Towards Replacing the Goods & Services Tax : Background Papers
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Implementing a Harmonized Value-Added Sales Tax

Table of Contents

• Towards Replacing the GST.
• Impact on Harmonizing Provinces.
• Impact on Consumers.
• Why the Current System Inflates Prices.
• Impact on Business.
• The Tax Rate.
• The Tax Base.
• Tax-included Pricing.
• Administering the Harmonized Tax.
• Implementation Date.
• Sacrificing Deficit Reduction?
• Flat Taxes/Income Taxes?
• Economic Impact.

Questions and Answers

Towards Replacing the GST

Q. Why didn't the federal government eliminate the GST as it promised during the last election?

A. We know that many Canadians believed we would be able to do more than we are announcing today. So did the government. We understand their disappointment and we share it. But we are moving forward with the best possible alternative -- and it is in keeping with our Red Book commitment.

The Finance Committee of the House of Commons and the government have looked at 20 possible alternatives to the GST. All had failings. Some were economically damaging; some were unfair; some failed to raise the necessary revenues; some were simply not workable.

Unfortunately, there are none which would allow us to fulfil both our hopes for the sales tax system and our responsibilities as managers of the nation's finances. The fact is that the government could not give up the $18 billion in annual revenues that the GST brings in to maintain its ability to provide essential programs and services for Canadians.

We were right to criticize the GST. It was costing small business valuable time, energy and money and creating needless overlap and duplication. But we were mistaken to have believed that, once the GST was in place, a completely different alternative would be within reach. It has not been.

We are nevertheless determined to move ahead on addressing the shortcomings of the sales tax system in Canada in the best way possible.

The Finance Committee, with the support of a wide range of business and other groups, identified a number of ways in which the current sales tax system could be improved. The sales tax harmonization and simplification measures we have announced reflect the committee's recommendations.

We could have dressed up the announcement and pretended it was more than it is. We did not. We are being honest with Canadians about this.

These measures are a significant first step towards replacement of the GST with an integrated federal-provincial sales tax -- a better sales tax system for Canada. The government is committed to work with the remaining provinces to make this a single harmonized sales tax system for Canada.

Q. What is the government's Red Book commitment regarding the GST?

A. "A Liberal government will replace the GST with a system that generates equivalent revenues, is fairer to consumers and to small business, minimizes disruption to small business, and promotes federal-provincial fiscal co-operation and harmonization." (Liberal Party Red Book, 1993)

Q. What did the House of Commons Finance Committee recommend regarding the GST?

A. In 1994, the House of Commons Standing Committee on Finance conducted an extensive review of sales tax reform options. During the review, the Committee heard from nearly 500 witnesses and received more than 700 briefs. The Finance Committee considered a wide range of alternative sources of revenue for the federal government and rejected all of them in favour of a harmonized value-added sales tax.

In its June 1994 report, the Committee:

• favoured a value-added tax;

• urged harmonization of the federal value-added tax with provincial retail sales taxes;

• recommended simplification; and,

• advised the adoption of tax-inclusive pricing.

The Committee stated that the harmonization of federal and provincial sales taxes offers key benefits to Canadians, including simplified tax compliance for business, lower administration costs through the elimination of existing overlap and duplication, and increased economic efficiency and competitiveness.

In addition, the Committee recommended a two-level approach to tax-included pricing. Under this approach, goods and services would be priced for public consumption on a tax-included basis, while receipts and invoices would show the amount of value-added tax payable or the rate at which value-added tax was charged.

Q. How can you call this replacing the GST, when all you've done is make it bigger by folding in provincial taxes?

A. The Memoranda of Understanding with Nova Scotia, New Brunswick and Newfoundland and Labrador, together with the pending full harmonization with Quebec, represent an important step towards replacing the GST with a simplified, harmonized value-added tax. This will represent a significant improvement in Canada's sales tax system.

For one thing, the new harmonized system will include a broader sales tax base that will spread the tax burden fairly to all sectors of the economy. That creates a level playing field at a time when services are one of the fastest growing parts of our economy.

The government's overriding commitment has been to create and sustain the right economic conditions to encourage jobs and growth. That's what sales tax harmonization and simplification is all about.

As well, over 100 measures are being introduced to streamline and simplify the operation of Canada's value-added tax system.

Q. Why is harmonization only taking place with "Liberal" governments?

A. This initiative is the result of extensive continuing discussions we have carried out with the provinces on sales tax issues since coming to office.

We are moving ahead now with Nova Scotia, New Brunswick and Newfoundland and Labrador because they clearly understood how much their economies would benefit from sales tax harmonization. As a result, discussions proceeded at a faster pace with these provinces.

We made a formal harmonization proposal to the provinces in mid-1994. Other provinces have also showed strong interest.

As of November 1996, Quebec's value-added tax will be fully harmonized with the federal tax.

The federal government is ready to pursue discussions on harmonization with all interested provinces.

Impact on Harmonizing Provinces

Q. How will the changes affect harmonizing provinces?

A. For harmonizing provinces, sales tax harmonization means:

• for consumers, a lower combined sales tax rate than under the current system -- from just under 19% down to 15% in Nova Scotia and New Brunswick, and from just under 20% down to 15% in Newfoundland and Labrador;

• for business, one administrative system, one tax, one base, and one rate through a simpler, fairer system;

• for the first time, small business with less than $30,000 of taxable sales will no longer have to register for either federal or provincial sales tax;

• a stronger economy;

• a value-added tax will make the harmonizing provinces more competitive on world markets -- exports will be more competitive because they will be free of sales tax;

• similarly, products will be more competitive vis-à-vis imports;

• this competitive edge both at home and abroad is a positive step towards keeping and creating jobs in the province; and

• a streamlined and more cost effective system that will reduce government duplication and administrative costs.

Impact on Consumers

Q. What's in it for consumers?

A. Harmonization will mean lower prices, lower taxes and a new, simpler system for consumers in the three harmonizing provinces:

• prices will be lower because the cost of doing business will be reduced;

• the harmonized tax rate will be 15 per cent, an effective reduction of almost 4 percentage points in Nova Scotia and New Brunswick and almost 5 percentage points in Newfoundland and Labrador;

• the price will include the tax -- the price consumers see will be the one they pay at the cash register.

Prices will fall on many consumer purchases such as cars and appliances because the harmonized value-added tax will eliminate hidden provincial retail taxes. Under the current provincial retail sales tax systems, businesses are taxed on the items they buy to make their products, deliver their services and keep their business going. If businesses pay a tax up front, it is the consumer who pays for it in the end. The tax is embedded in the price. That is true for products and services that are taxed today -- and it is true for those that aren't.

For goods and services not previously taxed, prices will go up by less than the full extent of the provincial tax. That is because the taxes embedded through business inputs will be removed.

Inclusion of services in the harmonized tax base reflects the need for governments to ensure that revenues keep pace with changes in the economy -- services are the fastest growing component of expenditures in Canada. This will also spread the tax burden more evenly across all sectors of the economy and hence reduce distortions.

A harmonized sales tax on a broad range of goods and services will also permit governments to keep sales tax rates at a lower level, and ensures a greater degree of fairness in the tax treatment of individuals and families which consume different mixes of goods and services.

In the three provinces which will harmonize next year, the lower combined rate will ensure that consumers face a lower overall sales tax burden even under an expanded sales tax base.

Supplementary Information

Consumers already pay most taxes on business inputs in the form of higher prices. This occurs because payment of provincial retail sales tax on business inputs results in tax compounding, whereby tax on intermediate inputs sticks to the selling price of each participant in the production and distribution chain, effectively forcing up the price and tax paid by the final consumer. Tax compounding leads to:

• higher prices for Canadian exports, and an associated reduction in the competitiveness of Canadian products on international markets;

• reduced competitiveness between Canadian produced products and imports into the domestic market;

• distortions in price between products which use a high percentage of taxable inputs and those that do not; and

• locational distortions, as businesses seek to locate in low tax rate jurisdictions to minimize costs and selling prices.

For consumers, elimination of tax on business inputs under a harmonized value-added tax will result in lower prices for many products and greater visibility of the full amount of sales tax being paid by consumers.

See the information box following for more details.

Why the Current System Inflates Prices

Tax Compounding Under Retail Sales Tax (RST)

Hardwood Furniture Inc. manufactures furniture and sells it to a national wholesaler, who in turn sells it to individual retailers for sale to final consumers.

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