Why the HST Drives Business to Canada
July 16, 2010
While politically controversial, when B.C. and Ontario eliminated their provincial sales taxes and harmonized with the federal GST/HST on July 1, 2010, they sent a clear message to the world that Canada is open for business.
It also represented one of the last significant steps in the federal Department of Finance's
plan that has converted Canada from an economic basket case into a powerhouse.
To understand why, it is important to put the switch from PST to HST in historical context.
Fiscally speaking, Canada was a mess from the mid-1970s to the early 1990s. The government was running annual deficits that, by the mid-1980s, were totalling more than eight per cent of the country's annual GDP; in 1985, Canada recorded a record annual deficit of $37 billion (the equivalent of $69 billion today).
As a consequence, the cost of servicing that debt - paying the interest charges - only augmented the problem. By the mid-1990s, the federal government's debt-to-GDP ratio reached its all-time high of 68.4 per cent.
With The Economist printing headlines such as "Bankrupt Canada!," finance officials knew deliberate steps were needed to rein in the country's deficit and debt.
They took a multipronged approach, which included everything from reining in government spending, modernizing Canada's infrastructure, opening up foreign markets to Canadian exports through free trade agreements such as NAFTA, "nationalizing" the Canadian federal debt by replacing government debt held by foreigners with debt held by Canadians and focusing on innovation and skills training.
One additional key component was tax reform.
With Canada being a small, open, export-based economy of only 30 million people, what the Canadian government understood was that in order to be relevant in the global economy, Canada had to create a tax system that did not discourage, but rather encouraged, business and innovation.
It was the maturation of the Canadian tax system.
What Canada and Canadians realized is that the historic debate as to whether it was better to tax individuals or tax corporations was really no debate at all. Corporations are merely conduits through which individuals - employees and shareholders alike - come together to carry on business. Furthermore, we realized that countries are not made up of corporations, only individuals. (After all, the largest shareholders in the country are our public pension plans like the Canada Pension Plan Investment Board and the Ontario Teachers' Pension Plan.) We realized that imposing an excessive tax burden on corporations merely drove business and investment from Canada - and the jobs, wages, salaries, dividends and income that went along with them.
From a tax policy perspective, the plan was simple:
- reduce, and where possible, eliminate taxes on capital and business inputs (including provincial sales taxes);
- tax consumer consumption, not business consumption; and
- reduce corporate income taxes.
The changes were gradual, but deliberate. And the changes took place regardless of the fact that political parties on both the left and the right have governed the country over the past two decades. Fundamentally, political rhetoric and dogma gave way to pragmatism and statesmanship, with long-term public policy taking precedent (generally) over short-term political gain.
So what have we achieved over the past two decades?
- In 1991, the Canadian federal government replaced its 13.5 per cent manufacturers' sales tax with the federal value-added tax - the GST - at a rate of 7 per cent. Concurrently, the province of Quebec began replacing its PST with a value-added tax similar to the GST.
- In 1997, Nova Scotia, New Brunswick, and Newfoundland went one step further, eliminating their PST regimes and replacing them with a fully harmonized value-added sales tax (HST) administered by the federal government.
- By 1998, after three decades of deficits, Canada posted its first annual budget surplus. We then continued posting annual surpluses for the next decade and only dropped back into deficit in 2009, following the global economic meltdown in October 2008.
- In 2003, the federal government began reducing corporate capital tax, and completely eliminated it by 2007. Canada's provinces have also been following suit, such that by 2011, provincial capital taxes on non-financial institutions will have been eliminated in virtually all Canadian provinces.
Possibly the most dramatic change has been the drop in Canadian corporate income tax rates. In 1999, Canada's average combined federal/provincial corporate income tax rate was 44.6 per cent, compared with a combined federal/states corporate income tax rate of 38 per cent in the U.S. Over the next decade, Canada's corporate income taxes steadily declined. Currently, the combined federal/provincial corporate tax rate ranges between 28 and 32 per cent (depending upon the province), and by 2012, it will be between 25 and 29 per cent. It will give Canada the lowest corporate tax rate among the G7, and between 11 and 15 per cent below the U.S.
The impact of this fiscal discipline on the part of the Canadian federal and provincial governments is clear. Recall that in the mid-1990s, Canada's debt-to-GDP ratio had reached an all-time high of 68.4 per cent. By 2007, that figure had been reduced to 32.3 per cent - its lowest level in 25 years. And remember, we achieved this success while at the same time reducing corporate income tax rates, eliminating capital taxes, and eliminating taxes on business inputs by replacing PST with a national HST.
With the introduction of HST in B.C. and Ontario, this progress and maturation of the Canadian tax system continues. Not only does sales tax harmonization eliminate the tax administration and compliance burden on businesses operating in these provinces, but it gives these provinces and Canada a significant competitive advantage over the U.S.
The U.S. (along with Saskatchewan, Manitoba, and P.E.I.) are the last jurisdictions among OECD member states that still impose antiquated sales and use taxes (i.e. PST).
The world is watching. Canada is unique in that our HST permits multiple tax rates in different regions of the country, is a single tax collected for both the national and provincial governments, and has a single tax administration (the Canada Revenue Agency). As a consequence, countries like the U.S., India, the United Arab Emirates, and even the European Union, are looking to Canada's HST as a model.
So while it may seem strange to say it - Canada's GST/HST should not be a source of protest, but rather a source of pride for Canadians.
is a sales and indirect tax specialist and partner with Fasken Martineau