In Financial, Fresh on October 18, 2009 at 9:32 AM

[This is a piece I wrote in the Spring when all this Harmonized Sales Tax stuff came up. I never ended up posting it because it really wasn’t as a big deal at that time (massive job losses and slumping economy were dominating the headlines). But the decision to harmonize our sales taxes with the Federal authorities will continue to pop up, most likely as a political issue. This should provide a good background on why we did it and what it means, and it’s a nice preface to my next article. The real reason I’m doing this is because I want you to be able to spot political misinformation as soon as you see it. When I hear the way politicians speak about tax issues, it’s obvious they’re counting on us to have no understanding of what is actually happening.]

Ontario recently passed the adoption of a single, unified, Harmonized Sales Tax which will now be referred to as the HST. It won’t fully affect Ontarians until 2010, but I figured it can’t hurt to know a little bit more about this change. This graphic from the Toronto Star provides a great summary of what goods will be affected by this tax change. You might want to take note of the “No longer PST Exempt” section of this graphic – this means all of these goods will be taxed at the new HST of 13%, rather than just GST at 5%.

There are some other important differences moving to a single harmonized sales tax. We’re moving entirely to a Value-Added Tax, whereas before only the GST portion was structured as a value-added tax. I’ll illustrate what that means with an example, but let’s cover some of the big stuff before we get into the detail.

Harmonizing the sales tax in Ontario (PST) with the federal tax (GST) to make one unified tax does several things:

  1. Businesses no longer have to file two separate sales tax returns. They still have to pay the same amount (8% PST +5% GST = 13% HST). According to several sources, including the graphic above, the government estimates that harmonizing will save Ontario businesses $500 million in costs associated with filing two separate retail tax returns (one to the Province, and one to the Feds). In other words, at $50,000/year, per person, harmonizing sales tax will put 10,000 people out of employment.
  2. Something Ontarians might find annoying in the future is that by harmonizing the sales tax with the federal government, Ontario has lost its ability to govern 8% of the total sales tax. They have given up their power to encourage or deter goods or services by using the sales tax. The feds decide that now.
  3. The truly interesting part of harmonizing sales tax is that we now have a single Value Added Tax. The GST was already a value added tax, while the PST was not.

So, what is a value added tax?

A traditional sales tax system simply slapped a tax on the end user of a product or service. The various businesses involved in producing the good or service did not have to deal with the tax – only the retailer would collect it on the government’s behalf, and submit it to the government periodically.

A value added sales tax, on the other hand, taxes a business each time it adds value to a product or service. If we were selling paper airplanes for a living, this is how it would work:

  • I would go to Grand & Toy and purchase paper, on which I pay 13% HST (the new value added tax) on $10 worth of paper. So I’ve paid $1.30 in tax;
  • I sit at home that night, adding value to the product by making sheets of paper into airplanes;
  • I sell my planes the next day, for $100, plus HST of $13, for a total of $113.

Total Taxes I collected on behalf of the government: $13

Total Taxes I paid in the process, that I should be reimbursed for is $1.30

I give the government the net of those two when I file my HST return: $11.70

Grand & Toy owes the government $1.30, because to them, I’m the end user of their product (paper).

In total the government receives the same amount as it would if only the final end user of the product (the consumer) paid the $13 tax. So why do it this way?

There are several advantages with a value added tax system, but two are relevant here. First, VATs require that businesses have to track the sales tax collected and sales tax paid, every step of the way. This means companies lose the ability to tax on top of tax, which is called “cascading,” and is something that unnecessarily contributes to higher prices.

The other benefit is that the government does not have to wait for the end user to pay the tax, it will receive money throughout the process, which helps facilitate tax collection for the government.

Ontario should be able to leverage more transfer payments from the Federal government in exchange for giving up its right to control sales tax. The Ontario government itself has projected provincial deficits until the year 2015. It’s not fair to analyze the economic affairs of a single province alone, because all provinces are heavily dependent on transfer payments from the Federal government to pay their bills. But if you are curious about what the projected Ontario 2009/2010 income statement looks like, this picture sums up the best guess.

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