Thursday, January 03, 2008

1% GST reduction, a mistake... which can be repaired

It was predictable; the Harper government announced that the 1% GST reduction would become effective as of January 2008. Even though this policy is widely regarded as less desirable than an equivalent income tax reduction, it would be hard to blame the Conservatives for it as it was one of their electoral pledges.

So, in the hope that the electorate will think about it twice before voting for such a policy next time, here is the most elegantly simple explanation that I could find. It is coming from Greg Mankiw, economics professor at Harvard University (

« If we are looking at the decision to work today in order to consume today, consumption and income taxes have similar effects. Both discourage work effort.

Consider, however, another margin of adjustment: Work today in order to save and consume in the future. Let's continue with Daniel's example of a 50 percent tax rate. Suppose that the interest rate is 7 percent, so $1 saved today becomes $2 in 10 years.

With income tax: 1 hr work --> $16 pre-tax --> $8 post-tax --> $16 of savings in 10 years --->$4 more in income taxes on the interest--> $12 of chocolate cake, video games, and Red Sox tickets.

With consumption tax: 1 hr work --> $16 pre-tax --> $32 of savings in 10 years --> $16 of chocolate cake, video games, and Red Sox tickets + $16 of tax.

So under a consumption tax, there is a greater incentive to work and save today in order to consume in the future.


The bottom line: Both consumption taxes and income taxes discourage work, but income taxes discourage saving as well.»
Source :

Worse, we are currently in a period of weak personal savings and of increasing consumption-related personal debt. If the U.S. should experience an economic slowdown in 2008 and a continuation of the liquidity crunch, the weak personal savings level in Canada would not allow consumers to reach for their "nest egg" to fuel further consumption. This, in return, would likely increase chances of an economic slowdown here as well.
Could something be done to correct this unfortunate policy decision of the current government?
Fortunately, yes. We would need Monique-Jerome Forget, Québec's finance minister, the integrate this 1% GST rebate to add it to Quebec's PST. For consumers, there would be no immediate impacts as prices of product sand services bought in Québec would not change.

This additional 1% would represent more than 1 billion dollars extra in Québec's budget. This would allow the option of either reduce the income taxes by the same amount or to invest it in the Generation Fund for the eventual purpose of debt reduction. Note that I did not even suggest that it could be used as part of the operational budget as I believe this would be an even greater mistake.

Some would argue that any tax reduction is good, wherever it is coming from. It is a view which lack, er... vision! In a stable and long-term perspective, Canada should progressively move towards income tax reduction and a raise of consumption taxes.

Now, I hear some object that consumption taxes are regressive and that its elimination improves the lot of the poorest among us. Well, in the short-term, maybe (although the GST is not applied to most of the basic consumption items). However, similar income tax progressiveness adjustments can be applied to consumption taxes.

The point is to be able to separate short term impacts (political, social and economical) from those, beneficial, that a sound fiscal policy will provide. For the result-based political observer, that is the bottom line and should be the goal in this specific case.

I'm leaving you with a few links to comments from various economists and other pundits on this topic: