GST Cut is the Least Beneficial

On Saturday, Canadians will begin enjoying their much anticipated GST cut -- a welcome $316 for the average Canadian family this year. Despite its popularity, many economists, the authors included, argued against the GST reduction in favour of reducing other taxes that are more damaging to our economy.

For similar reasons, the Organization for Economic Cooperation and Development (OECD) stated this week that the federal government was “off-track” in reducing the GST. With the politically saleable GST now out of the way, let’s hope the government begins to focus on reducing the more damaging taxes.

The need for even more tax relief is evident. After taking the GST cut into account, the average Canadian family will pay over $36,000 in taxes to federal, provincial and local governments in 2006. In total, Canadian governments are expected extract 41 percent of the economy this year in government revenues, significantly more than the average in the industrialized world including Europe, North America and parts of Asia. Finally, the total surplus of all Canadian governments came in at $26 billion last year. Clearly, Canadian governments are in a position to offer significant tax relief.

Going forward, the test for tax relief should be the degree to which it improves our economy. Some tax cuts do more to increase Canadian incomes, employment, investment, and opportunities in general than others. Indeed, the best types of tax cuts are those that enhance the incentives for Canadians to work, save, invest, and engage in entrepreneurial activities; activities that are the backbone of a prosperous economy.

By this test, the GST cut fails miserably. The lower GST encourages Canadians to increase their consumption at the expense of savings. Lower savings leads to reduced investment needed to finance the purchase of machinery, equipment, and research and development. Such investments are critically important as they make workers more productive and result in higher wages.

Compare the incentive effects of a reduction in the GST to those of a cut in personal income taxes. Canada’s high personal income taxes -- particularly for middle and upper-income earners -- penalize productive behaviour such as working, saving, investing, and starting a business. Reducing personal income taxes improves the incentives for Canadians to engage in these activities.

Business tax relief also improves incentives. Specifically, reductions in corporate income and capital taxes create stronger incentives for firms to invest. With one of the highest tax rates on investment in the world, it’s no wonder that Canadian firms have persistently invested less than firms in other industrialized countries.

The federal Department of Finance itself has estimated the impact of different types of tax cuts on economic well-being and found that reducing sales taxes yields the smallest benefits to society. Reductions in personal income taxes on dividends, capital gains and interest income, on the other hand, yield the largest benefit. Business tax cuts were also found to yield significantly larger benefits that sales taxes relief.

While the GST was a politically attractive target for tax relief, the reduction makes little sense economically. Personal income and business taxes are much more damaging to Canada’s economy. If Canadians want a stronger and more robust economy with higher incomes for workers, lower unemployment, higher job growth, and opportunities for all those who seek them, than it is critical that the country reduce taxes that penalize productive behaviour. Specifically, we should be using consumption taxes like the GST more, not less, while reducing our use of costly and damaging taxes like business taxes and personal income taxes.