Options for the Goods and Services Tax - CiteSeerX

Options for the Goods and Services Tax Jack M. Mintz Thomas A. Wilson* University of Toronto

Introduction The Liberal commitment to replace the goods and services tax (GST) with a better tax has been studied by the House of Commons Finance Committee. The question of alternatives to the GST is not a new one. Prior to its introduction in 1991, a minority of tax experts questioned the wisdom of the federal government’s determination to go ahead with the GST.1 Some developed detailed proposals that would have resulted in the elimination of the much-maligned manufacturers’ sales tax (MST) without introducing the GST. The arguments against the GST focused on the problems resulting from the enactment of the tax. These issues have not been resolved. An exploration of alternative approaches to consumption taxation is therefore warranted. In this article, we discuss reasons for either significant reform or replacement of the GST. We also outline a number of options.

Problems with the GST One option for replacing the GST is not in the cards: bringing back the flawed MST. The MST was a poor consumption tax on individuals since it not only had a narrow base, but also applied to certain inputs purchased by businesses, as well as to many capital goods. For many years, manufacturers had called for the replacement of the MST with a tax that would enhance competitiveness. The replacement tax became the GST, which largely eliminated the cascading of taxes by giving businesses full credits for

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taxes paid on most business inputs and capital goods. Although the GST has certain positive features, five major problems are associated with this tax. The first is fairness. Fairness is achieved by taxing at the same rate people with similar resources (horizontal equity) and at a higher rate people more able to pay tax (vertical equity). The GST applies at a single rate on most goods and services no matter what level of resources a family has to spend on consumption. The GST is thus a flat-rate tax on consumption, although this is no different from any other sales tax including the MST. However, to make the GST fair in terms of vertical equity (but not horizontal equity), the federal government allowed a number of goods to be taxed preferentially, such as food, drugs, health care and residential housing (Hamilton and Whalley, 1989). In addition, the federal government provided an enhanced refundable sales tax credit to make the GST progressive.2 While the refundable credits base reduced the sales tax burden on low income families, the GST remains proportional across a wide range of consumption. The second problem is tax evasion at the final point of sale, which has apparently increased since the GST was introduced. With respect to tax evasion, the GST increased the level of taxation on service and retail companies. Businesses selling at the final stage therefore had two taxes to evade: the income tax and the GST. As Spiro (1993, 1994) shows, there seems to have been a significant increase in the underground economy, since 1991 when the GST was introduced.3 It is difficult to argue that the increased rate of

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tax on services and retailers was the sole contributor to the increase in the underground economy. Instead, it would seem that the introduction of the GST was a “lightening rod” that increased the incentives for both vendors and consumers to engage in tax evasion. A third problem is tax competition and incentives for increased cross-border shopping in the United States. The GST increased the effective tax rate on goods and, especially, services to some extent compared to the MST (the federal government estimated a 1.25 per cent increase in the general price level). However, the GST could be avoided completely if consumers did not report sales purchased in the United States that should be subject to the GST. Moreover, those products which experienced significant declines in tax included capital goods (which are not imported by consumers) and “big ticket” consumer durables, such as automobiles, furniture and appliances, which are difficult to smuggle. For most non-durable goods and most services, effective tax rates are higher under the GST. Furthermore, they became highly visible to the consumer. These are precisely the products which can be crossborder shopped legally (tourist services) or easily smuggled (clothing and other non-durables). This is not to argue that the GST was the principal factor driving cross-border shopping. The exchange rate was the major factor (Di Matteo, 1993). In the United States, there is no federal sales tax, and state retail sales tax rates vary widely from zero in New Hampshire to 10 per cent in New York. Cross-border shopping by Canadian consumers is affected by differential sales tax rates on a localized basis. It is easier for the provinces to respond to tax rate differentials across the U.S.-Canadian border than the federal government. Although the recent fall in the value of the Canadian dollar has reduced the incentive for cross-border shopping, there is evidence to suggest that one-day trips have not fallen to the same level as in 1987 when the CanadaUS exchange rate was at a similar level (Spiro, 1993:247-59). Recent problems of tax competition with the United States have been highlighted by the smuggling stimu-

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lated by heavy excise taxes on tobacco and alcohol. The fourth problem is complexity. Unlike the MST that applied to about 75,000 firms, the GST includes virtually the whole business sector of two million firms. Given that many businesses already had to comply with federal and provincial corporate and personal income taxes, capital taxes, payroll taxes, and various provincial retail sales taxes, the GST became another major tax adding to an already complex tax system. Furthermore, the federal government made the tax much more complex than needed by exempting some goods for fairness reasons and using arbitrary rules for the taxation of transportation, financial services and purchases made by municipalities, universities, schools and hospitals (the MUSH sector). It also chose a low threshold for exempting small businesses.4 This increased the level of administrative and compliance costs borne by governments and the private sector. Finally, the fifth major problem relates to the impact of the GST on federal-provincial tax harmonization. With the GST, the federal government imposed a sales tax that effectively applied at the retail level which is similar to the provincial retail sales tax (RST). Prior to the enactment of the GST, the provinces were initially asked to join a national sales tax that would be designed and administered by the federal government. However, such a tax would lead to a centralization of tax collection in Canada, since both income and taxes would be collected by the federal government. Under the national sales tax, there would be little tax policy autonomy left to the provinces. Moreover, centralization of tax policy was inconsistent with the trend towards decentralization of expenditure policy and unilateral federal reductions in transfer payments made to the provinces. In the end, the provinces balked at a national sales tax. The only “harmonization agreement” that has been achieved since the inception of the GST is that with Quebec. This agreement allows Quebec to administer and audit both the GST and its own tax, the Quebec sales tax (QST) for businesses operating in Quebec. The Quebec government is given considerable autonomy in its design of the sales tax. For example, Quebec initially taxed serv-


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ices at a lower rate than goods, and exempts books. Furthermore, unlike the GST, the QST fails to allow Quebec companies to claim credits for taxes on many taxes on business inputs such as power, telecommunications and transportation, thereby violating a basic principle of value-added taxation of reducing the cascading of taxes. Administrative practices also differ, including filing times and the treatment of goods sold at intermediate stages of production.5 There are so many design and administrative differences between the GST and QST that businesses dealing in Quebec are reeling from the complexity introduced by GST-QST harmonization. If all other provinces were to follow a course of action similar to Quebec, businesses would be faced with a nightmare of increased tax complexity. The two particular issues of complexity and federal-provincial tax harmonization were never satisfactorily resolved prior to or after the inception of the GST. It is these two issues that now require serious review. Given the lack of federal-provincial sales tax harmonization and the political unacceptability of a fully centralized sales tax system operated by the federal government, other options for sales tax reform must be considered. The failure by the federal government to address major problems arising from the GST brings to a head a public perception that the sales tax system, particularly the GST, should be modified in a major way. However, the Liberal party promise to scrap the GST and replace it with an alternative is more difficult now that Canadians have incurred the start-up costs of the GST. Any replacement would have at least some start-up costs attached to it.

Some Unattractive Alternatives It is useful to review two alternatives to the GST that we would reject out of hand: (i) eliminating the GST in favour of increased income taxes (Brooks, 1990), and (ii) substitution of a payroll tax for the GST (Kesselman, 1993).6 The first alternative would increase significantly the tax rate imposed on

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savings. The second would not be a viable alternative.

Savings and Tax Policy Our proposals look at replacing the GST with another form of consumption tax or a close alternative. We are not looking for ways to broaden the income tax base that entail additional taxes on savings (such as the taxing of investment income of registered pension plans and RRSPs). Studies following the U.S. Treasury’s (1977) Blueprints for Basic Tax Reform and the Meade Committee report (1978) in Britain suggest that increased levels of tax on savings would be an ill-conceived and wrong-headed policy. Here are three reasons why this is important to Canada at this time: Taxation of the Return to Savings is Unfair: Those who advocate that income taxes are fair are wrong. It is precisely the opposite that is true: income taxes can be unfair since they discriminate against savers. Consider the following. A person who works pays tax when the income is earned. If the person consumes the income immediately, no further income tax is owing. On the other hand, if the person puts the money in a bank account to earn interest, and consumes the principal and interest in the future, tax must be paid on interest income. Thus, a tax on interest income is a second tax on savings. Or, in other words, an income tax is a non-neutral consumption tax which taxes future consumption relatively more heavily than current consumption. If interest income were exempt from taxation, people who save (to consume in the future) would be treated on the same relative basis as people who consume income immediately. Savings for the Future Reduces the Reliance on Government Support: Demographic trends indicate that the proportion of the population over 65 will increase substantially after 2010. The elderly by that time will need to provide resources for retirement income and health care. Moreover, deficitconstrained federal and provincial governments will likely reduce many benefits of social policies for elderly middle-income groups, such as more stringent clawbacks of public pensions and user charges (a taxation of benefits) of publicly financed health care.


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People need to save for future consumption or else they become reliant on government assistance. If we wish to preserve the social safety net in Canada for the poor, it will be important to make sure that there are no tax disincentives for savings of the non-poor. Otherwise, as recent studies have demonstrated, taxation of savings would reduce the willingness of people to provide resources for future needs and this will increase their future reliance on government support (see studies referred to in a recent survey by Smith, 1990). Domestic Savings Reduce Reliance on International Capital Markets: Canada is now heavily indebted. In 1981, Canada’s international indebtedness as a percentage of GDP was 38 per cent. By 1992, this ratio had risen to 44 per cent. This increase in international indebtedness requires us to produce more goods and services in the future to service our debt owed to foreigners. Thus, a higher domestic savings rate is important if Canada is to reduce its dependency on foreign debt. A number of recent studies have found that countries with higher domestic savings rates enjoy more rapid productivity growth. Canada had the third lowest private savings rate of the G-7 countries over the 1979-89 period (Table 1). It also had the second lowest rate of productivity growth. It is noteworthy that Japan and continental European countries tend to tax interest and other sources of capital income at a lower rate than North American countries and Great Britain.

These arguments provide good reason to dismiss the idea of simply increasing the level of taxation on savings as an alternative to the GST. In our view, tax systems should be a hybrid of income and consumption taxes — there is no perfect tax. Thus, we offer proposals that would not result in an increased level of taxation on savings compared to the current system.

Payroll Tax Payroll taxation has been suggested as an alternative to the GST. We wish to take issue with this view. In fact, the payroll tax base would likely be narrower than the GST base and would be an inappropriate substitute compared to the other alternatives. Consumption is derived from more than labour earnings: A common argument made in favour of payroll taxation as a substitute for the GST is the following. Under the GST system, a business remits an amount based on the difference between its taxable sales and taxable inputs. It is then argued that the difference is essentially labour costs, or the business’s value-added as measured by its total payroll and related employee benefits, the same base used by a payroll tax. Theoretically, this view is erroneous since it excludes consumption derived from economic rents (returns that are in excess of the opportunity cost of using inputs). When there are irreproducible factors of production (land and natural resources) and imperfectly competitive industries, value-added includes economic rents that would be subject to taxation under a consumption tax. A tax

Table 1 Savings and Productivity Growth, 1979-89. Private Savings Rate (per cent of GDP)

GDP per Employed Worker (average annual per cent change)

Italy

19.3

2.1

Japan

16.4

3.0

France

12.5

2.0

Germany

12.2

1.8

Canada

9.9

1.2

United States

7.4

1.1

Great Britain

5.4

1.7

Source: OECD.

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on payroll would apply to a narrower tax base compared to consumption. Earnings and incorporation: Self-employed earnings would need to be taxed under a payroll tax (with an adjustment for the treatment of capital). The appropriate treatment would allow businesses to expense capital expenditures with no deduction permitted for interest and depreciation expense as under a “cash flow” tax. However, the cash flow tax would have to apply to more than self-employed earnings. It would have to be applied to all businesses, including corporations. Otherwise, labour earnings and rents could be paid out to employees as dividends and other forms of capital income rather than salaries, thereby escaping the payroll tax. International Issues: The GST and payroll tax would not be equivalent once international trade and factor flows are taken into account. An advantage of the payroll tax is that border-adjustments (zero-rating of exports and taxation of imports) required by the GST would not be needed. Putting it more precisely, a payroll tax is an originbased tax on production while the GST is a destination-based tax on domestic consumption. In principle, the GST applies to domestic consumption no matter where the earnings (and economic rents) are sourced. The payroll tax only applies to earnings sourced in Canada. The payroll tax could be avoided by shifting production abroad and importing the good without tax back into Canada. Indeed, labour earnings of Canadians earned abroad may not be taxed especially if the payroll tax is applied to business payrolls rather than labour earnings received by the individual. Intergenerational differences: There is a significant difference between the payroll tax and GST with respect to their impact on younger and older generations. The payroll tax would only apply to the working population, while the GST applies to consumption of the whole population, including retirees. Transitional Problems: Payroll taxes have increased significantly in recent years. Some studies attribute an increase in structural unemployment to the rise in payroll taxes (Poloz, 1994). Recently, the federal govern-

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ment has recognized the adverse effects of payroll tax increases on unemployment and has overridden the UI contribution formula. In our view, one should not consider the payroll tax as a reasonable alternative to the GST.

Viable Alternatives to the GST We believe, however, that there are a number of options for sales tax reform which represent viable alternatives to the existing GST. Each option has its benefits and costs: any one who believes that these options are less acceptable than the current GST would prefer the status quo. The six options that we suggest are the following: The Business Transfer Tax: The business transfer tax (BTT) could be a replacement for the GST. Indeed, this was one of the three options seriously considered by the federal government in its white paper on sales tax reform in 1987. Moreover, there is some international experience (Japan’s VAT and Michigan’s BTT) that Canada could use in developing this option. One important difference between the BTT and the GST is the way in which the taxes are collected. The BTT would use accounts of firms: each firm would pay the BTT periodically (such as once a year) on the difference between revenues from sales and purchases from other registered businesses. This differs from the GST, which collects taxes on each invoiced sale and provides credits for tax-paid purchases. Depending on how the BTT is put into place, there may not be a significant gain in simplifying the sales tax, since a substantial amount of paperwork may be required for filing. To keep the BTT simple, it is necessary that businesses be allowed to report taxable revenues and deduct eligible expenditures without having to track the BTT paid on each invoice. Otherwise, the BTT would mimic the GST as an invoice-credit VAT. The BTT would thus need to be more broadlybased in application to avoid economic distortions of allowing or disallowing deductions for expenditures from suppliers who may or may not have been subject to tax. For


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example, most firms should be included in the base so few transactions are exempt. Moreover, it would be easier to operate the BTT on an origin basis so that imported purchases would not have to be taxed. Otherwise imported supplies would have to be identified and subject to BTT (see also House of Commons Standing Committee on Finance, 1994). There are other difficulties with the BTT that would need to be sorted out. First, some businesses may be exempt, such as small suppliers and financial services. This could lead to potential problems as found with the GST whereby there would be a cascading of taxes or low rate of tax of goods (if purchases from exempt suppliers are deductible for businesses subject to BTT). Second, as the BTT is imposed on the vendor, not the purchaser, the BTT is an indirect tax, and cannot be used by the provinces without a constitutional amendment. The BTT would therefore coexist with provincial retail sales taxes, and fail to reduce significantly the complexity in the dual sales tax system. Exchange Tax Fields with the Provinces: The federal government could vacate the sales tax field in favour of additional income, capital and/or payroll tax room taken from the provinces.7 We have calculated that the federal personal and corporate tax rates would need to increase by about 4 points with a transfer of all GST revenues to the provinces. The provinces would then need to increase their taxes on consumption (retail sales and excise taxes). This proposal, originally conceived by the Carter Commission in the 1960s, has the virtue of disentangling overlapping tax powers that lead to waste and duplication. It would clearly result in tax simplification. The proposal would enhance the federal government’s command over the personal and corporate income tax as the primary means of raising revenue, stabilizing the economy and redistributing wealth amongst Canadians. However, the proposal would lead to increased reliance by the provinces on other taxes, such as retail sales and excise taxes, which may be difficult to levy at sharply higher rates without leading to tax avoidance. Moreover, one of the provinces, Alberta, has no retail sales tax and would 32

have to gain revenues from other sources instead. Furthermore, Quebec has jealously guarded its rights to levy all types of tax within its jurisdiction. While such an exchange of tax fields would represent a vast improvement over the present system, it is highly unlikely to be accepted by the provinces. A Broad-based Single-stage Retail Tax: An alternative which would reduce compliance costs and facilitate harmonization with provincial sales taxes would be to replace the GST with a broad-based single-stage tax on consumer purchases of goods and services. Capital goods and business inputs would be exempt from tax though the “suspension” method.8 With federal sales tax levied only at the point of final sale, many businesses would no longer need to remit sales tax, and the suspension method would obviate the need for input credits, with favourable cash flow effects for start-up businesses. Such a tax could be more easily harmonized with existing provincial retail sales taxes, since these are also single-stage taxes. It is argued by some experts that it is difficult to administer the retail sales tax at a high rate. The argument is that tax evasion would result as businesses might abuse the exemption system by selling tax-exempt goods and services to non-registered persons, especially those with mixed business-consumption use. However, we would argue that such tax evasion need not always arise with proper administrative practices. Both an invoice-credit VAT with refundable credits and a retail sales tax with exemption certificates require the cross-checking of receipts of goods and services sold from one registered taxpayer to another. Abuse is possible under both systems. With the RST, however, the prevalent use of the exemption system with proper auditing would make the RST as costly as the GST in terms of administration. The advantage of the RST, however, is that there is less need to transfer funds around the economy since taxes on business-to-business sales do not need to be collected by vendor, remitted to the government and refunded to the purchaser, all done without raising a single penny of tax revenue. Compliance costs incurred by businesses would


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therefore be somewhat lower under the single stage tax. A Simplified Consumption Tax: Several years ago, we had argued in favour of the simplified consumption tax (SCT) as a personal expenditure tax (PET) which would be levied in conjunction with the personal income tax (Mintz and Wilson, 1990).9 The SCT is based on the principle that consumption is equal to income less savings. In essence, the opportunity cost of savings would be exempt from tax. The SCT would apply to adjusted personal income net of qualifying contributions to registered savings plans (similar to RRSPs and pension plans). The return on non-registered assets would be exempt. Adjusted income would include inheritances, pensions labour earnings, withdrawals from registered assets and other sources of business rents.10 The SCT rate could be graduated with the amount of the family’s consumption and hence be made progressive. The advantage of the SCT is that it can be made more equitable than the GST (or any sales tax) by using a progressive tax structure (although this need not be the case — a flat SCT accompanied by progressive income taxes can achieve the same redistributional objectives). It is also quite simple, since the tax applies to consumption of individuals without having to measure consumption from particular goods or services such as tourism, financial intermediation, and housing. If the SCT is collected at the same time as the personal income tax, there is considerable tax simplification achieved without interfering with provincial taxing powers. There are also disadvantages to the SCT. There are technical issues in measuring qualifying deductions for savings invested in foreign bank accounts and investments with an element of consumption (e.g. paintings). Also, if individuals misreport income, the SCT will also be misreported. Moreover, people can escape the tax by shifting rents and earnings out of the country to other jurisdictions. Increased Reliance on Direct Taxes with Increased Savings Incentives: There is another alternative to the GST which might

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achieve many of the efficiency gains, but which would avoid the administrative costs and complexities associated with the GST and other proposals such as the SCT. This alternative is the abolition of the federal GST, coupled with a replacement of the lost revenue via a modified income tax system which is closer to a personal expenditure tax system. The modifications to the income tax include increases in the federal income taxes to raise most of the revenues lost from the abolition of the federal sales tax, coupled with a liberalization of the RRSP/RPP contribution limits, the introduction of an interest income deduction, and income averaging to mitigate any adverse effect on personal savings. However, when added to current federal and provincial income tax rates, top marginal tax rates would need to approach 60 per cent which would increase tax avoidance and evasion. A Simplified Harmonized VAT: A final alternative is to reform the GST to make it simpler and fairer and harmonize it with the provinces (Bird, 1994: 37-47). The advantage of this approach is that there are no start-up costs for businesses since the GST is now in place. Such a national sales tax (NST) would require the federal government to enter into new negotiations with the provinces for a harmonized sales tax regime. The federal government should be flexible in allowing for selected exemptions and be willing to observe provincial autonomy. However, it should keep the following principles (Mintz, Wilson and Gendron, 1994): • only one agency (e.g. the federal government, or a joint federal-provincial agency) should administer and audit the tax; • cascading of taxes on business inputs should be avoided; and • administrative rules should be similar to those used for the GST. Indeed, the report of the House of Commons Standing Committee on Finance (1994) goes some way in providing a model for a flexible agreement, allowing differential rates across provinces and a tax base negotiated by federal and provincial governments. Our proposal would also allow for differing tax rates. We would also argue that tax bases should be set according to a na-


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tional norm with some differentiation permitted for goods or services sold primarily to consumers at final stage (e.g. burial services, books, magazines). The national sales tax could be enhanced by the following one of two schemes — a joint VAT or a joint federal VAT - provincial RST, referred to as the open architecture tax system (OATS). A joint VAT would have both federal and provincial governments tax the value-added of business as under the GST. To accommodate differing provincial tax rates, each province would zero-rate exports to registered businesses in other provinces and not provide an input tax credit to business for imports to other jurisdictions. Exempt businesses would pay both federal and provincial sales tax on inputs sourced from a particular province. This scheme is similar to the European system now in place and was recommended by the House of Commons Standing Committee on Finance (1994). The joint VAT would also entail the following changes: • Simplify the tax by eliminating zero ratings, tax exemptions, and partial exemptions of goods. With the resulting savings of about $2 billion in revenues, a reduction in personal tax rates or an increase in the refundable sales tax credit for lower income individuals and refunds for the MUSH sector could be implemented. More judicious use of the suspension system as under the RST could also reduce complexities. • Improve the treatment of the MUSH sector by rebating all taxes on their inputs rather than having differential formulas. The current system leads to the taxation of research and development, education and training, and expenditure on health and causes the cascading of taxes when the MUSH sector sells goods or services to GST registered businesses. Some goods sold by the MUSH sector are for private consumption and these should be taxed under the GST. • Increase the small trader exemption to allow most small businesses to choose whether or not to register (e.g. a $200

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thousand sales threshold would give 80 per cent of businesses this option). The small loss in revenue would result in a significant reduction in compliance costs. Japan has followed this course and some VAT proposals in the United States include such an option. Although this would reduce the neutrality of the VAT, pure obedience to one principle (neutrality) without recognition of another (simplicity) results in poor tax policy. Most countries favour more simplifications than Canada did in developing the GST (Bird, 1994). An alternate national sales tax would be a joint federal-provincial sales tax whereby the federal government would apply a VAT with the provinces imposing a retail sales taxes on the final sales to consumers (for further discussion, see Mintz, Wilson and Gendron, 1994). Essentially, the provinces would “suspend” payment of retail sales taxes on all goods and services sold from one registered business to another (only the federal VAT would apply). The advantages of this proposal are that it would: • eliminate provincial sales taxes on interprovincial transactions of registered businesses; • avoid provincial taxation of goods and services sold at intermediate levels of production and distribution thereby reducing cash flow considerations of businesses; • make it easier for the provinces to accommodate the new system with built-in flexibility; • broaden the provincial exemption system since all transactions under the federal VAT will be audited as part of the invoicecredit mechanism; and • reduce administration and compliance costs significantly for both federal and provincial governments. Provincial autonomy can be respected by allowing the provinces to negotiate exemptions for specific goods and services as in the joint federal-provincial VAT.

Conclusion The final alternative — sales tax simplification and harmonization — is our preferred option. As an alternative to the current GST,


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it would simplify the tax system and generate increased efficiency by eliminating the taxation of business inputs and capital goods. Other alternatives can achieve more equity than the current system, especially the simplified consumption tax. But given that the GST is now in place, it seems best to modify the current system to reduce complexity without imposing yet another set of large transitional costs upon the public. There have been recent reports that the federal government is offering a “12 per cent solution” that would involve one common sales tax base and rate across all provinces and flat rate income taxes to raise the remainder of revenues needed by each government. Ultimately this proposal would achieve simplicity and efficiency at the cost of sharply curtailed provincial autonomy. Given that Quebec already has an agreement with much more flexibility, it will no doubt reject such a proposal. It is unlikely that many of the other provinces would want to enter into an agreement with so little flexibility. We prefer the far more flexible open architecture sales tax system, in the hopes of obtaining harmonization, while preserving provincial tax autonomy.

5.

The QST introduces the notion of “non-taxable” goods moving through the production chain. Quebec feared that application of the GST at intermediate stages of production would be challenged as unconstitutional given the restriction imposed in Section 92 regarding provincial powers of taxation. Under the GST, there is no similar concept of “nontaxable goods”. A recent Supreme Court decision has confirmed that a value-added tax will be considered a direct tax.

6.

Recently, Kesselman (1994) proposed a payroll tax to include a cash-flow tax on business (revenues net of the cost of purchasing goods and services from other firms, including capital goods). His new proposal is to apply a “direct consumption tax” which is similar but not identical to our proposed simplified consumption tax.

7.

Alternatively, the federal government could exchange income tax revenues for additional sales tax revenues as proposed by Ontario and Manitoba. Under this scheme, provinces would yield the sales tax field to the federal government in exchange for more income tax room. Our concern with this proposal is that it could result in a balkanization of the income tax field. Moreover, we see no reason why Quebec would agree to this solution under which Quebec would lose autonomy.

8.

Under the “suspension method,” a purchaser provides an exemption certificate to the vendor who then does not charge the sales tax and remit the revenue to government. This method is used under the GST for farmers and provincial governments.

9.

Our approach draws on the Meade Committee (1978) and U.S. Treasury (1977) reports. See also House of Commons Standing Committee on Finance (1994) for a comprehensive discussion of this approach. We would have both registered (e.g. registered retirement income plans and pension plans) and non-registered assets. Kesselman’s proposal for a “Direct Consumption Tax” is a consumption-based tax that uses the non-registered asset approach only.

10.

A cash-flow tax on businesses may also need to be imposed to capture rents accruing to owners of nonregistered assets. The cash flow tax would apply to a base on an origin basis with wages and salaries deducted from the base. If equities are held in an RRSP or pension account, a refundable tax credit for the cash flow tax could also be paid to the owner of the account.

Notes *

Mintz is Associate Dean and Arthur Andersen Professor of Taxation, Faculty of Management. Wilson is Director of the Policy and Economic Analysis Program and Professor of Economics. This article develops the arguments first presented in Mintz and Wilson (1993).

1.

See Whalley and Fretz (1990), Mintz and Wilson (1990), Brooks (1990) and Boadway (1989).

2.

The refundable credit is based on family income and is clawed back from income greater than $25,921. To the extent that the income is misreported or mismeasured, the credit may not be well targeted.

3.

The growth of the underground economy may also have resulted from the increase in income tax during the 1980s from 15 per cent to 21 per cent of GDP (Mirus, Smith and Karoloff, 1994). Gervais (1994) suggests that the underground economy is not much larger than 5 per cent of GDP.

4.

See Bird (1994) for a discussion about the complexity of the GST. Estimates of the cost of the GST suggests that small businesses are particularly affected. It found that compliance costs are 16 per cent of sales for businesses of less than $100,000 in revenues and 3 per cent of sales for businesses with over $1 million in revenues (House of Commons Standing Committee on Finance, 1994: 17).

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References Bird, Richard (1994) “Cost and Complexity: The GST in International Perspective,” Tax Notes International, pp. 37-47. Boadway, Robin W. (1989) “Federal-Provincial Fiscal Relations in the Wake of Deficit Reduction,” in Ronald L. Watts and Douglas M. Brown (eds.) Canada: The State and the Federation 1989 (Kingston, Ontario: Institute of Intergovernmental Relations).


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Brooks, Neil (1990) “Searching for an Alternative to the GST,” Institute for Research on Public Policy Discussion Paper No. 90C-1 (Ottawa). Di Matteo, Livio (1993) “Cross-border Trips and Spending by Canadians in the United States,” Canadian Business Economics, Vol. 1, No. 3, pp. 51-61. Gervais, Gylliane (1994) The Size of the Underground Economy in Canada, Statistics Canada, 13-603E, No. 2. Hamilton, Bob and John Whalley (1989) “Efficiency and Distributional Effects of the Tax Reform Package,” in The Economic Impacts of Tax Reform, Canada Tax Report No. 84, (Toronto: Canadian Tax Foundation), pp. 373-398. House of Commons Standing Committee on Finance (1994) Replacing the GST: Options for Canada (Ottawa). Kesselman, Jonathan (1993) “The FPT as an Option to the GST,” Canadian Tax Highlights. Kesselman, Jonathan (1994) “Assessing a Direct Consumption Tax to Replace the GST,” Canadian Tax Journal, 42(3), pp. 709-803. Meade Committee (1978) The Structure and Reform of Direct Taxation (London: Allen and Unwin). Mintz, Jack M. and Thomas A. Wilson (1990) “Alternatives to the Goods and Services Tax,” Canadian Tax Journal, 38(3), pp. 644-665.

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Mintz, Jack and Thomas Wilson (1993) “Alternatives to the Goods and Services Tax,” Policy Options, October, pp. 40-43. Mintz, Jack M., Thomas A. Wilson and Pierre-Pascal Gendron (1994) “Canada’s GST: Sales Tax Harmonization is the Key to Simplification,” Tax Notes International, Tax Analysts, 8. Mirus, Rolf, S. Smith and Vladamir Karoloff (1994) “Underground Economy Revisited” Canada Public Policy, 20(2), pp. 235-252. Poloz, Stephen S. (1994) The Causes of Unemployment in Canada: A Review of the Evidence, PEAP Policy Study 94-5, Institute for Policy Analysis, University of Toronto. Smith, Roger (1990) “Factors Affecting Saving, Policy Tools and Tax Reform,” IMF Staff Papers, International Monetary Fund. Spiro, Peter (1993) “Evidence of a Post-GST Increase in the Underground Economy,” Canadian Tax Journal, 41(2), pp. 247-59. Spiro, Peter (1994) “Estimating the Underground Economy: A Critical Evaluation of the Monetary Approach,” Canadian Tax Journal 42(4), pp. 1059-81. United States Treasury (1977) Blueprints for Basic Tax Reform. Whalley, John and Deborah Fretz (1990) The Economics of the Goods and Services Tax, Canadian Tax Paper No. 88, (Toronto: Canadian Tax Foundation).


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