Why Harmonize?

The Harmonization of sales tax seems inevitable. And maybe that's a good thing.
by Glenn Feltham

Should Manitoba harmonize its Retail Sales Tax (RST) with the Goods and Services Tax (GST)? From a political perspective, the optics are ugly—harmonization shifts the tax burden from businesses to consumers. That is, individuals appear to lose by having to pay tax on goods and services not previously taxed under the RST (because the GST is on a broader base), while companies appear to win.

So why have Ontario and B.C. announced that they will harmonize, and why is harmonization inevitable in Manitoba? Simply put, it is inevitable because without the HST, our future prosperity is at stake.

The bottom line is competitiveness. Many things matter in our ability to compete in a global economy, including having an educated work force, the nature and extent of regulation, and broader quality of life issues. Yes, it matters that Manitoba has a vibrant arts and cultural scene. But our future prosperity rests on our ability to attract, grow, and retain business. Manitoba is not an island, and as our world becomes increasingly global, tax competitiveness
is taking on increased importance.

There are several different ways to measure tax competitiveness. I believe that the most appropriate measure is the marginal effective tax rate on new business investment—a rate that combines federal corporate income taxes, provincial corporate income taxes, capital taxes, and provincial sales taxes. This is perhaps the best determinant of whether a company will choose to set up business in Manitoba, or whether an existing local business will choose to expand here. Using this criterion, it appears that Manitoba is in trouble. According to a 2007 Economic Statement from Finance Canada, our combined rate is the highest in Canada.

Much of the problem lies with the RST. This tax restricts new business investment and reinvestment and is strangling the historic economic drivers of the province: manufacturing and transportation. In fact, the RST plays a larger role in hampering business investment (it adds 11.3 per cent to the tax rate on new investment) than do federal corporate income taxes (which add 9.3 per cent). In other words, if Manitoba harmonized, it would have a larger impact on new business investment than if the federal government stopped taxing corporate income altogether.

Harmonization will make Manitoba competitive. When one factors in the elimination of the capital tax, Manitoba would have one of the lowest rates in Canada and be internationally competitive. Failure to harmonize, however, will leave our companies at a significant disadvantage.

Let’s take a big step back to understand why this is.

The RST is a seven per cent tax applied to the retail sale or rental of most goods and certain services in Manitoba. There are goods exempted from the RST (books, children’s clothing), tax exempt situations (goods purchased for resale or goods delivered by the seller outside the province) and materials being manufactured into a product for sale. Notable services not subject to the RST include: services to real property (construction labour or janitorial services), personal services and consulting of a general nature.

The RST affects business in two ways. First, they do not receive credits for inputs. That is, they do not get the tax back, and the same input can be taxed several times as it works through the value chain. Let me provide an example.

An individual is deciding whether to build a factory in Winnipeg or in a city in Ontario, say Sudbury. To build the factory he will need to purchase an input from another company costing $1,000,000, which is subject to RST. The additional cost on this input is seven per cent, or $70,000. But that company may have also paid RST on components in developing this input. And each of these components may also have had RST applied at an earlier stage. This effect is usually referred to as “cascading.” These earlier hidden taxes explain why the effect of the RST on the marginal effective tax rate on new business investment is greater than seven per cent—recall that the rate is 11.3 per cent. Currently the provincial sales tax effects will be similar between Manitoba and Ontario. But what is the comparative rate in Ontario under a harmonized tax, or any other province that has harmonized? Zero! This is the problem: without harmonization we do not have a level playing field.

It is important that our tax regimes are competitive overall, but critical that we are competitive in the sectors that have driven past wealth creation, and will drive future wealth creation, in Manitoba. Construction, manufacturing and transportation are most greatly disadvantaged under the RST and will benefit most from harmonization.

Further, harmonization is important for Canada. A common value-added tax system and base significantly increases Canada’s tax competitiveness and greatly simplifies the message that Canada is a place to invest. It allows Canadian firms to compete internationally. This is particularly important when the Canadian and U.S. dollars are near par, and when our manufacturing sector is “under siege.” We can compete with other manufacturing nations, but not with structural tax disadvantages.

Harmonization also further reduces the economic barriers between provinces. Canada is a small economy and it can only succeed in an increasingly global world where goods and services flow between provinces. Provincial sales taxes are an impediment to this.

Finally, harmonization guards the borders and integrity of the tax system—it is a defensible and rational system and base. It creates fewer economic distortions and is less costly to administer—both for the government and for business. It will lead to greater compliance, lower administrative cost for the province and for business and greater transparency.

Yes, there will be a shift in tax burden—both perceived and real—from business inputs to consumers. This may be partially addressed by tax credits. It is important to remember, however, that individuals ultimately benefit from a stronger and growing economy. We want there to be a place in Manitoba for our children. And yes, the GST tax base has some difficulties. For example, there is not a level playing field across the financial sector. These concerns need to be addressed. But, as I said in my introduction, harmonization is inevitable. The cost of the status quo is simply too great. The sooner we harmonize, the sooner we can achieve growth and prosperity.

Glenn Feltham is dean of the Asper School of Business and CA Manitoba Chair in Business Leadership. He has undergraduate degrees in business and in economics, a master’s degree in business administration, a law degree from Queen’s University, and a doctoral degree in accounting, specializing in taxation, from the University of Waterloo. He is a Fellow of the Society of Management Accountants of Canada. Glenn has published extensively in the areas of tax planning and tax policy.