Jun 24, 2010

The HST and BC family budgets


That the HST will take a bite out of family budgets is clear to everyone. The main question right now is just how big of a bite.

Two studies released earlier this week asked this exact question but came to very different conclusions.

On Monday, the Fraser Institute released a paper arguing that lower and middle income families will be better off under the HST (because of the low income tax credits), while the average family will only pay $44 extra per year under the new tax net of the tax credits. They conclude that the impact of HST on family budgets will be negligible.

The very next day, the Victoria Times Colonist reported that this same average BC household stands to pay $521 more as a result of the tax (see HST will hit some hard: Analysis). These were the findings of a simulation the newspaper commissioned from Statistics Canada.

Now, they can’t both be right, so which one is it?

We’ll have to take a closer look at the way they did the calculations to find out — a classic example of the devil in the details.

Digging into the how of the calculations may seem cumbersome and it makes for lengthy blog posts (be warned!), but it’s the only way to move beyond the he said, she said game that often plays out in the media and understand what’s really going on.

Curiously, both reports start off using with the same tool — Statistics Canada’s social policy simulation database and model (SPSD/M) — the state of the art model that’s used by the federal government (and other researchers) to estimate the costs of proposed changes to the tax system.

The key seems to be in how exactly the researchers model the passing through of savings from business to consumers.

The Fraser Institute is vague about their methodology, basing their calculations on “the Fraser Institute’s Canadian Tax Simulator,” which is developed in house by Institute analysts on the basis of the SPSD/M. Their brief methodology paragraph provides the following explanation:

We use the SPSD/M to calculate a distribution series for each specific type of tax and income. For example, we calculate the amounts of provincial personal income tax paid by each family as a share of the total provincial personal income tax collected. We then use the distribution series to distribute the 2011 and 2012 tax revenue figures forecasted in the provincial and federal budgets to the individual families.

In other words, they start off with the BC government’s own estimate of how much more tax they will collect as a result of the HST and divvy up the extra among households based on what share of the BC sales tax pie they paid last year. No wonder the average household comes out paying so little extra under the HST: the BC government estimates that they will only collect about $410 million more in sales tax.

$2 billion in savings to business gets offset by households paying HST on goods and services that were not subject to the PST before and the Fraser Institute’s calculation assumes not only that 100% of the savings is passed on in the first year of the HST but also that the savings are distributed among households exactly in proportion to the amount of PST they paid last year. These are both highly questionable.

The Victoria Times Colonist enlisted Statistics Canada to run a simulation using the SPSD/M to look at the effects of HST on 15 different household types and 15 different income classifications. They find that the tax change could range in net costs anywhere from $78 for households with single parents and one child to $801 for a married couple with no children (see table).

The SPSD/M by definition assumes that all consumption taxes are passed on to households, but these calculations are obviously passing the savings differently, because they project that households will pay $1.5 billion more in commodity taxes and that excludes higher taxes to be paid on new housing.

This is because the analysts look at the impact of the tax on personal expenditures for households in BC and there are considerable savings for business as a result of the HST that do not accrue to industries producing items of personal expenditures.

Exporters, for one, will realize big savings from HST that will not be passed on to BC consumers. The construction industry will benefit considerably as well, and households are not the final consumers of construction output so they won’t be the ones realizing the savings (arguably, a limitation of the SPSD/M is that it cannot account for household spending on new housing, where we may see some pass-through of savings, though as a current renter I’m not holding my breath).

Given that the biggest business savings as a result of introducing the HST in BC will be realized by forestry, mining, oil and gas, construction and manufacturing — all sectors producing goods that BC households do not directly purchase — it’s no surprise that households will face an extra $1.5 billion in HST on personal expenditures.

This is the main difference in calculation used in the two reports and it explains why they come up with such different impacts for the average households. The Times Colonist/Statistics Canada method captures the tax outlay of British Columbians in a more realistic way than the Fraser Institute calculation, so their findings are likely closer to the true impact of HST on the average households.

Interestingly, the two reports work with different definitions of the BC family. The Fraser Institute only considers families of 2 or more people, leaving out of their analysis almost 1/3 of BC households that are made up of unattached individuals, some of whom — unattached elderly, for example — would likely take quite a hit as a result of the HST. The Times Colonist analysis includes unattached individuals in their definition of households.

What makes the Times Colonist/Statistics Canada calculation much more helpful is that they examine the impact of HST on families of different composition and different income levels separately.

This is important because in reality there is no such thing as the average family — it’s an abstract mathematical construct that doesn’t represent anybody’s experience — and using only averages glosses over potentially large distributional differences in the impact of the tax.

Calculating the average among all families produces particularly meaningless results when we’re dealing with an income-tested benefit, such as the HST low income tax credit. On average, however, BC households will get $147 (the total value of the credit divided by the number of households in BC). This means nothing in practice, as 1.1 million British Columbians are slated to receive some amount of the credit, according to government calculations, while the remaining over 3 million people will not.

The Times Colonist/Statistics Canada reveals large distributional differences in the impact of HST with single parents getting off lightly with an extra cost of only $78 on average, while married senior couples can expect to pay $639 more. Married couples with no children would pay the most, $801 extra on average. While this group tends to be among the higher income families so their HST bill does not necessarily present a public policy problem, claims that the HST won’t take a bite of family budgets in BC simply do not hold up to careful scrutiny.

The government should reconsider the structure of the HST low income credit to ensure that vulnerable households such as seniors and modest-income families with children are not pushed into poverty as a result of the new tax, especially at the heels of a painful recession when unemployment rates remain high (currently 7.5%).

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