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1920 – Federal Sales Tax: Servicing War Debt through Taxes

Until the outbreak of the First World War, the federal government did not collect any direct taxes, such as income tax and sales tax. The Constitution Act of 1867 gave the federal government authority to impose both direct taxes and indirect taxes, such as customs duties and excise taxes. The provinces, on the other hand, were given authority to impose only direct taxes. As a result, the provinces had to rely on direct taxes while the federal government raised revenue through customs duties and excise taxes. The demands of the war, however, necessitated that the federal government impose both income and sales taxes for the first time.

The war drastically increased the federal government’s spending. By 1915, military spending alone equalled the entire government expenditure of 1913. In 1918, the federal government’s war outlay was more than $2.5 million a day—a large amount in those days. Because of this, the government’s budget deficit rose from 10% of gross national product (GNP) in 1913 to around 15% during the war, when both the deficit and GNP grew substantially. In order to offset the growing deficit, the federal government decided to impose direct taxes on Canadians. In 1917, the government levied a personal income tax and a corporate income tax. At the time, these measures were viewed as temporary.

After the war ended in 1918, the government was paying $164 million a year in interest on the debt created during the war, and $76 million in soldiers’ pensions. This was more than the entire federal budget before the war.

In the budget of May 18, 1920, the Minister of Finance, Sir Henry Drayton, introduced a 1% sales tax on the value of goods sold. Several items—including most dairy products, raw and unprepared foods, sugar and coal—that the government perceived as essential, particularly for low-income people, were exempted from the tax. The sales tax rate was gradually increased in the following years. In 1924, the tax rate reached a peak of 6%. The government’s revenue increased from about $38 million in the first year to nearly $100 million annually from the sales tax. This revenue accounted for about 25% of total revenue.

From the beginning Canadian businesses and individuals, who were already paying income and corporate taxes, disliked the sales tax. In 1926, the federal government posted a substantial budget surplus, which enabled the government to run its affairs with reduced sales tax revenue. The government gradually reduced the sales tax and by the late 1920s, the sales tax rate became very low.

Links

1917-- Income Tax: Financing War through Taxes
Source: Government of Canada
http://canadianeconomy.gc.ca/english/economy/1917income_tax.html

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