Harmonized Sales Tax
| June 2010
The challenge for most provincial governments in making the change was the need to somehow reconcile the myriad of exemptions, deductions and exceptions in the application of the two taxes. And, of course, there were the various political implications associated with making one big tax out of two. Only the Atlantic Provinces took up the Fed’s original offer, and now, thanks to that decision ten years ago, Ontario and B.C. have a window into their respective futures as they introduce the HST themselves.
The HST studied
In July 2007, economist Michael Smart was commissioned by the C.D. Howe Institute to examine the impact of the HST on businesses in the Atlantic Provinces. The resulting report, entitled “Lessons in Harmony: What Experience in the Atlantic Provinces Shows About the Benefits of a Harmonized Sales Tax,” suggested that, in the long run, the HST encourages investment and improves business conditions.
Some odd bedfellows also support that view. In Ontario, when the bill to harmonize the taxes was introduced in the provincial legislature, all three major papers—the Globe and Mail, Toronto Star and National Post—have come out in support of the change. The papers agree that, in the long run, a single tax is business friendly. “Economists of every political leaning agree that a harmonized tax will be good for companies in Ontario because it will lower the cost of business inputs…. That will, in turn, attract more investment and create more jobs,” says the Star. The Post calls it a “tax change for the better,” and says that it also expects business investments to increase as the cost of inputs to business were reduced. The Globe editorials on the subject are pro-HST because the paper believes the tax is pro-business. The opposition to the tax has come mostly from those whose job it is to oppose the government: the provincial Progressive Conservatives and the NDP.
In B.C., the media consensus is also strongly in favour of the new tax. “More competitive businesses (from the elimination of the provincial tax on inputs) create high-paying jobs and generate tax revenues needed for essential services like health care and education,” says the Vancouver Sun. That paper estimates that businesses across the board will save almost $2-billion in costs because of the change.
Housing pays the price
Where there is this much consensus, it is hard to argue that the HST was, in Atlantic Canada, or will be, in B.C. and Ontario, bad policy. There are rumblings to that effect, however, in the housing industry. New homes will be subject to the PST portion of the federal tax for the first time, and in B.C., says the Vancouver Sun, the HST will add $42,000 to a $600,000 home. Even after the proposed rebates for new homes being proposed are factored in, the HST will mark up the cost of the same home by $22,000. Under the current tax regime, there is no PST applied to house purchases or renovations. With the PST now included in the new HST, the tax on new homes rises dramatically.
Fortunately, in both B.C. and Ontario, the government has decided to mitigate the effect of the tax increase by reducing the tax (on a sliding scale) applied to new homes priced under $500,000. But there are no plans to ease the pain of higher taxes to renovation customers, and that has many reno contractors worried. Steve Barkhouse, president of renovation firm Amsted Construction Ltd. in Stittsville, Ont., says he will have a much harder time competing with the underground economy as a result of the new tax. “The increase is very visible to the customer,” says Barkhouse. The C.D. Howe report notes that, when the “very visible” GST was first introduced, it created “distortions by favouring businesses in the informal (read: underground) sector since they can evade it more easily.”
The HST, many renovators fear, will have the same effect. Ben Polly, president of Evolve Builders Group in Beeton, Ont., points to the danger posed by the tax in growing the underground economy to unprecedented levels. “Right off the top, because I have to show it as a separate line item, everybody is going to see a 13 per cent higher minimum cost,” says Polly. “And the reality is that the real difference is even greater because the guys that are avoiding the HST are also avoiding their workers insurance payments, EI and other hidden costs that also make our price higher.”
Polly believes that, where competing with the underground is concerned, the effect of the tax is even worse than the 13 per cent he has to charge on his invoice. Because HST taxes the labour component of a contractor’s work, it taxes all those labour-driven costs noted that the underground avoids. “It’s a cumulative impact,” he says.
Andrew Payzant, partner in Payzant Home Hardware in Sackville, N.B., confirms that the underground got a big boost from the HST when his province adopted it. “The contractor that did cash business could offer a 13 per cent discount right off the bat,” Payzant says. But offering tax-free work was not the only incentive for HST dodgers. “A lot of those guys just don’t like the paperwork, and there was more involved for them when the HST was introduced.” That will likely be the case in Ontario and B.C. as well. Though contractors will get a rebate on the PST portion of the HST, they will still have to pay it first and apply to get the money back.
Competition between renos and new homes
Because the HST comes with rebates on new homes (as proposed by the Ontario government), it will also make it harder for Barkhouse to compete with legitimate homebuilders. In fact, he says he wouldn’t be surprised if his large reno work dries up completely. “When a customer has the option to improve their home with a $150,000 renovation that carries the full, unrebated 13 per cent HST or buy a new home with an effective tax rate of two per cent (for homes under $400,000, after rebates), what do you think he will do?”
What happened down east?
According to the C.D. Howe study, business investment grew in the Atlantic Provinces after the HST was implemented. “By my estimate,” wrote author Michael Smart, “annual machinery investment in the harmonizing provinces (Atlantic Provinces) rose 12.2 per cent above trend levels in the years following the 1997 sales-tax reform.” This is the effect, says Smart, of the elimination of the PST from the cost of inputs to production that resulted from the implementation of the HST. Though Smart makes it clear that separating the effect of the HST from other economic and political factors can be very difficult, there is also evidence that both jobs and GDP increased in the region as a direct result of the tax change.
It seems that manufacturers passed on some of those input savings to consumers. When Smart compared pricing history in the HST provinces, he found that, relative to the rest of Canada, there are indications that prices to consumers went down. “Overall, consumer prices in the harmonizing provinces fell with the reform, although prices rose somewhat for shelter and clothing,” he writes.
The B.C. challenge
Until the tax actually kicks in on July 1, 2010, the change is a political issue more than an economic one. In B.C., the government is selling the tax to consumers by emphasizing the potential for the “cost of inputs” reductions translating into price reductions on goods and services, and that approach has a lot of retailers worried.
At a recent roundtable discussion hosted by Hardware Merchandising magazine in Toronto (see page 25), B.C. retailer Frances Sologuk, owner of Osoyoos Home Hardware in Osoyoos, B.C., spoke for many B.C. retailers when she expressed her thoughts about the expectations of her customers. “My biggest concern is the attention that’s been given that prices will be lower because of this,” Sologuk said. “The way they (the provincial government) are selling it, because businesses are going to save money, then you should see that at the retail level.” But when Sologuk asked fellow roundtable participant Jeff Redden, owner of Windsor Home Hardware in Windsor, N.S., if prices fell when the HST was introduced to his province his answer contradicted the Smart study. “Not a chance,” said Redden.
Ontario seems a bit more jaded on the subject of the HST. Dave Campbell, president of the Lumber and Building Materials Association of Ontario (LBMAO), says the expectation of everyone he has talked to is that prices will remain the same or increase.
Redden did say, however, that the harmonized tax has simplified administration processes for retailers. “One thing we enjoy now,” he said, “is it’s certainly a lot smoother at the point of sale, where there are no exceptions. Everybody pays, so it’s certainly not confusing at all and makes it much easier at the cashier level. That alone is worth it from a POS perspective.” Payzant agrees: “It’s smoother for us: you’ve got one tax; one organization you are dealing with; you’ve got one audit. You don’t have to keep two sets of records for the taxes. It is certainly better that way.”
Will it slow business?
For retail customers, Payzant remembers the introduction of the HST in his province as being relatively benign. “For retail customers, there wasn’t much difference. They still paid the same amount of tax on most goods,” he says. The problem comes when you realize that the taxes are increasing for that customer when he hires a contractor, because he is now paying more tax on the labour portion of work being done. “We don’t like to see that because they may buy less, or even be turned away from doing the project at all.”
Profiting from the transition
There is a bit of a silver lining that will appear during the transition from two taxes to one. In Ontario at least, contractors will be able to start applying for their PST rebates May 1 even though it won’t appear as a portion of the HST till July 1. It’s a big break for them on the jobs they can bill under the current tax regime.
The two-month PST rebate window may distort buying patterns, too. It encourages builders to hold back purchases that really should be made before May 1. Retailers should expect appeals from builders for some creative accounting during that time.
Polly thinks smart retailers will find a way to help their builder customers save money. “If you plan your purchases properly with your retailer, you can take advantage,” says Polly. “For instance, I might want to make some purchases early to be inside the PST rebate window and then ask the retailer to hold the product for me until I need it.”
Unfortunately, Polly sees this window rebate window as providing just enough cash to offset the increased costs of managing the HST. It may make life easier for retailers in the long run, as Redden points out, but for contractors who have to pay the PST and then apply for the rebate it means another layer of administration they don’t need. “The cost of implementing this for me will be in the thousands in the short term,” says Polly. In the long term, he is sure the cost will be jobs lost to the underground, or to the budgetary restraints of his customers. CC