Oct 5, 2020

Why a PST cut is a bad idea and directions for reform: A backgrounder on consumption taxation in BC


The BC Liberals have made a bold policy announcement that appears to be the centrepiece of their campaign: a one-year rollback of the 7% Provincial Sales Tax (PST), followed by  a reduction to 3% until the COVID-19 pandemic is over (although in reality there would be strong pressure to stay at the lower rate). This move, we are told, will boost the economy and because the PST is considered to be a regressive tax, it has been claimed that reducing it would have a greater benefit to low-income households. These are dubious claims and in this post I get into the details with a little history of the evolution of sales taxes in BC.

Economic and fiscal implications 

First of all, the PST cut is unlikely to have a major impact on the BC economy. Its temporary nature may shift some consumption that would have happened in 2022 into 2021. For example, if you were planning on getting a new fridge, you might do so a year earlier. But by and large, the benefits are highly skewed: you need to spend in order to save the PST. While lower-income households may spend more on the PST as a share of their income (hence the “regressive” label), those with higher incomes spend more on the PST in absolute dollars. Cutting the PST, therefore, puts the most money in the pockets of high-income people who spend the most, not those who are constrained in spending whether due to job loss, disability or retirement.

Overall, cutting the PST is an enormously expensive and blunt policy with minimal “bang for the buck” and lots of the economic benefit going to those who don’t need the help.   

Cutting the PST would also add to an already-high BC deficit ($12 billion in 2020/21), which is due to a loss in revenues from the COVID-induced recession and increased expenditures in areas like health care and income support for those who have lost work. 

BC has done better than other provinces in providing supplemental spending to maintain incomes during the pandemic. However, the capacity for a provincial government to run up deficits is not unlimited. A full PST cut would cost $8 billion per year, so we must also ask whether this is a good use of deficit spending. 

Back in 2001, the Gordon Campbell-led Liberals successfully ran on large tax cuts, claiming they would spur so much economic activity that they’d pay for themselves (via the new tax revenues generated from that growth). Instead, the reality played out as many predicted: ballooning deficits that then were met with a program of large spending cuts, not a reversal of the original tax cuts. While health care spending was generally allowed to increase, education spending flatlined, which meant real cuts in services due to inflation or the rising cost of salaries, operations and the like. Services outside of health care and education saw deep cuts and large numbers of layoffs of public sector workers. 

For all of this pain, there was no real bump in economic performance to speak of and the province overall was made more unequal. It was not the best of times for BC and the lesson is we should be wary of politicians promising huge tax cuts. Notably, the proposed elimination of the PST is almost four times the size of the 2001 tax cuts.

Is a PST cut good for low-income households? 

Many supporting the PST cut have tried to frame it as more beneficial to low-income households because the PST is a regressive tax. The reality is much more complex. Let’s take a look at what progressive and regressive mean in the context of tax policy. 

To pay for public spending, governments need to tax and it matters what tax bases we choose. From the perspective of inequality, different taxes impact the overall distribution of income in different ways. 

The income tax is a progressive tax due to multiple brackets that tax higher income at higher rates with each step. People with higher income pay a progressively greater share of their income to this tax as a result. 

Consumption or sales taxes are considered regressive because the opposite pattern holds: low-income households generally pay a greater share of their income to the tax than those with a higher income. This is because people with low income generally spend all of their income (and sometimes more if they have to go into debt) and they spend mainly on necessities, while people with high income are able to save a portion of their income and are more likely to spend on luxury goods. 

Cutting the PST is an enormously expensive and blunt policy. 

A flat sales tax applied to all consumption will thus lead to high-income households paying less tax as a share of their total income, but, importantly, they will still pay more in sales tax in dollars because they spend more. So it is correct to say sales taxes are regressive but equally correct to say cutting the sales tax puts dollars in the pockets of high-income households more than low-income households.

Another regressive tax was Medical Service Plan (MSP) premiums, which were mercifully eliminated in 2020. MSP premiums were particularly problematic because they were essentially a head tax, meaning everyone paid the same amount, scaled for family size, although there was some premium relief for very low-income households. This meant that modest- and middle-income folks paid a much larger share of their income in MSP premiums than high-income households. Importantly, revenue from MSP premiums was mostly replaced by the new Employer Health Tax, a payroll tax for enterprises with payrolls greater than $500,000 per year (see Alex Hemingway’s review). 

In practice, governments recognize the regressive nature of sales taxes. Most essential goods and services are not subject to PST and this has a greater benefit to low-income households. According to the BC Budget, these exemptions from PST include food (worth $1.4 billion in forgone taxes in 2020/21), residential energy ($260 million), prescription and non-prescription drugs ($260 million), children’s clothing and footwear ($44 million), specified school supplies ($31 million) and basic phone and cable ($54 million), among others. 

Regressive impacts are also offset by the PST credit (budget cost of $50 million), which provides a maximum value of about $75 per year for individuals and $150 for couples. This means an additional $1,071 and $2,141 respectively of goods purchased are effectively not subject to PST for qualifying households (in addition, most services, as opposed to goods, are not subject to PST). 

In practice, governments recognize the regressive nature of sales taxes.

The PST system could be made more progressive with bigger credits to households with lower incomes. We do this with the BC Carbon Tax, another regressive tax, through the low-income Climate Action Tax Credit. The Province’s MSP Task Force recommended the PST credit be increased to $220 per year to have a bigger impact on poverty reduction. Going further, if we removed all of the exemptions to PST and channeled the money into a substantially larger low-income credit, it could be an important part of a poverty reduction strategy (see my post here). 

From a public finance perspective, it’s helpful to have multiple tax bases so as not to have all of your eggs in one basket for raising revenue. Consumption or sales taxes are an important tax base and taxing them is considered to be efficient; i.e., they don’t distort people’s economic decisions and the overall economy’s allocation of resources. 

That said, the overall tilt of all taxes combined matters a great deal. The context for this conversation is an overall regressive shift in taxation starting in 2001 (see our analysis), combined with a reduction in public spending (relative to provincial GDP). The tax system has thankfully become somewhat more progressive over the past three years. 

Reforming sales taxes

The PST could be reformed to be more efficient through a shift to value-added taxation. This means companies would get credit for the PST they pay on inputs into production, so that the PST is not an additional cost to business. This is good for export-oriented businesses (of which we have many in BC and as a result the business community supports these measures). 

This was the gist of the federal Goods and Services Tax (GST), which replaced a narrower Manufacturers’ Sales Tax (MST) in 1991. The GST also taxed an expanded tax base to include previously untaxed services, but was implemented at a lower rate than the MST. A GST credit was created to reduce regressive impacts. It was a better tax than its predecessor but was hugely unpopular at the time. 

Flash forward to July 2010, when BC replaced the PST and linked with the federal GST through the Harmonized Sales Tax (HST). It likewise widened the tax base and included a HST credit. Like the GST, the HST was hugely unpopular, and under fire the BC government reverted to the PST in July 2013. These political difficulties were, at least in part, because it was sprung on the province right after the 2009 BC election, during which it was not even mentioned as a policy plank for the then-governing Liberal party. 

In spite of these political pratfalls, it’s worth noting, as I did at the time, that the HST was a better-structured tax than the PST although it could have been more progressive for low-income households. 

Flash forward to today, the promises of gains from a PST cut in say, BC’s forestry sector, largely have to do with the fact that companies would not have to pay PST on their inputs. However, most machinery and equipment purchases are already exempt from paying PST (a change made in the aftermath of the HST debacle) so the gains are likely to be limited and need to be set against the potential for provincial spending cuts. 

Anyway, this is a long way of saying that cutting or eliminating the PST is not going to reduce inequality in BC or benefit low-income British Columbians much at all, while giving huge tax breaks to the most affluent and likely leading to spending cuts that would hurt more than any gains from the tax cut. All the same, sales taxation could be made both more progressive and more efficient, but the BC and Canadian political experience says mess with the tax system at your peril.

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