Thursday, July 6, 2006

Reforming Canada's tax system: The GST

In my last couple of posts in this series, I talked about the need to shake up personal and corporate income taxes by cutting both the rates as well as a substantial number of the deductions out there. The next issue is the Goods and Services Tax. What I'm about to write won't be popular, but I think it's essential to understand why I think the one percent GST cut was irresponsible, and why it should go back up to seven percent for the foreseeable future. It's not because of the kids that I think it should be increased. It's because of seniors.

A refresher: One of the reasons why the GST was created was to finance the interest payment on Canada's crippling debt; by shifting the burden of consumption from the manufacturer to the end user. The old Manufacturer's Sales Tax was set at 13.5% and was buried into the price of items purchased. It was also not recoverable by wholesalers or by retailers as goods passed from one party to another. To say the least, it was unpopular. Its replacement, the GST, was even more so.

But it worked. By making it a multistage tax, middle people could now subtract the tax they paid from the tax they collected and remit the difference. Thus, it was the final consumer -- who has no business number and therefore can't claim a direct rebate -- who shouldered the pain.

It does have its drawbacks, such as the fact lower income Canadians have to pay a greater percentage of their income on GST than higher ones -- which is partially abated by the GST rebate; really one of a number of earned income tax credits. But consider that at one point, thirty three cents out of every tax dollar went to pay the interest on the debt. Now, because the GST is such a cash cow, the interest requirement is down to about 17 cents on the dollar and still falling. It declined so fast during the late 1990s and early aughts that in 2003 the Chrétien Administration decided to end the "debt retirement account" and simply roll the GST into general revenues.

Just as well, because they were collecting $32 billion per year. It costs about $30 billion to run Old Age Security -- the portion of senior's pensions paid out of general revenues and not payroll taxes (as the CPP and RRQ are). The excess went directly to interest payments -- and there was plenty left over from other sources, too.

Based on that, the Harperites say that "it's our money, we have the right to get it back." True to a point. But it's also our debt, and we still have to pay both the interest and the principal. By cutting the rate by 1 percent, they're losing about $5 billion per year, and at the same time jeopardizing the OAS whose costs are going to explode as the Baby Boom starts collecting on their entitlements, from 2011 onward. Since seniors are a powerful lobby, it was probably easy for the Cons to shaft kids the way they did this year to make up the difference. After all, the later constituency doesn't even vote.

But it's wrong to risk the economic security of both seniors and kids in the name of tax relief. In my opinion, the GST should not have even been touched until the debt-to-GDP ratio went down to 25%. Currently, it's at 38.7% (using 2005 numbers, the final tally for 2006 will knock that down some more); and that's also helped in part by big surpluses in the trust funds of the employment insurance and employee-funded pension plans, which as I will discuss later should also not be touched. (According to the CIA, the US ratio is at 64.7% -- but that's probably overstating; it's more like 45% when the current surplus in Social Security is factored in, but that's going to begin to erode too and rapidly with their Baby Boom crisis looming. Since Americans in both parties see contrary to GWB on this one and want to protect the fund, cuts will have to come elsewhere and they're going to hurt.)

So bottom line: I'd bring the GST back up to 7% until the debt got down to 25%. Then, and only then, I'd begin a phase down to 6%; reduced further to 5% when the ratio was 20%, 4% at 15 and 3% at 10. When the debt is finally paid off, the GST would be eliminated. We're looking long term here -- maybe 20 or 25 years. But I can see the day when the odious tax is eliminated because it's no longer fiscally necessary and not out of political expediency.

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