Stanley HarttA hike to Canada’s much-debated Value Added Tax, the GST, could help solve the Liberal government’s budget woes, but they would be wise to retain the Harper cuts

Stanley H. Hartt

On the morning during the 2006 federal election campaign when the Conservative Party of Canada was to announce its policy priorities, including a two percentage-point cut in the GST, I got a telephone call from Party headquarters. “We know you are a big supporter of the GST, so we would appreciate it if we did not hear any criticism from you of this plank in our platform,” the voice said.

Caught off guard by the concept and the timing (I was in the bathroom shaving), I thought fast. I had been the Deputy Minister of Finance when the GST was first presented as part of the comprehensive Tax Reform proposed by Minister Michael Wilson, and I was Chief of Staff to the Prime Minister as the debate raged over this modernization of our consumption tax regime. I remembered the controversy and the childish manoeuvres by the Liberal majority in the Senate who employed noisemakers, normally seen at a fifth birthday party or a particularly enthusiastic New Year’s Eve celebration, to attempt to block a vote in the Upper Chamber.

“I have three reasons why you don’t have to worry about that,” I replied. “First of all, the Liberals made sure with their antics that the scarlet letters “GST” were emblazoned on Tory foreheads, so there is no reason Conservatives shouldn’t take an opportunity to turn the tables and do something popular on this issue. Second, if I knew someone who was a dope addict, I would like to be able to take the drugs out of their hands. So, if this means there will be less money for the policy development apparatus to spend, good show. Finally,  if you cut it, no one will ever be able to raise it again”.

Well, I was right on at least two counts. However well-designed and well-intentioned, the GST was massively unpopular. Seen as a new tax rather than as a replacement for an existing levy, it was fiercely opposed by the Liberal Opposition, and by the Canadian Federation of Independent Business (who foolishly thought their members could somehow deflect shopper outrage and stimulate sales by constantly reminding customers of the 7 percent by posting signs that read “Don’t Blame Me for the GST”). When the Senate vote was impeded by infantile  interruptions, the Prime Minister was forced to resort to the little-known provisions of Section 26 of the Constitution Act, allowing him to appoint 8 supernumerary Senators to give him the predominance in the Upper Chamber needed to pass this measure.

The GST had been conceived as a reform to our outmoded and inefficient Manufacturers Sales Tax. It employed the classic design of a value-added tax which is common in dozens of countries all over the world (and is a condition of entry into the European Union because it is the form of consumption tax most compatible with the rules of free trade). Our leaky MST, on the other hand, was experiencing declining revenues even in the midst of a prolonged economic expansion. And it was easy to plan around, largely because it had been designed for an earlier, simpler era where manufacturers bought inputs only from producers of raw materials or other manufacturers, and then sold to distributors, wholesalers or retailers.

The MST’s system of credits (manufacturer to manufacturer) created an unintended tax on inputs which could not be removed when our goods crossed international borders, while imports were taxed as they entered the country, and before all of the inbound transportation, warehousing, insurance, and marketing expenses were incurred. As a result, our MST penalized domestic producers and favoured imports, a dumb position for a country then embarking upon a Free Trade Agreement with the United States.

As a result, the design of the GST was seen as attractive by most economists and tax experts because of its efficiency as a revenue-producing mechanism, its encouragement of saving and investment, and its consistency with free-trade obligations because it couldn’t disguise subsidies by favouring certain products and services.

But politicians were receiving a quite different perception from their constituents. During the 1987 Christmas adjournment of the House of Commons, Tory MPs were reporting back to the policy makers in Ottawa that the initial proposal to tax food (and keep the GST rate at 5 percent) was being greeted with derision. As a result, the original design was altered to exempt food (and create the classic laugher where a doughnut purchased at a coffee shop was a restaurant meal, but if an enterprising customer organized the next six people in line to pool their orders, they could avoid the tax because the six doughnuts had now become food).

Less well known is the fact that when Wilson held his annual pre-budget briefing with his provincial colleagues and informed them of the change, there was a long period of silence, with Ministers staring at their shoes. Then Mel Couvelier, Finance Minister of BC and Chair of the group, ventured, “Well, Michael, I suppose that we really don’t have the right to comment, since none of us was brave enough to join the federal government and create a national sales tax, but you can tell from the reaction you just got that we collectively think you’re making a mistake”.

The higher rate of 7 percent, mitigated by the food exemption, together with exempting resale housing and a low income credit managed to make the GST modestly progressive. But you would never know that from the political feedback. Jean Chrétien led the country to believe he would repeal the GST (and cancel NAFTA) if elected in the 1993 election. He did neither (to his credit, and due to the advice he got from senior officials once he became Prime Minister) which eventually allowed the Liberals to claim they had eliminated the deficit, albeit with building blocks left over by the decimated Conservatives.

So the context of Mr. Harper’s 2006 pledge was to attempt to occupy some of the razed ground the Liberals had arranged for the GST. Harper promised to cut the rate by one percent right away and another point over the next five years.

Astonishingly, the Liberals, by then holding the levers of federal power, were brazen enough to oppose the Conservative initiative. Perhaps the Liberals’ resistance had to do with the fact that they feared that the Tories would have to reverse the package of income tax cuts proposed in their Fall, 2005 mini-budget. For whatever reason, the Liberals chose the less popular side of the debate on that occasion.

The Conservatives kept their promise and took one percentage point off the GST on July 1, 2006. They rushed the implementation of the second one-point reduction which went into effect on Jan. 1, 2008. There can be little doubt that this latter change was advanced in time as part of the negotiations to bring Ontario and (unsuccessfully) British Columbia into the fold, to join Nova Scotia, Newfoundland and Labrador and New Brunswick in what has come to be called the Harmonized Sales Tax. Ontario joined the system as of July 1, 2010. PEI adhered to it on April 1, 2013. Quebec had already integrated its provincial sales tax base with the GST by an agreement made in September 2011.

As to my second, quick-thinking reaction, I was motivated by the knowledge that the Mulroney government, under Finance Minister Don Mazankowski, had been quite aware of what a powerful revenue-raising tool the GST was. Maz went so far as to refer to it as a “deficit reduction tax”, implicitly suggesting some change once the deficit was slain. Little did he know that, as the result of the automatic stabilizers (lower tax revenues accompanied by higher payments for employment insurance, welfare and other income support programs) which kicked in during the recession of the early 1990s, it would take more than a decade before Paul Martin, armed with the very tool labelled by Minister Mazankowski, would succeed in actually accomplishing the task.

By that time, the GST was churning out the predictable fiscal bounty at a rate that no believer in small government thought consistent with conservative ideology. Undoubtedly, this clash of visions was operating when the 2006 CPC platform was developed. Who knows what might have happened differently if the Harper/Flaherty team had foreseen the Global Financial Crisis and the degree to which Conservative fiscal rectitude would be driven offside by efforts to stimulate an economy side-swiped by disastrous financial structuring decisions made by Wall Street’s best and brightest.

So the decision to shrink the cash cow which the Harper Tories took in 2006 can help explain why the Liberals might choose to occupy the politically distasteful position of proposing a restoration of the two points. In our most recent federal election, there was considerable attention devoted to an alleged tactic by the Conservatives to leave the cupboard bare, or in less-elegant terms, to “starve the beast”. Many of the Conservative tax baubles, such as the increase in Tax Free Savings Account contributions and income splitting for families, were seen as being intended, apart from providing the promised tax relief, to deprive a potential Liberal or NDP government of the financial wherewithal to sponsor new blockbuster, government programs.

Enter Bill Morneau, our new Minister of Finance, who caused a stir when he refused to rule out raising the GST in a mid-December, 2015 interview, although he has since stated that a GST hike isn’t being considered. However, beset by unexpected economic and fiscal tides and the need to fund a considerable repertoire of campaign promises, his first budget will be a challenge without a new source of revenue. And the idea of a GST hike is gaining currency in pundit circles.

Determining soon after taking office that the projected surplus was already a modest deficit, the Liberals added to it by implementing their tax cuts for middle class taxpayers (not quite balanced by the hike on the “one-percent” who earn more than $200,000). The deepening downturn in the resource sector (along with our export performance) means that the budget is likely to show a deficit more in the $20 billion to $25 billion range instead of the $10 billion mooted during the recent election campaign, so a new revenue source may prove irresistible, particularly one the chattering classes of experts is likely to applaud.

It may yet be that our new political masters will decide that now would not be the best time to increase consumption taxation, with the economy in the doldrums, voters feeling anxious about their futures and personal debt levels rising. Just as “improving” the Canada Pension Plan might not be a great idea right now because it involves new payroll taxes and new deductions at source, so too a hit to retailers and service providers by a 40-percent increase in the federal share of our national consumption tax might be neither economically defensible nor politically appetizing.

Perhaps the Minister will decline the pleasure of a more robust revenue source and rely instead on Liberal campaign rhetoric to the effect that modest fiscal deficits (defined by Mr. Trudeau as deficits that don’t cause the debt to grow faster than GDP) don’t really matter, even though we might soon be seriously stretching the definition of the word modest.

Stanley Herbert Hartt, OC, QC is a lawyer, lecturer, businessman, and civil servant. He currently serves as counsel at Norton Rose Fulbright Canada. Previously Mr. Hartt was chairman of Macquarie Capital Markets Canada Ltd. Before this he practised law as a partner for 20 years at a leading Canadian business law firm and was chairman of Citigroup Global Markets Canada and its predecessor Salomon Smith Barney Canada. Mr. Hartt also served as chairman, president, and CEO of Campeau Corporation, deputy minister at the Department of Finance and, in the late 1980s, as chief of staff in the Office of the Prime Minister.

 

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