Michael Smart is an economics professor at the University of Toronto and co-director of the Finances of the Nation project.
Finance Minister Chrystia Freeland has promised up to $100-billion in new fiscal stimulus beginning with the April 19 budget, which should help to support the economic recovery as the pandemic wanes later this year. But not all stimulus programs are equally effective and not many can be rolled out in a timely fashion. So how should new government support to the economy be delivered?
There is one simple measure that is shovel ready and would support consumer spending as the lockdowns and restrictions end. The government should temporarily reduce the GST rate to 2 per cent from 5 per cent and keep it there until the recovery is well underway.
Some commentators have in contrast recently called for an increase in the GST to help repay the debt accumulated during the pandemic. Right now, these commentators are simply wrong. As long as output remains substantially below potential, this is the time for fiscal stimulus, not restraint.
This recession is unlike any other because it has hit retail and service businesses the hardest, not manufacturing. We can’t rely on large infrastructure spending to boost aggregate demand as we did in the 2008-2009 crisis, because construction and manufacturing employment has already recovered in most of the country. Meanwhile, household savings rates are at historic highs, but many Canadian families expect only modest growth in their spending this year, preferring to maintain precautionary savings instead.
A GST cut would encourage consumers to go back into stores and to take vacations, thus unlocking some of the extraordinary level of personal savings accumulated during the pandemic. That would make use of the “preloaded stimulus” that Ms. Freeland hopes to get from household savings.
A recession-era sales tax reduction is not a new idea. The British government made a reduction in sales taxes a key part of its stimulus package after the 2008-2009 financial crisis. The B.C. Liberal Party proposed temporarily eliminating the sales tax in the last provincial election. Several European countries have already implemented sales tax reductions to support their economies during the pandemic.
The GST cut in Canada should be temporary and time-limited. The reduction should take effect on Canada Day (by which time we hope many physical-distancing restrictions will have been relaxed), with the normal rate being restored in early 2023.
In fact, the government might consider a temporary increase in the GST rate once the recovery is well underway in 2023 – say to 7 per cent and for a limited time. That would give consumers even greater incentives to spend their savings now, as well as generating revenue later to help restore fiscal balance.
The fiscal impact would be substantial. My proposed three-point reduction in the GST would increase the deficit by more than $36-billion over 18 months, or about one-third of Ms. Freeland’s planned total stimulus. The effect could be even greater if provinces were spurred to decrease their rates in tandem with the federal cut.
Cynics will object that a GST cut would be ineffective – either because businesses would not pass on the tax cut to consumers in the form of lower prices, or perhaps because a tax cut from 5 per cent to 2 per cent would be seen as too small to affect spending. But, here too, the cynics are wrong. Sales tax cuts do get passed on to consumers, and they can lead to a surge in consumer demand.
In recent research for Finances of the Nation, I examined the experience around a recent sales tax cut in Canada. In October, 2006, Saskatchewan reduced its provincial sales tax rate to 5 per cent from 7 per cent. The evidence from the reform is clear. Prices of taxable products and services fell immediately by virtually the full amount of the tax cut. In other words, businesses did pass on the tax cut to consumers.
Retail sales in Saskatchewan rose with the tax cut, an average of 5 per cent more than in comparison with other provinces in the year after the tax cut.
The Saskatchewan tax cut is just one case study, but it is suggestive. A reduction in the federal GST rate this year is likely to have similar effects on consumer prices, and it could well induce a significant boost to consumer expenditure to help spur the economic recovery.
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