Fiscal Cost of PST Harmonization

Amid speculation that the Government of Ontario may harmonize its provincial sales tax with the GST, today’s Toronto Star reports, “The government has offered no analysis to determine how much of a benefit or a drain harmonization would be on the provincial treasury.”

I have seen at least one estimate from outside government. Michael Smart and Richard Bird wrote a chapter advocating harmonization in the John Deutsch Institute’s analysis of the 2006 federal budget. This chapter appears to have been replicated as a Rotman School working paper, which is available online.

The authors conclude that “provincial revenues would change relatively little in aggregate.” This conclusion is based on revenue gains in BC and Saskatchewan offsetting revenue losses in Ontario, Manitoba and PEI.

The authors estimate that harmonization in 2002 would have reduced Ontario revenues by $121 million, with $4,090 million less collected from businesses but $3,822 million more collected from consumers and $147 million more collected from municipalities, hospitals, etc. However, additional taxes paid by public institutions cannot be considered a net gain because these funds come out of provincial expenditures.

Therefore, the net cost of harmonization to Ontario’s treasury would have been $268 million per year. If the provincial government felt compelled to continue exempting certain consumer goods and services, the annual cost of harmonization would be even higher.

When the harmonization debate last flared up in 2007, I noted that the issue is overblown. The fact that PST applies to business inputs supposedly creates a disincentive for investment. However, most provincial sales taxes already exempt major purchases of machinery and equipment.

In Ontario in 2002, for example, business paid $4.1 billion in PST. However, only $1.0 billion was paid on capital goods. The remaining $3.1 billion was paid on construction materials, office supplies, and other intermediate inputs. If the provincial government’s goal is to encourage capital investment in Ontario, there are more targeted and cost-effective options than exempting all business inputs from PST through harmonization.