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Finance Department at odds with government over GST cut


Monday, April 24, 2006

Finance Minister Jim Flaherty, whose upcoming budget will lower the GST, has been told by his department that Canada is already out of step with many peers because it relies relatively little on consumption taxes, and heavily on income taxes, to raise money.

“Canada raises more of its revenue as a share of [gross domestic product] from personal and corporate income taxes than any other G7 country,” Finance Department officials say in briefing books prepared for Mr. Flaherty and obtained under access to information law. “Correspondingly, Canada raises relatively less tax revenue from consumption taxes, the tax that least damages productivity and standard of living.”

Officials tell Mr. Flaherty that while Canada's “personal and corporate income tax burdens are the highest among the G7 countries,” the broader trend favours consumption taxes. “In recent years, the tax burden has been moving toward consumption taxes (away from income taxes) in a number of OECD countries,” officials say, referring to the Organization for Economic Co-operation and Development. In fact, Finance officials say, Canada's 7 per cent GST is relatively small compared with many other countries with value-added taxes — which are similar to sales taxes in that both are levied when goods and services are sold.

“Of all OECD countries with a [value-added tax], Canada has the second-lowest rate,” officials say.

The heavily censored briefing books released to The Globe and Mail found no evidence that officials are outright fighting the Tory election pledge to cut the GST.

But the 700-staff department, which enacted the GST 15 years ago, is full of economists — and most economists applaud the 1991 levy as an efficient replacement of a badly functioning tax on manufactured goods that had been crimping business competitiveness.

Most economists strongly favour consumption taxes over income taxes or levies on business.

They consider consumption taxes, such as the GST, the least evil among taxes because they are the least damaging to economic growth. The consensus is that other taxes, on personal or business income or corporate assets, are far more harmful in terms of dulling the incentive to work, save and invest.

While other countries are turning more to consumption taxes, and many rely less on corporate and income taxes — Canada is poised to take a different tack.

The new Conservative government campaigned on a pledge to cut the GST by two percentage points over five years — and repeal personal income tax breaks enacted by the former Liberal government in order to pay for the first one-percentage-point GST reduction.

The Finance briefing book draws on examples and statistics to make the case that there is an international trend favouring consumption taxes and backing off income taxes.

Finance officials bolster their case by pointing out that the German government plans to increase its standard VAT rate to 19 per cent in 2007 from 16 per cent and that Japan has been advised by the OECD and an internal tax advisory committee to increase its VAT rate.

Officials also note “recent tax reductions in the United States have focused on [cutting] income taxes and taxes on savings.”

The Department drives home its point with two charts, drawn from publicly available statistics.

One is labelled “Canada Relies More on Personal and Corporate Income Taxes Than Do Other Countries.”

A second chart labelled “Value Added Tax Rates in OECD Countries,” outlines how little Canada relies on consumption taxes compared with other market economies, showing that only Japan has a lower rate.

Ottawa is forecast to collect more than $132-billion in personal and corporate income taxes this fiscal year, while it's only expected to take in about $32.7-billion from the GST.

Consumption tax revenue from the GST is expected to drop even when Mr. Flaherty lowers the rate to 6 per cent from 7 per cent in the budget, expected the week of May 2.

Personal income taxes collected could rise, as well, if the Tories proceed with campaign promise to repeal the Liberal income tax breaks in order to fund the GST cut.

The briefing book is not the first time that Finance officials have expressed their views on consumption taxes versus income taxes.

Analysis by Finance officials — in 2004 documents available on the department's website — shows that cutting personal income taxes is far better for the economy than cutting consumption taxes.

Finance Department analysis in 2004 showed three times the gain in “economic well being” for a personal income tax cut compared with an equivalent-costing reduction in consumption taxes.

Economists say the fact that the United States has not more aggressively embraced consumption taxes is a big factor in explaining why Canada has not gone further in relying on consumption levies in place of personal and corporate income tax.

As for federal Finance officials, Toronto-Dominion Bank chief economist Don Drummond says that he believes they would prefer to cut personal or corporate income taxes rather than trim the GST.

“In fact their preference would be to raise the GST and use the revenue from the higher GST to cut further the personal and corporate” taxes, said Mr. Drummond, a former senior Finance official.

© The Globe and Mail
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