The first objection is that other OECD countries rely more heavily on consumption taxes than Canada. This may come as a surprise to some, since our perspective of international practice in Canada is clouded to some extent by the United States, which has no tax corresponding to our GST. The objection extends also to the direction of change--the movement internationally tends to be toward greater reliance on consumption taxes rather than less. For example, Germany plans to increase the rate on its value-added tax (the equivalent of our GST) to 19% from 16%. This new German rate is more than three times our new rate of 6%. Even at 7% our GST is reportedly already the second-lowest rate in the world. Leading economists and tax scholars in the United States are becoming more consistent in their calls for a value-added consumption tax like our GST. Some would, at least rhetorically, go so far as to abolish the IRS and replace the Internal Revenue Code with a flat rate consumption tax. According to the smart money the IRS is, of course, not going away any time soon. But the point remains that most developed countries are taking quite seriously the idea that we should be placing more, not less, reliance on consumption taxes. Nevertheless, this first objection isn't really an argument in support of consumption taxes, any more than all your friends jumping into the proverbial lake is support for the same. So let's turn to the second argument.
The second claim, which is attributed to economists within the Department of Finance is that a consumption tax is least damaging to economic growth because it does the least to discourage working, saving and investing. This is at least a sound argument, if it can be made out. To see the logic, consider that an income tax directly taxes the fruits of working and also investment returns. To some economists, this looks like double taxation. So, for example, if one works, earns salary income, pays income taxes on that salary income, and reinvests the remainder, earning interest or dividends on the saved after-tax earnings, the interest and dividends--the returns to saving--are taxed. A consumption tax such as the GST avoids this by imposing tax only when earnings are spent on consumption. Advocates of cutting the GST would argue, however, that with RRSPs, we already have many of the benefits of a consumption tax built-into the income tax. The person who works, earns salary and invests will receive a deduction for an RRSP contribution and not pay tax on the earnings within the RRSP until retirement, when the original earnings and any interest / dividends / capital gains within the plan will be taxed upon withdrawal. So, the argument goes, we already have a hybrid income-consumption tax in the Canadian income tax. One significant problem with this is the fact that corporations cannot make use of RRSPs and are subject to full income taxation on corporate income, and are taxed on the returns to corporate investment. This explains the position of Don Drummond, chief economist at TD Bank, who would prefer to reduce income taxes--both personal and corporate--and increase the rate of the GST. For its part, the Deparment of Finance claims that the increase to economic well-being is three times greater for a reduction to income taxes than to the GST.
This all gives rise to a puzzle. Why, if the GST is such a good tax, is the government still planning to reduce it rather than income taxes? What's missing from the above account? Comments are welcome.