well.

So all is not lost. The federal tax cuts provided this week will not only provide relief to many Canadians, but might lead to a better overall tax structure. Let's hope this happens.