Sales tax harmonization is gaining ground. Given the enormous economic benefits available to Ontarians through harmonization, the McGuinty government would be wise to move quickly.

The main problem with Ontario’s provincial sales tax (PST) is that it applies to business inputs such as machinery and equipment. Estimates for Ontario’s sales tax indicate that more than 40 per cent of the PST revenues come from taxing business inputs. Taxing business inputs has a negative effect on Ontario’s investment climate by raising the cost of investing in productivity enhancing machinery, equipment, and technology.

The federal department of finance estimated that harmonizing Ontario’s PST would have the equivalent effect as completely eliminating the provincial corporate income tax. Ontario can dramatically reduce the tax rate on investment by simply fixing its PST. Such changes would help all businesses and in particular those that rely heavily on machinery and equipment, such as manufacturers and processors.

Another problem with an independent PST is that the goods and services upon which it is applied—the tax base—is different from that used by the federal government for the GST. With differing tax bases, businesses are forced to operate with two sets of sales records, which impose additional compliance and reporting costs.

Canada has a natural experiment from which we can observe the benefits emanating from sales tax harmonization. In 1997 three Atlantic provinces (NF, NB, and NS) harmonized their PSTs with the federal GST. Professor Michael Smart of the University of Toronto examined the effects of harmonization in Atlantic Canada and made two conclusions.

First, he found that total per person investment increased by more than 11 per cent in the harmonizing provinces. In addition, total investment in machinery and equipment increased by over 12 per cent annually above the trend that existed prior to the reforms. Second, he found that consumer prices in the harmonizing provinces fell after the 1997 reforms, which somewhat offset the effects of the sales tax.

The major obstacle to harmonization is political rather than economic. The resistance is based on two misunderstandings.

First, many believe that harmonizing a sales tax with the GST results in a shift of the tax burden from business to individuals. Such views ignore that the burden of all taxes falls on people (consumers, workers, or owners) in the form of higher prices, lower wages or reduced rates of return. However, consumer prices actually fell in the provinces that harmonized their sales taxes indicating that the shift in taxes was partially (at least) offset by the reduction in prices.

Secondly, some assume that the sales tax rate would have to be increased to offset the removal of business inputs. This ignores the fact that a whole host of goods and services are added to the tax base. Calculations for Ontario indicate that harmonization with the GST would lead to a negligible loss of $150 million.

Improving the investment climate and reducing costs for business with little or no effect on consumer prices is sound economic policy that Premier Dalton McGuinty should enact immediately.