GST and Transfer Reform

Commentary, Equalization, Frontier Centre

Good politics, bad economics. That was the verdict among Canada’s most economically literate think tanks on the Conservative platform plank of trimming the Goods and Services Tax by two points. For various reasons, the Fraser Institute and C.D. Howe appeared more favourably disposed towards the Liberal’s income tax cuts.

Here is another reason to leave the GST as is. It offers itself as a poker chip in the broader game of Canadian policy reform. Trimming the GST complicates the opportunity for a simple swap of the GST to the provinces, in exchange for an end to dysfunctional federal transfers. It’s a politically easy way to cut the Gordian Knot of the so-called “fiscal imbalance,” a consequence of the revenue-rich federal government’s decades-long encroachment into provincial jurisdictions.

The mathematics of such a swap are convenient. In 2002-03, the federal government took in $28.2 billion in GST revenue. Then, it sent a roughly equal amount, $29.6 billion, back to provinces through the two main federal transfer programs, the Canada Health and Social Transfer and Equalization payments. Lowering the GST rate would reduce the value of the federal government’s contribution to the trade.

A reflection of the simplistic predilection for throwing money at policy challenges— i.e. the Romanow Report—in the last three years, federal transfers have exploded. They’ve rocketed up by 44%, with the CHST up 54% and equalization 23%. This year’s projected GST revenues (including the Tory’s initial one-point cut) doesn’t kept up and can only cover 84% of 2005-06 transfers. Figure in an additional one-point cut, from six percent to five, and the ratio of GST revenues to transfers falls to 75% in 2006-07. A transparent tax swap would therefore require additional levers to make up the shortfall, perhaps an equivalent devolution of corporate tax points and a transfer of debt from have not provinces to the federal government.

Sorting out fiscal imbalances with tax-swapping may upset an establishment inured to the swampy, unaccountable and non-transparent netherworld of transfer programs. But it makes sense for many reasons.

A return to a real federation – If the federal government got back to its knitting, that would substantially deflate the raison d’être of Québec separatists and their nascent counterparts in Alberta. Rather than dilly-dally around in areas where it has little competence or business—social policy areas like healthcare and daycare—Ottawa could focus on the courts, the military, and enforcing free trade between provinces, areas where its lagged behind the curve.

End bureaucratic churn – Sending taxes to the federal government, merely to have it shifted back to the provinces under arcane, constantly changing rules, creates real dead-weight losses in unnecessary bureaucratic overheads. Connecting revenue sources directly to services removes this lack of accountability and scope for finger-pointing when federal and provincial politicians squabble over revenue-sharing formulas.

Curb spending coalitions – Major areas of public policy are dominated by government monopolies, which have a clear stake in maintaining and enhancing the status quo by equating policy reform with constantly growing budgets. Witness the massive increases in federal healthcare transfers, which have essentially raised salaries in healthcare but produce otherwise mediocre results. It is similarly convenient for the non-profit daycare establishment to tap into one big top-down federal program, even though the policy doesn’t fit the needs of most working families A tax-and-transfer swap would diminish provider domination of services as provinces, designing their own programs, focused more on consumer-centred policy innovation.

Sales tax reform – Fundamental sales tax reform could be a pre-condition to the GST tax swap. Harmonizing the GST with provincial sales taxes would eliminate an accounting nightmare, two parallel sales tax systems in much of the country, while giving businesses bigger input tax credits, lowering operating costs and increasing investment. At the same time, reform must broaden the base as much as practically possible to simplify the single sales tax—and lower the rate further—by applying them across the board, with minimal exceptions. To offset the burden of taxing food on low-income earners, raise the low-income GST tax credit.

Equalization reform – There is widespread agreement that the equalization program is in complete shambles, fragmented hopelessly by recent special deals for different provinces. On a more fundamental level, research reveals a well-intended program that produces dismal results. Equalization rewards “have not” provinces for having high taxes and making government spending their main economic driver. As more equalization flows in, the more the recipient provinces lag in growth, investment and job creation. It is no coincidence that Manitoba ranked last in the recent Conference-Board comparison of provincial healthcare models, though it has one of the most lushly funded systems in Canada.

Easy equalization money perpetuates creaky old policy models that simply don’t deliver results. Even more bizarrely, $1.6 billion in equalization allows Manitoba to underprice its electricity drastically, by $1.1 billion less than what it is worth, a policy that wastes a valuable resource while stimulating profligate energy consumption.

It’s time we move forward to policies that reward innovation and growth while once and for all slaying the fiscal imbalance policy zombie. With a simple tax swap as a big part of the answer.

This article originally appeared in the Calgary Herald, February 22, 2006.