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In Defence of the HST

Don't shoot me. I've come to believe that the Harmonized Sales Tax (HST) introduced by British Columbia's Liberal government was the right thing to do.

It's hard not to think so, if you take the time to speak with tax policy experts, look at the results of HST in other jurisdictions (most notably Atlantic Canada), and consider that most other provinces are following Ontario's example by moving to HST.

The opposition can muddy the waters, and consumers can complain that they are getting the short end of the stick, but the truth of the matter is very simple -- HST was a good policy move by the B.C. government.

Is it perfect? Of course not -- no government policy decision ever is. Are there going to be losers, especially in the short-term? Of course there are, there always are. Is this a policy that makes so much sense for the government that it belongs in the 'no brainer' category? Absolutely!

And it isn't just the government that believes so. Professor Kevin Milligan from the Department of Economics at the University of British Columbia is an enthusiastic supporter of the new tax policy and gave it high praise when I spoke with him last week. "HST isn't a left-right issue, and it isn't ideological as far as economists are concerned. It is just good policy," said Milligan. He went on to point out that "It isn't pro-business and anti-consumer. It is the necessary modernization of tax policy."

Over time, consumers will benefit

After I spoke with Milligan, The Tyee published a column highly critical of the HST for B.C., written by former NDP MLA David Schreck, who is a trained economist. Milligan fired back in the comments below the article, Schreck responded in turn, and a spirited back and forth ensued with economist Stephen Gordon jumping in. No doubt the debate is a hot one.

What seems to be lost in the HST argument, however, is that in the long-run, switching to a value-added tax instead of a retail sales tax is hugely beneficial to consumers. The current PST is an embedded cost in most of the good and services we purchase. Just because we don't see PST on the receipt doesn’t mean we didn't pay it. Businesses paid the PST and passed it right on to us as consumers. What is worse is that the current PST is a cascading tax, which means that often the embedded PST was paid multiple times depending on the supply chain of the good. B.C. consumers are often paying double or even triple PST as an embedded cost without even knowing it.

By implementing the HST system, the government is cutting the cost of doing business. It is reducing the marginal effective tax rate (METR) by 40 per cent. This makes business investment cheaper and will help the entire B.C. economy recover from the economic crisis. The METR is one of the most important drivers of productivity and the 40 per cent reduction will be worth $1.9 billion to businesses in B.C.

While some are clearly content to argue that this shows a pro-business bias on the part of Gordon Campbell's Liberal Government, such an argument is very precarious. Individuals rely on a strong business environment to drive the growth of our economy. I know it is akin to blasphemy in some circles to concede such a point, but like it or not, we are all hurt by a weak business environment.

What matters is the ‘passthrough effect’

However, it is indisputable that in the short-term the burden of this reform will fall on the shoulders of consumers. The magnitude of this burden will be dictated by what is known in economic terms as the 'pass-through effect'. This is the idea that in a competitive environment, businesses will pass their savings on to consumers in an attempt to increase market share. Simply put, HST will save businesses money and these businesses will in turn pass these savings through to consumers, which should balance out the seven per cent hike on the price of many goods from the HST.

This point is a little more contentious. There is a great deal of economic analysis about the passthrough effect and some disagreement about the speed and magnitude of the effect. Professor James Brander from the Sauder School of Business at UBC has some concerns about the scope of the passthrough effect in regards to HST in B.C. According to Brander, "There is a mountain of evidence showing that the pass-through effect will not be 100 per cent, and it is difficult to know how long it will take for some of the savings to reach consumers."

This point is supported by the government's position; they hope to see a 75 per cent pass-through rate within the first year as in Atlantic Canada. This number is not just pulled out of thin air. The Finance Ministry's position is based on the C.D. Howe Institute's July 2007 study of HST in Atlantic Canada. The paper, entitled 'Lessons in Harmony: What Experience in the Atlantic Provinces Shows About the Benefits of a Harmonized Sales Tax', supports the government's calculations in regards to the pass-through.

David Schreck attacked that study in his Tyee article. But Professor Milligan agrees with the government's assessment, saying that "There is some rigidity in pricing, but competition is strong in BC and should facilitate a strong pass-though effect." Milligan went on to point out that "We can see evidence of this overtime with other taxes, including the GST.”

Watch September's budget closely

However, the pass-through effect was not the only concern raised by Professor Brander. He suggested that his preliminary back-of-the-envelope calculations led him to believe that dropping the aggregate tax rate of the HST from 12 per cent to 10 per cent would have been a viable option for the government. During a phone conversation last week Brander told me that "A two per cent cut to the total would be a net tax reduction -- at 12 per cent I worry that HST is a slight tax increase."

We will not know the answer to this until the next budget is released in September and we are able to see the details of the government's calculations regarding the revenue-neutrality of the HST.

Milligan did not agree with his fellow UBC professor, pointing out that "I have not done the calculation yet, but it is likely that the tax credits, rebates and exemptions built into HST will make it revenue-neutral at 12 per cent." Milligan also seemed keen to give the government some latitude, pointing out that "Revenue neutrality is more of a range and hard to guess at, it is never an exact science."

Low earners will get tax credit

The tax credits, rebates and exemptions mentioned by Milligan are all important parts of the new tax policy. The government has indicated that part of the burden on low-income earners will be mitigated by a tax credit. According to the government's website: "The maximum amount of the credit would be $230 for individuals with income up to $20,000, and $230 per family member for families with incomes up to $25,000."

There are also point of sale exemptions on good such as fuel, children's clothes, and books. The HST will also maintain the current GST exemptions -- meaning that goods which are currently exempt from GST, like basic groceries, are also exempt from HST.

Furthermore, the HST will include a new housing rebate. Again the government's website makes the rebate very clear:

"B.C. is therefore proposing to provide a partial rebate for new housing equal to five per cent of the purchase price up to a maximum rebate of $20,000. Since purchasers currently pay on average the equivalent of a two per cent tax through embedded PST, there will not be a tax increase for new housing valued up to $400,000."

Government saves red tape costs

Another point in favour of HST is that it saves the government a lot of money -- an estimated $30 million in administrative costs annually -- as well as injecting $1.6 billion in federal funds into the B.C. economy. The position of the federal government in regards to HST was also an important catalyst behind the decision to adopt HST for July 2010. The government's decision to support a rate of 12 per cent, allow the point of sale exemptions, and permit the B.C. government to phase in the import tax credit over five years made HST even more appealing to the B.C. Liberals.

A possible downside of HST is that by increasing the tax rate from five per cent to 12 per cent on certain goods, the government could be increasing the incentive for tax evasion or avoidance. Brander worries this will be the case. Milligan believes that HST will be more of an incentive not to cheat, especially from the perspective of businesses, because they will have to pay HST on their inputs and will need to report their sales. Furthermore, from the government's perspective it is actually easier to police HST because they only need to be concerned with the final point of sale.

What was the premier thinking?

In the end, what both Brander and Milligan agree on is that HST is good policy.

Despite the support for HST from such tax policy experts, the detractors continue to adamantly oppose HST. What is most striking is the narrative that has emerged since July 23rd when HST was announced -- that somehow the B.C. Liberals, led by Premier Campbell, are out to 'screw over' low-income earners, consumers, restaurants, and other services industries in favour of big business. The image they are trying to present is one of Premier Campbell sitting in his office months ago (well before the election) hatching a plan to ruin the lives of anyone and everyone who is not big business. This can't be true.

Of course the Premier was considering HST before the election. The BC Liberals have been considering HST as a policy option since 2001 when Gary Collins was Finance Minister. Any discussions about HST before the election was simply due diligence by the government. It would have been neglectful of them not to discuss HST as a policy option.

The timing of the decision was dictated by practical policy reasons related to the incentives offered by the federal government, and by Ontario's decision to move forward with the HST. As far as the B.C. government was concerned, Ontario's decision made HST in B.C. a matter of 'when', not 'if'. As is often the case with new policy, even really good policy, there is never the perfect time to introduce it -- and rarely will the government be able to make everyone happy. There are often cases where good policy meets tough political realities.

This latest move fits in with a broader approach by the B.C. Liberals. Since this government came into office it has cut 37 per cent from personal income taxes. They have shown a consistent propensity for the shifting of taxes from income tax to consumptions taxes over the long-term.

The merits of that shift can and should be debated.

Still, it should also be noted that the NDP government of Manitoba, led by Premier Gary Doer, is likely to get on board the HST express. Every day he delays is damaging to the Manitoba economy. One has to wonder what Carole James is going to do when a fellow NDPer announces that HST is the future of tax policy in his province.

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