The downside of cutting the GST

Consumers hate paying tax, which makes the Conservative government’s promise to cut the GST particularly attractive, but the immediate relief provided by such a tax cut will likely be offset later on in pensions and programs where benefits are indexed to inflation, according to a C.D. Howe Institute report.

“Canadians, having sadly little experience with tax relief, should look forward to small gains in their wallets in the countdown to the changeover, but should also be aware of the longer lasting impacts of lower shopping prices,” writes Finn Poschmann in a report entitled Ready for Relief: There’s More to a Lower GST than Meets the Eye.

Poschmann argues that a lower GST will push the Statistics Canada Consumer Price Index lower, which will in turn affect annual adjustments and calculations for government benefits that Canadians pay and receive.

According to Statistics Canada, 63% of the items included in the CPI’s basket of goods and services are subject to GST. “On the assumption that the rate cut feeds through into consumer prices, the arithmetic of backing out one percent of sales tax on that 63% produces a decline in CPI inflation of 0.6%,” says Poschmann.

He says the government will save money because benefit amounts in turn would grow less than they would normally. “The amount is small for fiscal 2007 and 2008, but climbs above $600 million for the next year, before dropping back as currently scheduled increase to the personal amounts supersede indexing’s status quo impact on those amounts.” As a result, consumers could see a lower indexation of the child benefit, a reduction of about $30 a year and Old Age Security payments could fall by about $36 a year.

Perhaps more importantly, the report highlights the effect the implementation of a one percentage point GST cut will have on businesses. “The timing matters,” say the reports authors. “The Conservative campaign’s promise of immediate tax relief almost certainly means that GST relief will be part of the spring budget legislation, expected in April or May 2006.”

Even though businesses know this change is coming, an overnight change would disrupt business and “induce myriad local problems,” says Poschmann.

“A defined future date for rate relief would be friendliest to planning and to the federal government’s fiscal hopes. Businesses would have time to test their applications with revised tax parameters.” And there is good reason for the government to delay implementation. “The federal government’s interest in delay is relatively mercenary: each month of a 7% GST, rather than 6%, represents more than $400 million in federal revenue, a hefty sum in the context of the new government’s plan to reduce taxes and deliver numerous benefits under a no-deficits dictum.”

Filed by Kate McCaffery, Advisor.ca, kate.mccaffery@advisor.rogers.com