The case for higher GST

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Appeared in the Financial Post

When Ed Clark, TD Bank CEO, recently said that nearly all members of the Canadian Council of Chief Executives (a group composed of 150 of Canada's top CEOs) want the federal government to hike the GST to combat the deficit, he earned a quick rebuke from the Conservatives, who rejected his suggestion and referred to him in an email as the millionaire economic Czar to the Liberals. This in turn provoked responses from Liberal heavyweights including both Michael Ignatieff and former PM Jean Chretien.

But while Mr. Clark's call for a GST hike to balance the budget shows a surprising lack of understanding about the source of the federal deficit, the idea should not be dismissed out of hand.

For the next several years Canada will be hamstrung by deficits that will hinder any improvement in Canada's competitiveness, especially on the tax front. However, increasing the GST would create the revenue needed to reduce other, more damaging taxes (i. e. those on income and capital gains) that would dramatically improve Canada's competitiveness.

Before we get into all that, let's clear up any confusion regarding the source of the federal deficit. Primarily as a result of the economic downturn, federal revenues are expected to decrease by $16.5 billion this year (2009/10). Next year however, revenues are expected to rebound and then continue to grow at a rather robust average rate of 6.4% until 2014/15. While it's clear that the economic recession is having a negative impact on federal revenues, the impact is expected to be very short-lived.

Government spending is another story altogether. In 2009/10, federal spending increased by $33.7-billion, primarily as a result of the federal government's temporary stimulus plan. As the federal government's own projections show, the ramp-up in spending will be anything but temporary. Rather than decreasing in 2011/12 as the stimulus plan comes to an end, spending actually remains constant. More shocking however, is that from 2011/12 to 2014/15, spending increases at an average rate of 2.9%. There is simply nothing temporary about the current stimulus spending.

The federal government's unwillingness to reduce what they originally labelled as temporary spending is the reason we can expect federal deficits amounting to $109 billion over the next five years (2010/11-2014/15).

So, Mr. Clark, the federal government has a spending, not a revenue problem.

As we've argued previously on these pages, the federal government could realistically balance the budget by 2011/12 with modest spending cuts. And doing so would not require any tax increases for Canadians.

That said, it will take at least two years to balance the federal budget and several more before the government has enough fiscal room to significantly reduce taxes that improve Canada's ability to attract investment and create jobs.

Herein lies the rationale for increasing the GST.

Increasing this consumption tax will provide the revenue to reduce other more damaging taxes. While all taxes are economically damaging, economic research is clear that consumption taxes like the GST are among the least damaging. The key to improving Canada's competitiveness is either to reduce damaging types of taxes or to change the tax mix to rely less on damaging taxes.

Of particular concern in Canada are our high marginal personal income tax rates on middle and upper income Canadians that apply at relatively low levels of income. For instance, Canada maintains among the highest marginal personal income tax rates on middle and upper income earners among the G7 countries. Income taxes have proven to be much more economically damaging than the GST because they act as a penalty on productive activities such as work effort, savings, investment, risk-taking and entrepreneurship.

Interestingly, the destructive impact of Canada's graduated personal income tax rates has been identified by consecutive federal governments, both Liberal and Conservative. In 2005, then-prime minister Paul Martin's economic plan, A Plan for Growth and Prosperity, stated, Lower personal taxes would also provide greater rewards and incentives for middle-and high-income Canadians to work, save and invest. In fact, current Liberal finance critic John McCallum mused about increasing the GST back to 7% to pay for income tax cuts back in 2007.

Prime Minister Stephen Harper's economic plan, Advantage Canada, also stresses that, Canada's tax burden on highly skilled workers is too high relative to other countries ... Canada needs lower personal income tax rates to encourage more Canadians to realize their full potential.

By increasing the GST from 5% to 7%, the federal government would have approximately $12-billion in revenue to reduce income taxes. With that $12 billion, the federal government could eliminate the two top personal income tax rates (26% and 29%) and increase the threshold of the 22% income tax rate to $45,000 from $41,472. In addition, the government could completely eliminate the capital gains tax (and make good on one of its original election promises).

While Mr. Clark's talk of increasing the GST is definitely the wrong way to balance the books, it would provide a great opportunity replace more harmful income-based taxes with consumption taxes and improve Canada's long term competitiveness.

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