Mitigating a blow to BC’s competitiveness

With the defeat of the harmonized sales tax, BC’s competitiveness will suffer a crushing blow, as the province experiences a rebirth of the provincial sales tax.

September 7, 2011   by NIELS VELDHUIS and CHARLES LAMMAM

The defeat of the harmonized sales tax (HST) will deal BC’s competitiveness a crushing blow as the province experiences a rebirth of the provincial sales tax (PST), which will lead to a reduction in investment and job creation.

It now falls on Premier Christy Clark and her colleagues to show leadership and put forth a tax plan to mitigate the unrealized economic gains that the HST would have encouraged.

The HST’s greatest benefit is that it exempts all inputs used to create products and services. A return to the PST will mean items purchased by businesses to produce those goods and services will be subject to sales tax. This will increase the cost for businesses of investing in machinery, equipment and new technologies, which makes it more expensive for BC businesses to expand, upgrade and innovate.

In a world where provinces (and countries) compete for investment dollars, restoring the PST will negatively impact BC’s investment climate, making it a less attractive place for investors to set up or expand. This is especially true since other provinces such as Ontario are maintaining their harmonized sales tax and reducing other taxes on investment.

In addition, the rebirth of the PST will harm the competitiveness of export-oriented firms in BC. Since businesses will have to pay sales tax on their production inputs, firms that export their goods and services will face higher costs than their competitors operating in other jurisdictions that do not apply sales taxes on inputs (Alberta and Ontario).

Without additional tax changes, BC will be left behind and risks losing much-needed investment that will instead gravitate to jurisdictions with more competitive tax policies.
Consider the impact of restoring the PST on the overall tax rate imposed on new business investment (including corporate income taxes, capital taxes, depreciation, and sales taxes imposed on business inputs). Moving from the HST to PST will increase the overall tax rate from 20% to more than 27% and result in BC having one of the highest overall tax rates on investment among the provinces (only PEI will have a higher rate).

But all is not lost. The BC government can pursue other options to mitigate the damaging impact of restoring the PST.

One option is to completely eliminate BC’s corporate income tax. Currently, the general corporate income tax rate is 10%, the same as the rate in Alberta and New Brunswick (Ontario’s rate will fall to 10% by 2013). Abolishing the corporate income tax would increase the after-tax return to investment and, as a result, dramatically improve incentives for businesses to develop and expand.

In addition, abolishing the corporate income tax would provide BC with a unique tax advantage within Canada and join a handful of US states without a corporate income tax (Nevada, Texas, and Wyoming).

While some may be skeptical about affordability, consider that the provincial government was willing to reduce the HST to 10% from 12%. Returning to a 7% PST will bring in significantly more revenue than the province would have earned with a 10% HST – to the tune of about $1.4 billion. That is nearly the same amount a 10% corporate income tax would have brought in. In other words, eliminating the corporate income tax is perfectly obtainable in the current fiscal framework.

Another option is to reintroduce the PST but mitigate the impact on business inputs by introducing a complete sales tax exemption on machinery, equipment and technology for all businesses. This was attempted back in 2001, but the province limited the exemption by narrowly interpreting the types of machinery and equipment and manufacturing companies that qualified. Indeed, the exemption was not available to most businesses. This option is not ideal since not all business inputs would be exempt, yet it would significantly improve the incentives for businesses to invest in things that make BC workers more productive.

Finally and most significantly, BC could move to an integrated approach to business and personal income taxation by instituting a flat tax. Under a flat tax, all sources of income, capital gains, business income, wages and salaries, and interest income are taxed at one rate. In addition, all savings and investment are exempt from the tax that provides businesses with incentives to increase investment and encourages individuals to work, save, and take entrepreneurial risks.

Internationally renowned tax expert and University of Stanford Professor Alvin Rabushka calculated that BC could introduce a flat tax at less than 8% and collect the same amount of revenue as it currently does.

While the HST’s defeat strikes a blow to BC’s competitiveness, Premier Clark has options to mitigate the damage. Hopefully, she will create a new tax plan that ensures a brighter economic future for the province.

Niels Veldhuis (@nielsveldhuis on Twitter) and Charles Lammam (@charleslammam) are economists with the Fraser Institute.

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