their income in low-tax countries as possible. The 1986 US Tax Reform Act put US corporate taxes on the same reform track as personal income taxes. Canada was compelled to follow suit, and for exactly the reasons that Laurier believed were decisive: we live in a competitive world, especially vis-à-vis the US, and we could never allow our tax rates to rise above theirs without paying a painful price. In fact, given the other disadvantages Canada faced, having lower rates than the US was almost compulsory.
In putting his tax reform package forward, Michael Wilson sounded a Laurier-like note:
Statutory corporate tax rates in Canada are above those in the United States and other countries, and without early implementation of significant reductions in Canada the gap would widen. If the gap between Canada and U.S. rates were not narrowed, considerable income-earning activities would shift to the United States. The gap would also encourage firms with operations in both countries to arrange their operations so as to allocate more of their taxable income outside Canada. The result of such shifts would be less economic activity in Canada and a significant erosion of our corporate tax revenues. The proposed reduction in Canadian statutory tax rates is designed to avoid these results.57
Of course, these reforms were only a down payment on what would come later, because while they reduced the gap between the tax burden borne by American and Canadian workers and companies, they did not eliminate it, and still less did they restore Laurier’s ideal: a gap in favour of Canadian workers and companies. Still, just as Laurier had to be content in the early days with tariff reform rather than the free trade in which he so fervently believed, the movement was in the right direction, even if the way station fell far short of the cherished final destination.
Perhaps even more important than this early down payment on income tax reform was the wholesale reform of federal sales tax that Michael Wilson engineered.
The chief sales tax at the federal level was the manufacturers’ sales tax (MST). A more foolish and damaging tax it would be hard to conceive. The MST was a tax that applied only to manufacturing, and even within that narrow field, taxed some activities but not others. Companies could organize themselves and their activities in such a way as to blunt or even escape much of the tax—practically a textbook definition of a poorly designed tax. Because the tax could be largely avoided with a little effort and imagination, Ottawa found its revenues from this source to be declining over the years.58
Yet leaving aside the misleadingly named MST, sales taxes per se have increasingly won approval from economists and policy thinkers because, if you are going to levy taxes, a well-designed tax on consumption is one of the least damaging. Unlike income taxes, which discourage work and effort and success, consumption taxes do not distort incentives to do these highly desirable things. And where saving is taxed—by the income tax and capital gains tax, which capture a part of the returns to savers—but consumption is not (i.e. when there is no sales tax), the absence of the sales tax also creates incentives for people to spend rather than save. Finally, a broadly based tax with few or no exemptions, and set at a low rate, means that the revenue is more reliable than under an MST-type tax, cause companies cannot escape the tax by artificial reorganization of their activities.
The highly courageous decision was therefore made by the Mulroney Tories to eliminate the MST and to replace it with the goods and services tax (GST). Unlike the MST, the GST was to be a “flow-through tax”: when businesses bought raw materials or machinery or advertising or telecommunications services, the tax they paid on those “inputs” was credited against the GST they collected from the consumers of their goods or services. The hidden 13.5 per cent MST, applied to a narrow range of goods, was abolished and replaced with a much more transparent and easy-toad-minister tax, applied to a wide range of goods and services but at the much lower rate of 7 per cent. The balance between saving and consuming was at least partially restored.
All of these good things were purchased, however, at a significant political cost. Because the new GST was so transparent and obvious, people had something quite concrete on which to focus their dislike of taxation, whereas the MST had been hidden and therefore called forth little popular agitation for its abolition. And it did not help that the introduction of the GST coincided with both a significant recession and a rise in the value of the Canadian dollar. A well-designed visible tax, even if it was replacing a badly designed invisible one, could only become a lightning rod for general economic discontent, and cross-border shopping with valuable Canadian dollars became an effective kind of tax protest.
The GST became a major money spinner for the federal government, although it was quickly forgotten that it replaced the revenue from the MST. The reception the tax received might well have been more positive had the government been able to follow through on their original plan to make it the centrepiece of a larger tax reform package that reduced income taxes and shifted the tax burden onto consumption, a highly desirable rebalancing of the tax load.59 Unfortunately, the economic circumstances of the time, including the government’s own inability to keep its spending under control, forced Ottawa to put off the planned reductions in personal income taxes until much later.
The GST was so politically unpopular that there is little doubt that, like Laurier’s reciprocity proposal, it helped sink the party that brought it in. But the victorious Liberals of Jean Chrétien, once in office, quickly dumped their platform commitment to axe the tax, choosing instead to set in motion the other half of the sales tax reform that was necessary.
Paul Martin, Chrétien’s finance minister, was given the job of finding some credible way of claiming that the Liberals had an “alternative” to the GST. The alternative he came up with was one that had been part of the original plan that the department of finance had put together for the GST but had fallen by the wayside in the face of the new tax’s disastrous public reception: “harmonization,” or the rolling of provincial sales taxes (PST) and the GST into a single tax, the harmonized sales tax (HST).60 In fact this was not an alternative to the GST at all; rather, it was an attempt to bring up to date the extremely archaic and damaging provincial sales taxes, putting them on a modernized footing like the GST’s.
Provincial sales taxes, like the old MST, were a tax that fell hard and damagingly on business. Every time a business bought something it needed for its production process, whether machinery or fuel or even restaurant meals for its workers, it paid a tax that had to be passed on to consumers in the final price, unless it got a specific exemption or credit. That put them at a disadvantage with competitors like Europeans, whose value-added tax (VAT) was a flow-through tax like the GST, or Americans, who generally faced much lower sales tax rates. PSTs were also levied on a unique mix of goods in each province and on a different mix than the federal GST. Each province had to pay for its own collection and verification machinery, although most of the cost of administering the tax fell on business, and businesses had to keep track of two different tax bases, tax rates, and audit and inspection requirements. It was all an expensive and counterproductive nightmare.
Martin was able to convince three provinces—Nova Scotia, New Brunswick, and Newfoundland—to agree to abolish their PST and simply tack the provincial consumption tax onto the federal GST, resulting in those three provinces in a combined HST rate of 15 per cent, composed of a 7 per cent federal tax and an 8 per cent provincial tax. Businesses in those provinces now had a flow-through tax that improved their competitiveness; Ottawa paid for all the administration and enforcement cost, removing that cost from provincial budgets; and Ottawa also gave the three provinces about $1 billion to help with the difficult politics of transition from the old regime to the new.61
Reflexively autonomist Quebec naturally decided not to harmonize with the federal tax but to do its own reform on similar lines, and to demand a higher payment from Ottawa to compensate the province for its administrative and transition costs. Four provinces were now essentially harmonized—five if you count Alberta, which is harmonized by the simple expedient of having no PST to harmonize.
Subsequent
