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Harmonized sales levy is the lesser of tax evils

It isn't often that political leaders take policy actions they know will be highly unpopular. The decisions by Ontario Premier Dalton McGuinty and B.C. Premier Gordon Campbell to harmonize the provincial sales tax with the federal goods and services tax are rare shows of political courage.

The unpopularity of harmonized sales tax (HST) arises almost entirely because the PST has a long list of exempted items that will now have the PST added to the existing GST.

Here in B.C., the most vocal opposition comes from the tourism and restaurant sectors, already hard hit by the recession and higher dollar. Accommodation will be protected by an offsetting elimination of the hotel tax, but services such as domestic air travel, hair care, dry cleaning, accounting and even funerals will be subject to the additional 7 per cent. New-home buyers will pay the tax on purchases over $400,000 and all homeowners will see the HST applied to cable, telephone, gardening, repairs, renovations and heating fuels.

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A recent headline in the Victoria Times Colonist captured the public's reaction: " HST slams into wall of opposition ." An Ipsos Reid survey found that 85 per cent of respondents opposed the July 1, 2010, HST implementation. And critics' mischievous portrayal of the move as bailing out big business on the backs of consumers seems to be a dream wedge issue for the Opposition New Democrats.

It's not that Liberal Premier Campbell couldn't have anticipated the reaction: Mr. McGuinty has endured similar opposition since Ontario announced sales tax harmonization in May. What could be so compelling about moving to the HST that these politically savvy premiers would take such a risk? Part of the answer lies in the reason the move is so unpopular - the dog's breakfast of complex and different exemptions between the PST and the GST. A second part of the answer lies in the investment and job-killing structure of the PST.

First, the dog's breakfast: Separate sales taxes require two costly administrative bureaucracies, taking a big bite out of the money needed for programs such as health care and education. The federal government will foot all of the HST's administrative costs, saving B.C. hundreds of millions of dollars. As a further incentive, Ottawa is providing a $1.6-billion one-time transition payment.

Second, creating jobs and encouraging investment: Unlike the GST, the PST hits at every step in the production chain. In the struggling forestry sector, for example, PST is paid on everything from raw lumber to transportation to delivery. This multiple, cascading PST is recovered in the cost of the finished product paid by Canadian consumers, but isn't possible in the case of exports because the price is set by competition from U.S. producers.

The export-oriented mining sector faces a similar difficulty. The B.C. forestry and mining sectors directly employ more than 116,000 people, even after province-wide layoffs because of low prices and cutthroat international competition. Many other sectors are hurt by the cascading PST structure.

Making matters worse, its complexity adds to administrative costs. B.C. government officials estimate that the HST will remove more than $2-billion from business operating cost. In addition, the HST will lower the tax rate on new capital investment to 16 per cent from 27 per cent.

B.C. Finance Minister Colin Hansen summarizes the province's motivation: "Introducing the HST remains the single biggest thing we can do to stimulate the economy. ... As we come out of recession, investors around the world will be making significant decisions about where to put their investment dollars and where to create jobs. ... While it's the right public policy and good economic policy, it's a tough sell."

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One of the things that makes it a tough sell is that the cascading PST structure hides a lot of the tax in the overall price paid by consumers, while the HST is clearly visible. But even for exempt items such as house construction and restaurant meals, consumers pay substantial hidden, cascading PST on input costs.

Opponents of the HST say there is no guarantee that businesses will pass on the tax savings to consumers. There are two answers to this. First, almost every business lives in a highly competitive world where pricing leverage is extremely limited. Margins have become so tight for most sectors that the issue is survival, not excessive pricing.

And then there is the experience with the 1997 HST implementation in the Atlantic provinces. Bank of Nova Scotia economist Mary Webb found that manufacturers quickly passed on savings when sales tax was removed from the production process; and a C.D. Howe Institute report found that dropping the tax rate on capital substantially increased machinery and equipment investment.

Prime Minister Stephen Harper recently stated: "There is no such thing as a good tax," and the furor in British Columbia and Ontario bear this out. Canadian governments have taken on big-time public program obligations - too big, in my opinion. But the reality is that every province is bleeding red ink as health care and other costs rise. Structures that minimize administrative costs mean more of the taxpayers' money actually gets to where it's needed.

The other reality is that cascading hidden taxes hold back Canadian business in the fiercely competitive environment that will follow global economic recovery. When it comes to either retaining an antiquated and counterproductive tax structure, or helping to create jobs, Gordon Campbell and Dalton McGuinty are making wise and courageous choices.

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