Social Policy in Ontario

On July 1, B.C. and Ontario will merge their provincial sales tax (PST) with the federal Goods and Services Tax (GST) creating a single harmonized sales tax (HST) — 12% in B.C. and 13% in Ontario. Unfortunately, the prospect of harmonization has been met with public discontent due to misinformation being spread by those who oppose the reform and want to derail it. Canadians mustn’t believe the anti-HST hype. The economic case for the HST is ironclad.

To understand why the move to an HST is beneficial, it is important to highlight the problem with the PST: It applies to business inputs in addition to many of the goods and services that consumers buy. When businesses are charged PST on production supplies and capital inputs such as machinery, production costs increase and these increased costs are largely passed on to consumers in the form of higher prices. In many cases, a product can be taxed multiple times before it is taxed one last time when purchased by the final consumer.

Even goods and services that are currently exempt from the PST in both provinces contain embedded PST, since service providers pay PST on many inputs they purchase including machinery, computers, office equipment and supplies.

The HST, on the other hand, is a “value added tax” like the federal GST: Only the value added by the business selling the good or service is taxed. In other words, all business inputs are exempt from the HST. Under the HST, businesses will receive refunds for the sales tax they pay on inputs.

Past experience with harmonization in Canada shows that competitive pressures will cause businesses to largely pass these savings on to consumers through lower prices.

In 1997, Newfoundland, New Brunswick and Nova Scotia harmonized their PST with the federal GST. University of Toronto professor Michael Smart examined the effects and found that overall consumer prices in the harmonizing provinces actually fell after the 1997 reforms.

Harmonization will not only reduce prices, but also the costs of business investment. Since the PST applies to business inputs, including much of the machinery and technology firms purchase, it discourages business investment. By eliminating the PST on inputs, the HST will spark more business investment and development.

Here again past experience with sales tax harmonization in Canada is telling. After the three Atlantic provinces harmonized their PST with the federal GST in 1997, professor Smart found that investment in machinery and equipment rose by more than 12% in these provinces compared to the non-harmonized provinces.

With more investment and business development, British Columbians and Ontarians stand to gain higher wages and more job opportunities. For instance, University of Calgary professor Jack Mintz estimates that harmonization will account for a net increase of 113,000 and 591,000 jobs in B.C. and Ontario, respectively, over 10 years.

Finally, Canada’s competitiveness will be improved with B.C. and Ontario’s move to an HST, since businesses that export goods will see their prices become more competitive relative to businesses operating in other provinces and countries without sales taxes on inputs. Improving Ontario’s competitiveness is especially important given the blow to the manufacturing sector from the recent recession.

To recoup the lost revenue from refunding the tax paid on business inputs, the HST will apply to a wider array of goods and services than the PST. Broadening the tax base this way ensures that more goods and services will be treated fairly, meaning the HST will produce a more uniform tax burden on all forms of consumption of goods and services.

Opponents of harmonization claim that the elimination of sales taxes on business inputs and the expansion of the sales tax base would result in a shift of the tax burden from business to individuals. However, such a view ignores that the ultimate burden of all taxes falls on people in the form of higher prices, lower wages, or reduced rates of return.

Moreover, both B.C. and Ontario are implementing several initiatives concurrently with the HST to offset the total additional amount of sales tax paid. This makes harmonization revenue neutral for government.

British Columbians and Ontarians would do well to ignore the anti-HST rhetoric. The HST is a significantly more efficient sales tax system that will improve the investment climates in both provinces and ultimately benefit Canadians through more opportunities, higher rates of economic growth and increased prosperity. The three remaining non-harmonized provinces, Saskatchewan, Manitoba and Prince Edward Island, should follow suit.

Niels Veldhuis and Charles Lammam are economists at the Fraser Institute.