GST cuts, harmonization and other blessings in disguise - Macleans.ca
 

GST cuts, harmonization and other blessings in disguise

The case for cutting consumption taxes


 

When the federal Conservatives promised two years ago to cut the GST, Canadian economists replied with a single voice. Or so it seemed. Cutting consumption taxes is regressive, many warned, because it rewards the rich with proportionately greater discounts (two per cent off the price of a BMW, they reasoned, is worth a lot more than two per cent off a Chevy Cavalier). Better to provide targeted income tax cuts, they said, to the earners you hope to help.

Yet average Canadians seemed pleased with the relief. They rewarded the Tories with consecutive minority governments, while a proposal by then Liberal leader Stéphane Dion to restore the GST fell flat. The current Grit leader Michael Ignatieff has said he will leave the cuts in place if elected.

Now, without warning, consumption taxes are back in the news. The Ontario government plans to harmonize its provincial sales tax with the GST. That will subject many household items previously exempt from provincial tax to a new 13-percent tax. Opposition politicians have branded it taxation by stealth.

Meantime, the former governor of the Bank of Canada, David Dodge, has called for the federal government to restore at least one percentage point to the GST when the economy begins recovering from its swoon: otherwise, he suggested, the country is headed toward a pit of debt.

But not all economists favour consumption taxes. Patrick Grady, who held several key posts with the federal Department of Finance, counts among the minority of influential economists who have voiced support for the GST cut. Grady is now an economic consultant. Maclean’s reached him in Cambodia, where he is participating in a World Bank mission to enhance that country’s public financial management.

Q: You’ve argued that the federal Tories two-point GST cut “wasn’t so stupid.” What is your rationale?
A:
In my view, it’s hard to find a discretionary tax change that was made at a more appropriate time. It was made in advance of the need [i.e. the economic downturn], and it did provide significant support to consumers. These kinds of cuts can be more expansionary than an income tax cut because of their impact on the price level. When prices hold steady, that allows a much more expansionary monetary policy. You could certainly see the opposite effect when the GST was imposed. It was a revenue-neutral shift—they were removing the manufacturer’s sales tax. But there was a huge run-up in inflation, which resulted in a very large tightening of monetary policy. And that, in effect, produced the recession of the early ’90s.

Q: What about at the level of guy on the street? How do consumption taxes affect, say, low or middle-income earners?
A:
If you look at consumer spending patterns, you’ll see lower income people tend to spend a higher proportion of their income on consumer goods, so a consumption tax cut benefits them disproportionately compared to upper income people. It becomes a bit more complex if you provide exemptions for food and things like that. But the point is that upper income earners spend a smaller share of their income on household goods.

Q: Why, then, do so many economists think so highly of consumption taxes today?
A:
The notion is that they’re less distortionary because they don’t double-tax savings by taking money first as income tax, then claiming still more as capital gains taxes. That’s true of pure consumption tax versus a pure income tax. But we don’t have a pure income tax in Canada.

Q:
We don’t?
A: Not when you add in things like RRSPs and tax-free savings accounts. They allow people to save on a tax-free basis.

Q: Still, a lot of economists argue things like GST cuts are not nearly as progressive as an income tax cut.
A: Well it depends on the nature of the income tax cut. If it were all for low-income people, that would be more progressive.

Q: What do you think of Ontario’s plan for a harmonized tax?
A: I haven’t seen the details yet, but I’m a big proponent of harmonization. I was actually hired by federal Finance in the mid-’90s to help negotiate the harmonized sales tax now in use in three Atlantic provinces. You have to understand, one of the biggest problems in the Canadian tax system is the taxation of business inputs at the provincial level. It tends to discriminate against investment and that undermines productivity. It’s very pro-productivity to move a provincial sales tax to a model like the GST, which is not imposed on exports, and not on business and investment inputs. It also saves on administrative costs to just have one tax. Then business have to deal with only one bureaucracy and one set of tax regulations [when they remit taxes].

Q: We’ve been told again and again that we need to get out to the malls to revive the economy. Yet some things are taxed under harmonization that weren’t previously subject to the PST. If that’s true, won’t it actually discourage consumer spending? And isn’t that counter-productive?
A: It is a problem, yeah, and the timing may not be perfect for harmonization. These things almost never get done when the timing is best. But I would imagine the implementation will get delayed, and if we’re into 2011, well, what’s the economic situation going to be then? So it will probably have some impact, in the short term, in terms of raising prices. But in the long run, the lower costs of production and capital will be passed on.


 

GST cuts, harmonization and other blessings in disguise

  1. Ok i’m no economist so i have to observe my limits, but Mr Grady argues that the imposition of the gst sparked inflation and the 90s recession – maybe, but then he says that reducing the gst had essentially the opposite effect – really, was gst lowered over two years by 1% per annum. Is this really as stimulative?And what about the fact it wasn’t offset by spending cuts? Someones gotta pay the piper.
    As for his guy on the street arguement. That one makes me laugh since none of these guys have been on the street. The arguement that reducing the gst disproportionately benefits the poor is absurd in real terms. The working poor spend much of their income on essentials like rent and food, on which is gst exempt – not much discretionary spending left over. The well off, whether they spend less of their income or not, can still see big savings on big ticket items ; this is a canard. Mr Grady does however sheepshly concede if all the gst cuts were targeted at the middle class and the poor it would be progressive.

    • You may not be an economist, but I can’t argue with your logic. He briefly acknowledges that things like rent & groceries are GST exempt but then ignores the effects of the exemptions.

      What I think Mr. Grady is referring to with the imposition of the GST is that the old MST was “invisible” to consumers — it was included in the price tag, so it was harder for manufacturers to pass all of it along to consumers. Then along came the GST, which was separated from the rest of the price on the bill. Manufacturers could pass it all on to consumers & blame the government. I was pretty young at the time, but I remember consumer groups complaining that the base price didn’t drop once the manufacturers stopped paying MST. Same price plus new tax equals inflation.

      Also, GST applied to a lot more things than the MST. Tax on more things also equals inflation.

      It’s a little simplistic (aka stupid) to blame the 90’s recession on the GST. Off-shoring jobs really increased around this time due to developing infrastructure in China, and a fair number of manufacturing jobs left Canada due to FTA/NAFTA.

      • Thanks, that’s clearer. I was around at the time and there was a lot of talk about shifting the tax burden onto the middle class, seems they did, and more. Another real howler from this time was Mulroney’s assertion that the gst would be revenue neutral – now of course he brags he planted the deficit reduction flowers for Martin et al. to pick.

  2. I spend approx: $14000 on Gst taxable items a year. 1% saves me $140. Big deal Cut my income tax. No tax on the first $15,000 per person and $10,000 for each child might put some real money into the economy. Otherwise don’t waste my time.

  3. But we don’t have a pure income tax in Canada.

    This is a spectacularly lame and incurious dismissal of pretty much everything the public finance and the economic growth literature has to say on the issue.

    • I think he’s taking “pure income tax” as a technical term meaning something like a flat tax or a progressive bracket system like we have, only without tax credits or deductions. Also, different types of income, such as capital gains, are taxed differently. So he’s probably correct on a purely technical level, but he could have qualified his statement more. Income not invested in a RRSP or RESP or spent on child care, etc. is taxed, so it’s not “pure” income tax.

      He’s answered my question from yesterday as to whether or not Ontario businesses will pay PST. It sounds like it will work like the GST, where businesses pay the tax and then get it back. Only consumers will pay PST. I really haven’t done much with Ontario PST other than try to convince our Ontario vendors they don’t charge PST on out-of-province sales, but I think in the current system business only pays PST on goods & services they “consume” within the business; ie, not on inventory & material they buy for resale. So it will cut costs for Ontario businesses in two aspects: firstly, they pay less tax, and secondly, they only have to do one set of sales tax calculations.

      So for this to be revenue neutral, consumers will have to pay a lot more PST, or, given the crazy low corporate income tax rate in Canada, stimulate about 15 times the business income that was previously subject to PST.

  4. Nobody with half a brain EVER argued that consumption taxes were regressive compared to income taxes. The poor spend ~100% of their income (even after rent, which is not taxed, it is still a large percentage). The rich save. Now compare that to an income tax cut, which people making no income get none of and people with a low income get very little from.

    • You have no idea what you’re talking about. Go and talk to some working poor individuals, and get your nose out of those books!

      • *sigh*
        Lets say I am single, living in Ontario and make $25000/year. Of that I must pay
        $3,297 in income taxes. Lets say I pay $600/month in rent, which adds up to 7200/year. I also spend $4000 on food, which is not taxed. These are pretty liberal assumptions. This leaves me with ~13,900 to spend on various goods and services upon which the GST and PST applies. At 15%, I would pay $2,085 in sales taxes. A 2% cut in the GST gives me an extra $278/year, or an additional 1.1112% in disposable income.

        Source for income tax calculations.
        http://www.ey.com/GLOBAL/content.nsf/Canada/Tax_-_Calculators_-_2008_Personal_Tax

        Lets say a second Ontarian makes 100,000/year. They are single and own their own home, meaning they need not pay rent. They spend $8,000/year on food, which is exempt from sales taxes. They pay 28,744/year in income taxes. They can afford to cover additional costs of their lifestyle by spending 40,000/year (3 times as much as our poor person, as well as more spending on food), saving the rest (23,000 – probably includes some mortgage payments).

        At a 15% rate of GST they would pay $6000 a year. The 2% GST cut nets them an additional $800 a year, or 0.8% of their income. In other words, relative to their income, the benefit of a cut in GST is greater for poorer people. Why? The wealthier person saves a greater proportion of their income than the poorer person. Is this a realistic assumption? These numbers are a little old, but they make the point pretty dramatically.
        http://www.scielo.cl/fbpe/img/cecon/v38n113/fig3.gif
        Share of income saved by income in Canada, 1996-7
        1st quintile (the poorest): 4.8%
        2nd: 8.5%
        3rd: 12.5%
        4th: 19.7%
        5th: 54.6%

        But that’s not all – this only shows that cutting the GST (which is a regressive tax) is progressive relative to a neutral tax (say a flat tax). The income tax, however, is not a neutral, it is a progressive tax. This implies that income tax CUTS are regressive.

        If you make $8000 or less, the benefit from an income tax cut is zero.

        If you make $25,000 you would need an 8% reduction in your average income tax rate to take home as much as in the GST cut case.

        If you made $100,000 you would only need a 2% reduction in your average income tax rate to take home as much as in the GST cut case.

        The income tax in Canada is clearly progressive, and income tax cuts are clearly regressive. That doesn’t mean they are a superior policy option – consumption taxes encourage saving (relative to income taxes) which is good for medium-run growth, while income taxes (particularly top marginal rates) discourage productive activities. It only means that your ridiculous notion (which you claim to have developed by “talking to working people” – the same folks your logic is screwing) and that of the hare-brained article is wrong.

        Of course I do apologize if there were too many facts in there for you, and not enough dialogue with garbage-men.

        • Hey, it’s amazing what you can do when you jury rig the numbers.

          Tell me, how’d you figure that they can spend an extra 40,000 for their lifestyle completely GST exempt?

          • As i said H toH you need to look at the real world of poor people, not jus use yourself [ a student?]
            Keep your stats, they mean little or nothing in the real world. Most workinng poor families [ hardest hit, apart from the destitute] see a savings of between $ 1-2oo/yr. This is a ridiculous waste of money -[ in terms of bang for your buck ] almost bad as the adsurd $100/mnth daycare joke. You conveniently ignore the fact that higher earners do get major savings on big ticket items, particularly if you’re single with no kids. No one saves any more at the rate you predict. Gst cuts are a sick joke unless you have the disposable ncome to realize the benefits – [ very similar in effect to tax credits ] of course there are benefits to business, but this hardly proves your point. You have no point to prove.

          • T. Thwim,

            I realize 5 in the morning is awfully early to think clearly but where did he say they can spend an extra 40,000 completely GST exempt. On the contrary he indicated they would pay $6000 for GST at the 15% rate (40k * .15) and save $800/annum with a 2% cut. The GST exempt portion would be the 23,000 unspent but rather put into savings.

  5. The thousand dollar carrot is just a smoke screen to trick Canadians into letting the politicians deeper into our pockets so they can turn around and pay themselves even more in the future. We need to stand up to these financial terrorists, vote them out and have an election recall. Say no to the HST (Hit-them-Hard-in-the-pockets Sales Tax)!!!!!!!

    And as far as the economy goes, anyone who has taken Economics in College or University would know that the economists’ jobs consist of finding ways to ruin the economy. They look for rumours of wars, financial troubles, and any excuse they can get to make the market place as bad as possible so they and their friends can get on the bottom floor for the lowest price and can make as much profit as they can on the backs of the average person. I call this unethical. I’m labelling those economists financial terrorists. Cerberus is a company with is board made mostly of economists. Look what they have done to companies they have boughten part or in whole. Chryslers is one of the latest Cerberus victims. A matter of fact when I was in College taking Economics, I was always disagreeing with my professor and nearly failed until the final exam, where I needed more than a perfect mark to pass. It was then where I regurgitated what the professor wanted to hear, followed by blasting him with why I thought his and the course’s positions on Economics was wrong and unethical. We were doing fine until the economists started their fear-mongering in the media and the media ran with it. If we would have all just ignored the messages that the economists were spreading, we would not have the financial mess we have now. However, it’s not too late; we can choose to ignore them now and spend money again so that our economy fixes itself.