Jul 5, 2010

On the economic impacts of the HST


My previous HST post focused on the impact of the tax on households and I concluded that it’s likely that it will cost families and that some modest income families will be hurt by the tax. Is this sufficient reason to campaign for the tax to be repealed? Not necessarily.

Public policy is about choices and trade offs. As a society, we may be willing to impose costs on families in order to pay for goods and services we deem important. If HST turns out to be a boon on the economy and everyone earns higher wages and pays lower pre-tax prices as a result, then the initial costs may be well worth it. But is this what I expect to happen? The short answer is no.

The HST is certainly an improvement on the PST from an economic efficiency point, but it’s a relatively small improvement. I am convinced that the economic benefits touted by the BC government and over exaggerated and the significant job growth, in particular, will not materialize.

It’s still worth it to move to value-added taxation as it exempts business inputs from taxes and it streamlines tax administration somewhat (though less now that every province gets to determine its own exemptions). But let’s make sure that these efficiency gains are not paid for by low and modest-income families.

While I do not question the move to a value added system of taxation, I see two serious problems with the way the tax is being implemented in BC. First, the low income credit is insufficient to compensate many modest and middle income families that will see their budgets stretched to cover the HST, especially initially while they wait for business savings to be passed on. Hey, we’re already paying the tax, did anyone notice pre-tax prices of anything going down? If so, please post a comment below, I’d love to keep a running list of price decreases.

The second problem I have with the HST is that it shifts taxes from business to consumers. I have heard many arguments that if one is against the HST, one must be again taxes because we need to pay for health care, education, etc. This line of argument is misguided because the extra $2 billion that consumers will be paying now as a result of broadening the tax base are not increasing government revenue. They are merely filling the gap left after providing input credits to business (estimated at $2 billion annually). The government will not have any more money for important services than it had under the PST. Consumers will be footing the bill for a business tax cut, plain and simple.

Note that both of my concerns can be easily resolved within the framework of the value added tax. What’s needed is for the government to increase the low income tax credit amount and to make sure that it phases out more gradually, so more families with modest and middle incomes can get something back. The tax shift can also be fixed — what’s needed is a business tax increase of a similar magnitude. If you believe, like I do, that it’s inefficient to tax inputs of production, then go ahead and exempt them from tax, but tax something else instead. Profits, for example. If you believe that businesses don’t pay taxes, then it shouldn’t matter if corporate income tax is increased — businesses can just pass all taxes to consumers or to their workers.

The problem is that the BC government has shown no interest in having any discussion about how the tax should be structured. The very way they announced the tax without any public consultation and to the surprise of everyone except perhaps a few select Boards of Trade is indicative of this. And implementation really is the key to achieving the objectives the government set itself with the tax — increase jobs and stimulate economic growth to the benefit of all British Columbians.

Implementation design flaws aside, let’s talk about the economic impacts of the HST in our province.

How much of an incentive to make new capital investments will the HST be? The PST by design “cascaded” through the production line, adding costs at every step, but provincial governments were aware of that and tried to remedy it by exempting a large number of goods that were clearly used for production from PST. Most machinery and equipment used in manufacturing was exempt, for example, so the cascading tax was not as big of an issue as the government would like you to believe.

Look at the tax savings that export-oriented industries in BC are expected to realize (according to the governments’ website): $320 million total for forestry, manufacturing, mining, oil and gas, compared to $880 million for construction only:

* Forestry – $140 million
* Mining, oil and gas – $80 million
* Transportation – $210 million
* Construction – $880 million
* Manufacturing – $140 million

It seems clear that the current PST exemptions greatly minimized the cascading impact of the tax for exporters, but they presented more of a cost to construction and transportation industries.

Now with the value-added method of taxation businesses would be able to claim the tax back for business inputs like office furniture, computers, etc. How much would that impact the bottom line? I don’t anticipate a huge rush to invest in BC as a result of the HST because taxes are not the primary determinant of investment.

Yes, all else being equal, a tax change would have an effect, but all else is never equal in the real world.

Expectations for future sales, driven in part by the general economic environment, play a much larger role in investment decisions than taxes. Proximity to markets, the availability of appropriate infrastructure, access to cheap energy, proximity to a skilled labour force, political stability — these are all more important considerations when a firm is looking where to set up shop than the tax system.

Even if a significant capital investment occurs, however, there’s no guarantee that it will translate into large-scale job growth. Remember that all the industries that benefit most are relatively capital intensive, while services, which will be hurt by the tax, tend to be more labour intensive. We may actually see a drop in employment, at least initially, as goods-producing industries move to even more capital-intensive production and service industries scale back if their sales are hurt by the extra consumption tax they now have to charge.

While I agree that we’ll see an increase in business investment and quite likely a GDP boost, I don’t expect to see job growth of the magnitude the government predicts. For a more detailed discussion of the expected job impacts, check my next blog post on jobs and the HST tomorrow.

If you believe in trickle-down theory, you’d approve of the HST and argue that the benefits accrued to the businesses who are the owners of capital should be passed on in the form of higher wages for workers, etc.

However, my recent work on poverty and income inequality in Canada has convinced me that a boost in GDP does not necessarily translate in a boost in incomes for most households. In fact, over the last two decades we’ve seen significant GDP growth while the incomes of the bottom 60% of British Columbian families have barely kept pace with inflation.

This is why my assessment of the HST is more nuanced. I am for value-added taxation, I think it is a better way of taxing consumption than PST. But I think that it won’t be the economic boon the government’s trying to sell it as, and we should be mindful of implementation problems and of the impact the tax will have on modest income British Columbians.

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