Download Options for the Goods and Services Tax

Options for the Goods and
Services Tax
Jack M. Mintz
Thomas A. Wilson*
University of Toronto
Introduction
The Liberal commitment to replace the
goods and services tax (GST) with a better
tax has been studied by the House of Commons Finance Committee. The question of
alternatives to the GST is not a new one.
Prior to its introduction in 1991, a minority
of tax experts questioned the wisdom of the
federal government’s determination to go
ahead with the GST.1 Some developed detailed proposals that would have resulted in
the elimination of the much-maligned manufacturers’ sales tax (MST) without introducing the GST.
The arguments against the GST focused on
the problems resulting from the enactment
of the tax. These issues have not been resolved. An exploration of alternative approaches to consumption taxation is therefore warranted. In this article, we discuss
reasons for either significant reform or replacement of the GST. We also outline a
number of options.
Problems with the
GST
One option for replacing the GST is not in
the cards: bringing back the flawed MST.
The MST was a poor consumption tax on individuals since it not only had a narrow
base, but also applied to certain inputs purchased by businesses, as well as to many
capital goods. For many years, manufacturers had called for the replacement of the
MST with a tax that would enhance competitiveness. The replacement tax became the
GST, which largely eliminated the cascading
of taxes by giving businesses full credits for
Fall 1994
taxes paid on most business inputs and capital goods.
Although the GST has certain positive features, five major problems are associated
with this tax.
The first is fairness. Fairness is achieved by
taxing at the same rate people with similar
resources (horizontal equity) and at a higher
rate people more able to pay tax (vertical equity). The GST applies at a single rate on
most goods and services no matter what
level of resources a family has to spend on
consumption. The GST is thus a flat-rate tax
on consumption, although this is no different from any other sales tax including the
MST. However, to make the GST fair in terms
of vertical equity (but not horizontal equity),
the federal government allowed a number of
goods to be taxed preferentially, such as
food, drugs, health care and residential housing (Hamilton and Whalley, 1989). In addition, the federal government provided an enhanced refundable sales tax credit to make
the GST progressive.2 While the refundable
credits base reduced the sales tax burden on
low income families, the GST remains proportional across a wide range of consumption.
The second problem is tax evasion at the final point of sale, which has apparently increased since the GST was introduced. With
respect to tax evasion, the GST increased the
level of taxation on service and retail companies. Businesses selling at the final stage
therefore had two taxes to evade: the income
tax and the GST. As Spiro (1993, 1994)
shows, there seems to have been a significant increase in the underground economy,
since 1991 when the GST was introduced.3 It
is difficult to argue that the increased rate of
Canadian Business Economics
27
tax on services and retailers was the sole
contributor to the increase in the underground economy. Instead, it would seem
that the introduction of the GST was a “lightening rod” that increased the incentives for
both vendors and consumers to engage in
tax evasion.
A third problem is tax competition and incentives for increased cross-border shopping
in the United States. The GST increased the
effective tax rate on goods and, especially,
services to some extent compared to the
MST (the federal government estimated a
1.25 per cent increase in the general price
level). However, the GST could be avoided
completely if consumers did not report sales
purchased in the United States that should
be subject to the GST. Moreover, those products which experienced significant declines
in tax included capital goods (which are not
imported by consumers) and “big ticket”
consumer durables, such as automobiles,
furniture and appliances, which are difficult
to smuggle. For most non-durable goods and
most services, effective tax rates are higher
under the GST. Furthermore, they became
highly visible to the consumer. These are
precisely the products which can be crossborder shopped legally (tourist services) or
easily smuggled (clothing and other non-durables). This is not to argue that the GST was
the principal factor driving cross-border
shopping. The exchange rate was the major
factor (Di Matteo, 1993).
In the United States, there is no federal
sales tax, and state retail sales tax rates vary
widely from zero in New Hampshire to 10
per cent in New York. Cross-border shopping by Canadian consumers is affected by
differential sales tax rates on a localized basis. It is easier for the provinces to respond
to tax rate differentials across the U.S.-Canadian border than the federal government. Although the recent fall in the value of the Canadian dollar has reduced the incentive for
cross-border shopping, there is evidence to
suggest that one-day trips have not fallen to
the same level as in 1987 when the CanadaUS exchange rate was at a similar level
(Spiro, 1993:247-59). Recent problems of tax
competition with the United States have
been highlighted by the smuggling stimu-
28
lated by heavy excise taxes on tobacco and
alcohol.
The fourth problem is complexity. Unlike
the MST that applied to about 75,000 firms,
the GST includes virtually the whole business sector of two million firms. Given that
many businesses already had to comply
with federal and provincial corporate and
personal income taxes, capital taxes, payroll
taxes, and various provincial retail sales
taxes, the GST became another major tax
adding to an already complex tax system.
Furthermore, the federal government made
the tax much more complex than needed by
exempting some goods for fairness reasons
and using arbitrary rules for the taxation of
transportation, financial services and purchases made by municipalities, universities,
schools and hospitals (the MUSH sector). It
also chose a low threshold for exempting
small businesses.4 This increased the level
of administrative and compliance costs
borne by governments and the private sector.
Finally, the fifth major problem relates to
the impact of the GST on federal-provincial
tax harmonization. With the GST, the federal
government imposed a sales tax that effectively applied at the retail level which is similar to the provincial retail sales tax (RST).
Prior to the enactment of the GST, the provinces were initially asked to join a national
sales tax that would be designed and administered by the federal government. However,
such a tax would lead to a centralization of
tax collection in Canada, since both income
and taxes would be collected by the federal
government. Under the national sales tax,
there would be little tax policy autonomy left
to the provinces. Moreover, centralization of
tax policy was inconsistent with the trend towards decentralization of expenditure policy
and unilateral federal reductions in transfer
payments made to the provinces. In the end,
the provinces balked at a national sales tax.
The only “harmonization agreement” that
has been achieved since the inception of the
GST is that with Quebec. This agreement allows Quebec to administer and audit both
the GST and its own tax, the Quebec sales
tax (QST) for businesses operating in Quebec. The Quebec government is given considerable autonomy in its design of the sales
tax. For example, Quebec initially taxed serv-
Canadian Business Economics
Fall 1994
ices at a lower rate than goods, and exempts
books. Furthermore, unlike the GST, the QST
fails to allow Quebec companies to claim
credits for taxes on many taxes on business
inputs such as power, telecommunications
and transportation, thereby violating a basic
principle of value-added taxation of reducing the cascading of taxes. Administrative
practices also differ, including filing times
and the treatment of goods sold at intermediate stages of production.5 There are so many
design and administrative differences between the GST and QST that businesses dealing in Quebec are reeling from the complexity introduced by GST-QST harmonization. If
all other provinces were to follow a course of
action similar to Quebec, businesses would
be faced with a nightmare of increased tax
complexity.
The two particular issues of complexity and
federal-provincial tax harmonization were
never satisfactorily resolved prior to or after
the inception of the GST. It is these two issues that now require serious review. Given
the lack of federal-provincial sales tax harmonization and the political unacceptability
of a fully centralized sales tax system operated by the federal government, other options for sales tax reform must be considered.
The failure by the federal government to address major problems arising from the GST
brings to a head a public perception that the
sales tax system, particularly the GST,
should be modified in a major way. However, the Liberal party promise to scrap the
GST and replace it with an alternative is
more difficult now that Canadians have incurred the start-up costs of the GST. Any replacement would have at least some start-up
costs attached to it.
Some Unattractive
Alternatives
It is useful to review two alternatives to the
GST that we would reject out of hand: (i)
eliminating the GST in favour of increased
income taxes (Brooks, 1990), and (ii) substitution of a payroll tax for the GST (Kesselman, 1993).6 The first alternative would increase significantly the tax rate imposed on
Fall 1994
savings. The second would not be a viable
alternative.
Savings and Tax Policy
Our proposals look at replacing the GST
with another form of consumption tax or a
close alternative. We are not looking for
ways to broaden the income tax base that entail additional taxes on savings (such as the
taxing of investment income of registered
pension plans and RRSPs). Studies following
the U.S. Treasury’s (1977) Blueprints for Basic Tax Reform and the Meade Committee report (1978) in Britain suggest that increased
levels of tax on savings would be an ill-conceived and wrong-headed policy. Here are
three reasons why this is important to Canada at this time:
Taxation of the Return to Savings is Unfair: Those who advocate that income taxes
are fair are wrong. It is precisely the opposite
that is true: income taxes can be unfair since
they discriminate against savers. Consider
the following. A person who works pays tax
when the income is earned. If the person
consumes the income immediately, no further income tax is owing. On the other hand,
if the person puts the money in a bank account to earn interest, and consumes the
principal and interest in the future, tax must
be paid on interest income. Thus, a tax on interest income is a second tax on savings. Or,
in other words, an income tax is a non-neutral consumption tax which taxes future consumption relatively more heavily than current consumption. If interest income were
exempt from taxation, people who save (to
consume in the future) would be treated on
the same relative basis as people who consume income immediately.
Savings for the Future Reduces the Reliance on Government Support: Demographic trends indicate that the proportion
of the population over 65 will increase substantially after 2010. The elderly by that time
will need to provide resources for retirement
income and health care. Moreover, deficitconstrained federal and provincial governments will likely reduce many benefits of social policies for elderly middle-income
groups, such as more stringent clawbacks of
public pensions and user charges (a taxation
of benefits) of publicly financed health care.
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29
People need to save for future consumption
or else they become reliant on government
assistance. If we wish to preserve the social
safety net in Canada for the poor, it will be
important to make sure that there are no tax
disincentives for savings of the non-poor.
Otherwise, as recent studies have demonstrated, taxation of savings would reduce the
willingness of people to provide resources
for future needs and this will increase their
future reliance on government support (see
studies referred to in a recent survey by
Smith, 1990).
Domestic Savings Reduce Reliance on International Capital Markets: Canada is
now heavily indebted. In 1981, Canada’s international indebtedness as a percentage of
GDP was 38 per cent. By 1992, this ratio had
risen to 44 per cent. This increase in international indebtedness requires us to produce
more goods and services in the future to
service our debt owed to foreigners. Thus, a
higher domestic savings rate is important if
Canada is to reduce its dependency on foreign debt.
A number of recent studies have found that
countries with higher domestic savings rates
enjoy more rapid productivity growth. Canada had the third lowest private savings rate
of the G-7 countries over the 1979-89 period
(Table 1). It also had the second lowest rate
of productivity growth. It is noteworthy that
Japan and continental European countries
tend to tax interest and other sources of capital income at a lower rate than North American countries and Great Britain.
These arguments provide good reason to
dismiss the idea of simply increasing the
level of taxation on savings as an alternative
to the GST. In our view, tax systems should
be a hybrid of income and consumption
taxes — there is no perfect tax. Thus, we offer proposals that would not result in an increased level of taxation on savings compared to the current system.
Payroll Tax
Payroll taxation has been suggested as an
alternative to the GST. We wish to take issue
with this view. In fact, the payroll tax base
would likely be narrower than the GST base
and would be an inappropriate substitute
compared to the other alternatives.
Consumption is derived from more than
labour earnings: A common argument
made in favour of payroll taxation as a substitute for the GST is the following. Under
the GST system, a business remits an
amount based on the difference between its
taxable sales and taxable inputs. It is then argued that the difference is essentially labour
costs, or the business’s value-added as measured by its total payroll and related employee benefits, the same base used by a payroll tax. Theoretically, this view is erroneous
since it excludes consumption derived from
economic rents (returns that are in excess of
the opportunity cost of using inputs). When
there are irreproducible factors of production (land and natural resources) and imperfectly competitive industries, value-added includes economic rents that would be subject
to taxation under a consumption tax. A tax
Table 1 Savings and Productivity Growth, 1979-89.
Private Savings Rate
(per cent of GDP)
GDP per Employed Worker
(average annual per cent change)
Italy
19.3
2.1
Japan
16.4
3.0
France
12.5
2.0
Germany
12.2
1.8
Canada
9.9
1.2
United States
7.4
1.1
Great Britain
5.4
1.7
Source: OECD.
30
Canadian Business Economics
Fall 1994
on payroll would apply to a narrower tax
base compared to consumption.
Earnings and incorporation: Self-employed earnings would need to be taxed under a payroll tax (with an adjustment for the
treatment of capital). The appropriate treatment would allow businesses to expense
capital expenditures with no deduction permitted for interest and depreciation expense
as under a “cash flow” tax. However, the
cash flow tax would have to apply to more
than self-employed earnings. It would have
to be applied to all businesses, including corporations. Otherwise, labour earnings and
rents could be paid out to employees as dividends and other forms of capital income
rather than salaries, thereby escaping the
payroll tax.
International Issues: The GST and payroll
tax would not be equivalent once international trade and factor flows are taken into
account. An advantage of the payroll tax is
that border-adjustments (zero-rating of exports and taxation of imports) required by
the GST would not be needed. Putting it
more precisely, a payroll tax is an originbased tax on production while the GST is a
destination-based tax on domestic consumption. In principle, the GST applies to domestic consumption no matter where the earnings (and economic rents) are sourced. The
payroll tax only applies to earnings sourced
in Canada.
The payroll tax could be avoided by shifting production abroad and importing the
good without tax back into Canada. Indeed,
labour earnings of Canadians earned abroad
may not be taxed especially if the payroll tax
is applied to business payrolls rather than labour earnings received by the individual.
Intergenerational differences: There is a
significant difference between the payroll
tax and GST with respect to their impact on
younger and older generations. The payroll
tax would only apply to the working population, while the GST applies to consumption
of the whole population, including retirees.
Transitional Problems: Payroll taxes have
increased significantly in recent years. Some
studies attribute an increase in structural unemployment to the rise in payroll taxes
(Poloz, 1994). Recently, the federal govern-
Fall 1994
ment has recognized the adverse effects of
payroll tax increases on unemployment and
has overridden the UI contribution formula.
In our view, one should not consider the
payroll tax as a reasonable alternative to the
GST.
Viable Alternatives to
the GST
We believe, however, that there are a number of options for sales tax reform which represent viable alternatives to the existing GST.
Each option has its benefits and costs: any
one who believes that these options are less
acceptable than the current GST would prefer the status quo. The six options that we
suggest are the following:
The Business Transfer Tax: The business
transfer tax (BTT) could be a replacement
for the GST. Indeed, this was one of the three
options seriously considered by the federal
government in its white paper on sales tax
reform in 1987. Moreover, there is some international experience (Japan’s VAT and
Michigan’s BTT) that Canada could use in
developing this option. One important difference between the BTT and the GST is the
way in which the taxes are collected. The
BTT would use accounts of firms: each firm
would pay the BTT periodically (such as
once a year) on the difference between revenues from sales and purchases from other
registered businesses. This differs from the
GST, which collects taxes on each invoiced
sale and provides credits for tax-paid purchases.
Depending on how the BTT is put into
place, there may not be a significant gain in
simplifying the sales tax, since a substantial
amount of paperwork may be required for filing. To keep the BTT simple, it is necessary
that businesses be allowed to report taxable
revenues and deduct eligible expenditures
without having to track the BTT paid on
each invoice. Otherwise, the BTT would
mimic the GST as an invoice-credit VAT. The
BTT would thus need to be more broadlybased in application to avoid economic distortions of allowing or disallowing deductions for expenditures from suppliers who
may or may not have been subject to tax. For
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31
example, most firms should be included in
the base so few transactions are exempt.
Moreover, it would be easier to operate the
BTT on an origin basis so that imported purchases would not have to be taxed. Otherwise imported supplies would have to be
identified and subject to BTT (see also
House of Commons Standing Committee on
Finance, 1994).
There are other difficulties with the BTT
that would need to be sorted out. First, some
businesses may be exempt, such as small
suppliers and financial services. This could
lead to potential problems as found with the
GST whereby there would be a cascading of
taxes or low rate of tax of goods (if purchases from exempt suppliers are deductible
for businesses subject to BTT). Second, as
the BTT is imposed on the vendor, not the
purchaser, the BTT is an indirect tax, and
cannot be used by the provinces without a
constitutional amendment. The BTT would
therefore coexist with provincial retail sales
taxes, and fail to reduce significantly the
complexity in the dual sales tax system.
Exchange Tax Fields with the Provinces:
The federal government could vacate the
sales tax field in favour of additional income,
capital and/or payroll tax room taken from
the provinces.7 We have calculated that the
federal personal and corporate tax rates
would need to increase by about 4 points
with a transfer of all GST revenues to the
provinces. The provinces would then need
to increase their taxes on consumption (retail sales and excise taxes). This proposal,
originally conceived by the Carter Commission in the 1960s, has the virtue of disentangling overlapping tax powers that lead to
waste and duplication. It would clearly result in tax simplification.
The proposal would enhance the federal
government’s command over the personal
and corporate income tax as the primary
means of raising revenue, stabilizing the
economy and redistributing wealth amongst
Canadians. However, the proposal would
lead to increased reliance by the provinces
on other taxes, such as retail sales and excise
taxes, which may be difficult to levy at
sharply higher rates without leading to tax
avoidance. Moreover, one of the provinces,
Alberta, has no retail sales tax and would
32
have to gain revenues from other sources instead. Furthermore, Quebec has jealously
guarded its rights to levy all types of tax
within its jurisdiction.
While such an exchange of tax fields would
represent a vast improvement over the present system, it is highly unlikely to be accepted by the provinces.
A Broad-based Single-stage Retail Tax: An
alternative which would reduce compliance
costs and facilitate harmonization with provincial sales taxes would be to replace the
GST with a broad-based single-stage tax on
consumer purchases of goods and services.
Capital goods and business inputs would be
exempt from tax though the “suspension”
method.8 With federal sales tax levied only
at the point of final sale, many businesses
would no longer need to remit sales tax, and
the suspension method would obviate the
need for input credits, with favourable cash
flow effects for start-up businesses.
Such a tax could be more easily harmonized with existing provincial retail sales
taxes, since these are also single-stage taxes.
It is argued by some experts that it is difficult
to administer the retail sales tax at a high
rate. The argument is that tax evasion would
result as businesses might abuse the exemption system by selling tax-exempt goods and
services to non-registered persons, especially those with mixed business-consumption use. However, we would argue that
such tax evasion need not always arise with
proper administrative practices. Both an invoice-credit VAT with refundable credits and
a retail sales tax with exemption certificates
require the cross-checking of receipts of
goods and services sold from one registered
taxpayer to another. Abuse is possible under
both systems. With the RST, however, the
prevalent use of the exemption system with
proper auditing would make the RST as
costly as the GST in terms of administration.
The advantage of the RST, however, is that
there is less need to transfer funds around
the economy since taxes on business-to-business sales do not need to be collected by vendor, remitted to the government and refunded to the purchaser, all done without
raising a single penny of tax revenue. Compliance costs incurred by businesses would
Canadian Business Economics
Fall 1994
therefore be somewhat lower under the single stage tax.
A Simplified Consumption Tax: Several
years ago, we had argued in favour of the
simplified consumption tax (SCT) as a personal expenditure tax (PET) which would be
levied in conjunction with the personal income tax (Mintz and Wilson, 1990).9 The
SCT is based on the principle that consumption is equal to income less savings. In essence, the opportunity cost of savings would
be exempt from tax. The SCT would apply to
adjusted personal income net of qualifying
contributions to registered savings plans
(similar to RRSPs and pension plans). The
return on non-registered assets would be exempt. Adjusted income would include inheritances, pensions labour earnings, withdrawals from registered assets and other
sources of business rents.10 The SCT rate
could be graduated with the amount of the
family’s consumption and hence be made
progressive.
The advantage of the SCT is that it can be
made more equitable than the GST (or any
sales tax) by using a progressive tax structure (although this need not be the case — a
flat SCT accompanied by progressive income taxes can achieve the same redistributional objectives). It is also quite simple,
since the tax applies to consumption of individuals without having to measure consumption from particular goods or services
such as tourism, financial intermediation,
and housing. If the SCT is collected at the
same time as the personal income tax, there
is considerable tax simplification achieved
without interfering with provincial taxing
powers.
There are also disadvantages to the SCT.
There are technical issues in measuring
qualifying deductions for savings invested in
foreign bank accounts and investments with
an element of consumption (e.g. paintings).
Also, if individuals misreport income, the
SCT will also be misreported. Moreover, people can escape the tax by shifting rents and
earnings out of the country to other jurisdictions.
Increased Reliance on Direct Taxes with
Increased Savings Incentives: There is another alternative to the GST which might
Fall 1994
achieve many of the efficiency gains, but
which would avoid the administrative costs
and complexities associated with the GST
and other proposals such as the SCT. This alternative is the abolition of the federal GST,
coupled with a replacement of the lost revenue via a modified income tax system which
is closer to a personal expenditure tax system. The modifications to the income tax include increases in the federal income taxes
to raise most of the revenues lost from the
abolition of the federal sales tax, coupled
with a liberalization of the RRSP/RPP contribution limits, the introduction of an interest
income deduction, and income averaging to
mitigate any adverse effect on personal savings. However, when added to current federal and provincial income tax rates, top
marginal tax rates would need to approach
60 per cent which would increase tax avoidance and evasion.
A Simplified Harmonized VAT: A final alternative is to reform the GST to make it simpler and fairer and harmonize it with the
provinces (Bird, 1994: 37-47). The advantage of this approach is that there are no
start-up costs for businesses since the GST is
now in place. Such a national sales tax
(NST) would require the federal government
to enter into new negotiations with the provinces for a harmonized sales tax regime.
The federal government should be flexible
in allowing for selected exemptions and be
willing to observe provincial autonomy.
However, it should keep the following principles (Mintz, Wilson and Gendron, 1994):
• only one agency (e.g. the federal government, or a joint federal-provincial agency)
should administer and audit the tax;
• cascading of taxes on business inputs
should be avoided; and
• administrative rules should be similar to
those used for the GST.
Indeed, the report of the House of Commons Standing Committee on Finance
(1994) goes some way in providing a model
for a flexible agreement, allowing differential rates across provinces and a tax base negotiated by federal and provincial governments. Our proposal would also allow for
differing tax rates. We would also argue that
tax bases should be set according to a na-
Canadian Business Economics
33
tional norm with some differentiation permitted for goods or services sold primarily to
consumers at final stage (e.g. burial services,
books, magazines).
The national sales tax could be enhanced
by the following one of two schemes — a
joint VAT or a joint federal VAT - provincial
RST, referred to as the open architecture tax
system (OATS).
A joint VAT would have both federal and
provincial governments tax the value-added
of business as under the GST. To accommodate differing provincial tax rates, each province would zero-rate exports to registered
businesses in other provinces and not provide an input tax credit to business for imports to other jurisdictions. Exempt businesses would pay both federal and
provincial sales tax on inputs sourced from a
particular province. This scheme is similar
to the European system now in place and
was recommended by the House of Commons Standing Committee on Finance
(1994).
The joint VAT would also entail the following changes:
• Simplify the tax by eliminating zero ratings, tax exemptions, and partial exemptions of goods. With the resulting savings
of about $2 billion in revenues, a reduction in personal tax rates or an increase in
the refundable sales tax credit for lower income individuals and refunds for the
MUSH sector could be implemented.
More judicious use of the suspension system as under the RST could also reduce
complexities.
• Improve the treatment of the MUSH sector
by rebating all taxes on their inputs rather
than having differential formulas. The
current system leads to the taxation of research and development, education and
training, and expenditure on health and
causes the cascading of taxes when the
MUSH sector sells goods or services to
GST registered businesses. Some goods
sold by the MUSH sector are for private
consumption and these should be taxed
under the GST.
• Increase the small trader exemption to allow most small businesses to choose
whether or not to register (e.g. a $200
34
thousand sales threshold would give 80
per cent of businesses this option). The
small loss in revenue would result in a significant reduction in compliance costs. Japan has followed this course and some
VAT proposals in the United States include
such an option. Although this would reduce the neutrality of the VAT, pure obedience to one principle (neutrality) without
recognition of another (simplicity) results
in poor tax policy. Most countries favour
more simplifications than Canada did in
developing the GST (Bird, 1994).
An alternate national sales tax would be a
joint federal-provincial sales tax whereby
the federal government would apply a VAT
with the provinces imposing a retail sales
taxes on the final sales to consumers (for further discussion, see Mintz, Wilson and Gendron, 1994). Essentially, the provinces
would “suspend” payment of retail sales
taxes on all goods and services sold from
one registered business to another (only the
federal VAT would apply). The advantages
of this proposal are that it would:
• eliminate provincial sales taxes on interprovincial transactions of registered businesses;
• avoid provincial taxation of goods and
services sold at intermediate levels of production and distribution thereby reducing
cash flow considerations of businesses;
• make it easier for the provinces to accommodate the new system with built-in flexibility;
• broaden the provincial exemption system
since all transactions under the federal
VAT will be audited as part of the invoicecredit mechanism; and
• reduce administration and compliance
costs significantly for both federal and
provincial governments.
Provincial autonomy can be respected by allowing the provinces to negotiate exemptions for specific goods and services as in the
joint federal-provincial VAT.
Conclusion
The final alternative — sales tax simplification and harmonization — is our preferred
option. As an alternative to the current GST,
Canadian Business Economics
Fall 1994
it would simplify the tax system and generate increased efficiency by eliminating the
taxation of business inputs and capital
goods. Other alternatives can achieve more
equity than the current system, especially
the simplified consumption tax. But given
that the GST is now in place, it seems best to
modify the current system to reduce complexity without imposing yet another set of
large transitional costs upon the public.
There have been recent reports that the federal government is offering a “12 per cent solution” that would involve one common
sales tax base and rate across all provinces
and flat rate income taxes to raise the remainder of revenues needed by each government. Ultimately this proposal would
achieve simplicity and efficiency at the cost
of sharply curtailed provincial autonomy.
Given that Quebec already has an agreement
with much more flexibility, it will no doubt
reject such a proposal. It is unlikely that
many of the other provinces would want to
enter into an agreement with so little flexibility. We prefer the far more flexible open architecture sales tax system, in the hopes of
obtaining harmonization, while preserving
provincial tax autonomy.
5.
The QST introduces the notion of “non-taxable”
goods moving through the production chain. Quebec feared that application of the GST at intermediate stages of production would be challenged as
unconstitutional given the restriction imposed in
Section 92 regarding provincial powers of taxation.
Under the GST, there is no similar concept of “nontaxable goods”. A recent Supreme Court decision has
confirmed that a value-added tax will be considered
a direct tax.
6.
Recently, Kesselman (1994) proposed a payroll tax
to include a cash-flow tax on business (revenues net
of the cost of purchasing goods and services from
other firms, including capital goods). His new proposal is to apply a “direct consumption tax” which
is similar but not identical to our proposed simplified consumption tax.
7.
Alternatively, the federal government could exchange income tax revenues for additional sales tax
revenues as proposed by Ontario and Manitoba. Under this scheme, provinces would yield the sales tax
field to the federal government in exchange for more
income tax room. Our concern with this proposal is
that it could result in a balkanization of the income
tax field. Moreover, we see no reason why Quebec
would agree to this solution under which Quebec
would lose autonomy.
8.
Under the “suspension method,” a purchaser provides an exemption certificate to the vendor who
then does not charge the sales tax and remit the
revenue to government. This method is used under
the GST for farmers and provincial governments.
9.
Our approach draws on the Meade Committee
(1978) and U.S. Treasury (1977) reports. See also
House of Commons Standing Committee on Finance
(1994) for a comprehensive discussion of this approach. We would have both registered (e.g. registered retirement income plans and pension plans)
and non-registered assets. Kesselman’s proposal for
a “Direct Consumption Tax” is a consumption-based
tax that uses the non-registered asset approach only.
10.
A cash-flow tax on businesses may also need to be
imposed to capture rents accruing to owners of nonregistered assets. The cash flow tax would apply to
a base on an origin basis with wages and salaries
deducted from the base. If equities are held in an
RRSP or pension account, a refundable tax credit for
the cash flow tax could also be paid to the owner of
the account.
Notes
*
Mintz is Associate Dean and Arthur Andersen Professor of Taxation, Faculty of Management. Wilson
is Director of the Policy and Economic Analysis Program and Professor of Economics. This article develops the arguments first presented in Mintz and
Wilson (1993).
1.
See Whalley and Fretz (1990), Mintz and Wilson
(1990), Brooks (1990) and Boadway (1989).
2.
The refundable credit is based on family income and
is clawed back from income greater than $25,921.
To the extent that the income is misreported or mismeasured, the credit may not be well targeted.
3.
The growth of the underground economy may also
have resulted from the increase in income tax during
the 1980s from 15 per cent to 21 per cent of GDP
(Mirus, Smith and Karoloff, 1994). Gervais (1994)
suggests that the underground economy is not much
larger than 5 per cent of GDP.
4.
See Bird (1994) for a discussion about the complexity of the GST. Estimates of the cost of the GST suggests that small businesses are particularly affected.
It found that compliance costs are 16 per cent of
sales for businesses of less than $100,000 in revenues and 3 per cent of sales for businesses with over
$1 million in revenues (House of Commons Standing
Committee on Finance, 1994: 17).
Fall 1994
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