GST Senate Brief

June 26, 1990

To: The Standing Committee on Banking, Trade and Commerce The Senate

From: Canadian Research Committee on Taxation

Ben Sevack, President

Harry Payne, Secretary-Treasurer

Leo Klag, Director

John R. Ferguson, CFA, President, Ferguson-Alder Investment Counsel Ltd.

Francis K. Peddle, Ph.D., Director of Research

Re: Submission on the Federal Goods and Services Tax

EXECUTIVE SUMMARY

This Submission presents a critique of the economic theories which have been used to justify the imposition of a broad based consumption tax like the proposed federal Goods and Services Tax (GST). The critique focuses on the Report on the Technical Paper by the Standing Committee on Finance of the House of Commons. Public finance experts have, for the most part, assumed that the reform of the Manufacturers Sales Tax (MST) can only take place by means of a general consumption tax levied on all goods and services in Canada. This widely held assumption is challenged in this Submission.

The possible alternatives to the GST have been very narrowly conceptualized by the government. It is presupposed that the revenues to be raised by the GST can only be alternatively raised through increasing taxes on personal income or on corporate profits, either of which could cause damage to the international competitive position of the nation's economy. It is shown in this Submission that there is another viable alternative available to the government.

On the basis of the concept of interrelating the fundamental tax principles of ability to pay and cost benefit, the Canadian Research Committee on Taxation proposes that the proposed GST (or MST) and the corporate income tax system be replaced by a business earnings tax. The GST does not conform to the principles of ability to pay or cost benefit. It is therefore unable to meet the important tax objectives of equity, efficiency and simplicity.

A business earnings tax levied on the broad base of the total cost of the factors of production would raise sufficient revenues to replace both the MST and the corporate net income tax. Unlike the GST, this tax conforms to the principles of ability to pay and cost benefit. A business earnings tax meets the important tax criteria of fairness, efficiency, simplicity, reliability, certainty and neutrality. It would be a deflationary form of taxation, unlike the GST, that enhances the competitive position of all Canadian businesses. It is also a tax which is easy to comply with and collect. At the same time a business earnings tax would provide a reliable and stable source of revenue for the government at a relatively low rate because of its incidence on a broad base.

This Submission concludes with five sound and practical recommendations that are intended to be the basis for genuine tax reform. By abandoning the proposed GST, and developing in its place a business earnings tax, the federal government would take the lead in international tax reform instead of merely repeating the mistakes of other countries. The GST does not represent a modernization of the nation's tax system but is in fact an outmoded and counterproductive means of raising revenue for the government. A business earnings tax is a forward-looking alternative to the GST that will enhance Canada's position in the global economy while at the same time restoring fairness, certainty and simplicity to their rightful place in the nation's tax system.

INTRODUCTION

For the most part debate about the Goods and Services Tax (GST), both politically and in the more specialized tax literature, has unfortunately shifted from the broader issue of whether Canada needs a general consumption tax at the federal level to specific concerns about various technical aspects of the GST. Acceptance of the principle of a commodities tax system for Canada and submissions with respect to derivative issues and various adjustments was the main theme of the Briefs and testimony in hearings before the Standing Committee on Finance of the House of Commons last Fall. In this sense the government has, to date, avoided serious discussion about constructive and viable alternatives to the GST.

Nevertheless, opposition to the GST is very widespread. Indeed, it is one of the more glaring paradoxes of the current debate that while the general public does not support the GST, it is hailed in the academic community, and amongst public finance experts, as a positive step forward in the government's ongoing program of tax reform. How is this discrepancy to be accounted for?

Economists generally believe that the GST is widely misunderstood by average Canadians.[1] This is usually attributed to a lack of experience in North America with multi-stage or value-added taxes (VAT). The government is of the view that opposition to the GST is rooted primarily in inadequate information and is therefore nothing more than a public relations problem which can be eventually resolved.

It could equally be said, however, that tax experts by their very training are frequently unable to appreciate the degree to which the tax system has demoralized and frustrated the citizenry.[2] The basic economic and fiscal thinking behind a proposal like the GST represents a particular orientation towards the philosophy of taxation that has become deeply institutionalized in the educational structure of our economics and public finance professions. The government's proposal merely reflects this thinking. It does not subject such thinking to a critical examination.

Indeed, it could be argued that in many ways public opinion is well ahead of the public finance profession. The latter has failed to evaluate correctly the important psychological connections between highly intrusive and complex tax proposals like the GST, and the profoundly debilitating effect these proposals will have on entrepreneurial and commercial activity in Canada. Multi-stage consumption taxes became fashionable in the early 1960s in Europe in order to replace turnover, wholesale and manufacturers sales taxes. During that period the exercising of a high degree of government intervention in the market economy by means of the tax system reflected mainstream economic thinking. This thinking is now no longer predominant, but we are still left with its residual influence in the area of tax policy - an area in which it is much more difficult to bring about fundamental reform. It is for this reason that it can be said public opinion is intuitively well ahead of economic thinking with respect to tax policy in Canada.

Some of the basic flaws in the reasoning of public finance experts who support the GST, as reflected in the Report on the Technical Paper on the Goods and Services Tax (the Report) by the Standing Committee on Finance of the House of Commons and other publications, will be examined later in this Submission. The primary objective of the Canadian Research Committee on Taxation (CRCT) in this Submission to the Senate, as in our previous submissions to the House Finance Committee, which are appended hereto, is to present a theoretically sound and practical alternative to the GST that has been largely ignored by most public finance economists. Although the government is aware of the overall contours of this alternative, it has not conducted any significant empirical research into its merits or viability on account of an institutional inertia that has been created by the GST proposal and by the generally ad hoc approach to the taxation of business enterprises which colours the thinking of the Department of Finance.

This Submission is divided into three separate, but interrelated, sections. First of all, it critically examines some of the theoretical arguments put forth in support of the GST in Part A of the Report by the House Finance Committee. We are focusing on the Report, not because it presents a scholarly and comprehensive account of the theoretical rationales for consumption taxes, but because it reflects in a general way the segmented thinking of public finance and tax policy experts with respect to the Canadian tax system.

Secondly, this Submission discusses the principles of taxation which ought to guide the design of any tax system. There is widespread confusion about these principles amongst tax experts, which is both the result of and a contributor to their technical and fragmented approach to the design of our tax laws.

Thirdly, a system for taxing business enterprises, called a business earnings tax, will be described which not only accomplishes what those who support the GST say the improved federal sales tax will achieve but without any of the detrimental effects to the economy that will inevitably accompany the implementation of the GST. This system for taxing business enterprises, which benefits consumers, wage-earners and efficient businesses, will be compared on a point by point basis to the GST.

CRITIQUE OF THE REPORT OF THE HOUSE FINANCE COMMITTEE

The words of Macaulay with respect to direct taxation are instructive. Referring to the ignominious "hearth" tax or tax on chimneys, he stated that it:[3]

"brought forth greater murmurs. The discontent excited by direct imposts is, indeed, almost always out of proportion to the quantity of money that they may bring into the Exchequer".

Although the GST is technically an indirect tax because it is remitted to the government by businesses, who will act as collection agencies - indeed the GST will turn almost every business person in the country into a tax collector - it will undoubtedly create great discontent amongst consumers for whom it will certainly seem to be a direct impost. The number of registrants will go from 75,000 under the antiquated Manufacturers' Sales Tax (MST) to over an estimated 1.6 million registrants, and possibly more given the experience of other countries, under the GST.[4] Historically, it has been the methods of taxation that have caused otherwise sedate citizens to be outraged, for example, the poll tax in Great Britain.

The manifold problems of compliance and collection are not, however, the primary reasons why the GST ought to be rejected as itself an antiquated and unsound method of raising government revenues. General consumption taxes should be avoided because the economic and fiscal theory used to justify these taxes is fundamentally flawed.[5] The Report of the House Finance Committee, as well as the GST Technical Paper, are both illustrations of confused thinking with respect to the basic principles of taxation. Until the theoretical orientation behind the GST proposal is subjected to proper criticism, it is unlikely that those involved in the tax reform debate will discern the correct alternative to the GST.

In Chapter One, "The Need for Sales Tax Reform" of Part A of the Report of the House Finance Committee there is a short repetition of the usual arguments for replacing the MST that can be found in numerous government and academic publications.[6] These publications cite the narrow base of the MST, its wide variation in effective rates, discrimination in favour of imports, tax cascading and unreliability as the chief reasons why the current federal sales tax must be replaced. These criticisms of the MST are apropos, as far as they go, although it should be noted that the government publications are devoid of any historical perspective on why the federal sales tax system collapsed into such an "ad hocracy" of administrative directives and dubious tax rulings. That it may very well be in the nature of a consumption tax to deteriorate into a highly arbitrary system of classifications is not usually addressed by the professional tax community.[7] If the generally oppressive nature of consumption taxes do necessarily lead to a porous and unwieldy tax base, then the future administrative efficiency and interpretive development of the GST system does not augur very well for the Canadian economy.

It is in Chapter Two, "Alternatives to the Existing Federal Sales Tax", of the Finance Committee Report that one finds a limited attempt to justify theoretically the GST. The arguments are framed within the context of "income vs. consumption" taxes. The Finance Committee undoubtedly felt obligated to address the issue in such terms because of the large number of submissions, primarily from organized labour and anti-poverty organizations, to the effect that there should be a "shift in government revenue sources towards a greater reliance on income taxes" (Report, p.19).

The argument for a greater reliance on income taxes by organized labour and the anti-poverty organizations is based on the position that income taxes are progressive, and thus more vertically equitable, while consumption taxes are regressive and thus vertically inequitable. Such a comparison invokes only the principle of ability to pay as the sole and equitable foundation of the nation's tax system.[8] The theoretically progressive structure of the income tax system has, however, produced the odd result that it is, de facto, more or less regressive at the upper and lower ends and roughly proportional in the middle.[9]

The Finance Committee challenged the arguments about the regressivity of consumption taxes on the basis of the principle "that what people take out of the economy through consumption is a fairer basis of taxation than what they contribute to it in the form of income" (Report, p.20). This argument is quite prevalent in the study of economics.[10] It is rarely criticized or even analyzed with respect to the presuppositions that lie behind it, which reflect the traditional antagonism in political economy between producers and consumers. There are, however, a number of problems, outlined below, with regard to the "claims on the community's resources" principle for justifying general consumption taxes. As will be seen, however, the main problem is that this principle has been misinterpreted by public finance experts as applicable only to the consumption side of the production equation.

First of all, this principle assumes that consumption is an inherently negative activity. As such, consumption is put into a parasitic relationship with production, which is approached as an activity that takes place irrespective of consumer needs. Such an argument is theoretically unsound because it divorces productive activity in the economy from consumption. Without the latter, however, or at least the anticipation of future consumption, usually expressed as "aggregate effective demand", there would be no investment, no productivity and no employment. Consumption is therefore in a dialectical, positive and inseparable relationship with productivity. Negate consumption and productivity is also necessarily negated, all other things being equal. The productive pool is not therefore diminished by dissaving, but in fact enhanced by it.[11] Modern economic thinking, however, has created the myth that investment, productivity and employment depend crucially on a nation's savings rate. This myth follows from the view, which is embedded in both Marshallian and Marxist economics, that capital formation and investment are the primary determinants of productivity.

Capital, in fact, is merely stored up labour or self-denial. The capital stock of a nation is the residuum of total output in the economy that can be subsequently drawn upon by the community at large to further sustain and enhance that output. Labour and nature together are respectively the active and passive factors of production, capital being the result of their interaction. If tax systems inordinately burden labour and thus raise labour costs, as does the GST, then it is inevitable that there will be a decline in productive economic activity. Any merits attributed to the GST in terms of an increase in the capital stock of the country are wholly relative to the present unnatural and inefficient form of federal sales taxation. With the GST, however, we are merely replacing one form of highly unnatural tax with only a slightly less unnatural version. Both taxes are, however, in principle, no less contrary to the economic and commercial interests of the country.

Secondly, limiting claims on the community's resources by means of the tax system assumes that the government has the right to regulate such claims and not the individual. In doing so, however, the government is onesidedly concentrating on demand management, and the redistribution of existing wealth, especially intergenerationally, instead of encouraging productivity - the lack of which is the primary cause of inflation in the nation's economy.[12] The complexity of the GST flows from the counterproductive and unnatural base upon which the tax is levied, namely, final consumption expressed in individual sales transactions. This complexity is also ultimately based on the view that government ought to play a highly interventionist role in the economic management of the economy. For instance, on the macro-economic level the GST will probably have some influence on the overall savings rate. At the level of more particular transactions it will artificially affect the activities of certain individuals. A typical example of this can be found in such arbitrary rulings, as recommended by the House Finance Committee, that "per diem rentals of residential units at a cost of $20 or less be exempt supplies" (Report, p.142).

Thirdly, it cannot be simply assumed that through savings the individual is putting resources back into the productive pool. This view comes from the onesided emphasis in contemporary economic thinking on capital as the source of all productivity. The tax system today often encourages the wasteful, misdirected and inefficient use of the capital stock of the nation. The ultimate source of productivity is human effort acting on the raw materials of nature. Capital is a residual category that flows from the interaction of human effort and nature. The manipulation of the utilization of capital by means of the tax system is, however, an aspect of the collective, rather than the individual, steering of economic activity which usually results in the misallocation of resources in the form of a mismatch between supply and demand.[13]

The historical failure of collectivist economies and command systems of allocation is one of the great lessons of the twentieth century. Unfortunately, the GST proposal is representative of collectivist thinking with regard to economic management. It is only by removing disincentives, or rather by decreasing the obstacles, with respect to the role of human effort in creating and providing goods and services, that productivity will increase and socially beneficial activity be encouraged, or at least not be systematically stymied, by tax policy. From this perspective it can be seen that the GST throws up yet another obstacle to the free employment of human effort. It is a very counterproductive way to raise revenues for the government.

Another argument stated in the Report of the House Finance Committee, and in many economic publications, is that income taxes violate the principle of equity in taxation because they tax savings twice. The Report declares (p.20):

A basic principle of equity in taxation is that individuals of similar economic capacity should be taxed similarly. Income taxes fail to satisfy this principle. They tax more heavily persons who save than persons with the same income but a higher propensity to spend. This is because income taxes tax savings twice, once when income is first received and then again when savings from that after-tax income yield a return. Thus, for instance, two individuals with the same initial endowments would pay the same income tax the first period, but the individual with a stronger preference for savings would bear a higher tax burden in later periods. The stronger the preference for savings, the heavier the additional burden.

The burden of consumption taxes, on the other hand, is independent of the time path of consumption. Of two individuals with the same income, the one who saves more is taxed less at first, but more in later periods when he spends his savings. On a present value basis, the tax burden is equal for both individuals.

There are a number of questionable economic assumptions in these statements that consumption taxes are fairer and more efficient than income taxes. First of all, it is necessary to grasp the meaning of the results of general equilibrium analysis that is based on the fact that over a lifetime an individual consumes all his income.[14] This analysis presupposes that the relation between income and consumption tax rates will remain static during one's lifetime and that the tax base of a consumption tax will not become porous over time. Consumption tax rates in VAT countries have historically increased.[15]

The inevitability of these increases is primarily based on the fact that taxes tend to diminish the base upon which they are levied. As consumption declines, or is artificially restrained and misdirected, because of taxation and the expansion of the underground economy, particularly with regard to services, it becomes more and more necessary to raise the rate in order to maintain the same amount of revenue from the tax. All taxes on individual economic activity, which violate individual property rights, have an inherent tendency towards a steadily narrowing tax base with an accompanying increase in rates, which is necessary in order to stabilize or increase revenues. A positive tax would result in an increase in revenues through the expansion of the tax base and not an increase in the tax rate.

If a consumption tax encourages a certain degree of savings at the time of its introduction, then the expenditure of those savings at a later point in time at a higher rate does not "equalize" the tax burden of individuals with respect to those who spend the same amount of income initially. Furthermore, those with a propensity to spend rather than save are treated more harshly by the GST than under a proportional income tax.

The example of the fairness of a consumption tax with regard to economic capacity given in the Report is based on a formal economic model that is completely divorced from the shifting realities of tax rate changes, of national fiscal policies and of the varying relations of consumption to income. In addition, the argument for the fairness of consumption taxes based on the tax incidence results of general equilibrium analysis, which recognizes the totality of the lifetime expenditure of income, seems intuitively perverse to many because it does not address the very real needs of low and middle income earners at the points in their lives when their taxable capacity is greatly diminished. Along with high interest rates, the GST is a form of fiscal policy that is inherently biased against younger people starting out in life or those most in need of adequate housing and the other necessities which accompany the raising of families.[16]

Like their analysis of the income tax system, economists tend to view consumption taxes from the limited context of the ability-to-pay principle. Tax reform in Canada will never address the economic concerns of average Canadians until it is recognized that the ability-to-pay principle must be interrelated with the benefit principle. Only then will the appropriate tax base for individuals, business enterprises, and property be accurately discerned.

This is also a reason why the regressivity of consumption taxes cannot be looked upon in terms of the lifetime incidence of the tax. When economists insist upon measuring the incidence of consumption taxes in terms of lifetime savings and spending patterns, it is obvious that the incidence of the tax will be more proportional than regressive (Report, p.21). However, extending the accounting period does not reduce the regressivity of current consumption taxes in relation to income - it refers only to postponed consumption. This is why it is necessary to provide refundable tax credits through the income tax system in order to offset the regressive nature of the GST on lower income groups.

The assumption that income taxes result in the double taxation of savings also needs to be critically analyzed. The view that the taxation of the after-tax yield on savings results in double taxation comes from a misunderstanding about how capital produces income. It is presupposed in the Report that the income yields from after-tax savings are doubly taxed by income taxation because such income is thought to be old income, that is, already taxed income. But such income is really reflective of the new income that comes from additional productivity. The income does not therefore arise directly out of capital itself, but out of the productive utilization of that capital which in turn creates new earnings. Since all earnings are properly included in the income tax base, such yields, i.e., investment income, should be a part of the taxable income of individuals. It should also be remembered that a proportional income tax would tax present and future income equally. The arguments with respect to the efficiency of consumption taxes vis-a-vis income taxes in the Report are therefore only partially valid in relation to the current progressive income tax system.

It should also be remembered that consumption taxes are paid out of after-tax income. They therefore constitute in themselves a form of double taxation. This is not recognized in the Report, nor is it mentioned often in the tax literature. The income tax system is relied upon by the government to reduce the regressivity of the GST, while at the same time it is conveniently ignored when policy analysts resort to formal economic models to argue for the supposedly inherent fairness and efficiency of consumption taxes.

A brief word also needs to be said about the nature of assumptions and the use of stipulative definitions in the practice of modern economics. It was a source of constant frustration for members of the House Finance Committee to hear widely divergent views from members of the economics profession, and from the nation's economic think tanks, about the effects the GST would have on productivity or total output, employment, capital investment, inflation, interest rates and so on.[17] The assumptions behind the generation of macro-economic models with respect to the GST and productivity, etc. rest primarily on guesses about how organized labour, the Bank of Canada and other groups and institutions will respond to GST-induced inflation, about how the spending habits of Canadians will change because of the tax and about how labour-intensive service industries will react to a fall-off in consumer demand caused by the GST and the redistribution of the federal sales tax burden to the service sector.

In other words, the economics profession obviously has a very difficult time quantifying the psychological reactions to the negative impacts of the GST on the economy. They therefore make assumptions about such reactions, or try to ignore them, and proceed to create quantitative models thereon. There are historical reasons why the practice of economics has become considerably narrowed in focus in recent decades. The nature of the profession has radically changed. Most economists are now "economic forecasters", or "economic mathematicians". They do not resemble the classical political economists, who had broad backgrounds in philosophy, ethics, jurisprudence, history and so on, and who articulated the conceptual foundations of the discipline. It is for this reason that modern economists are by and large unaware of the need or necessity of arguing conceptually from the standpoint of tax principles.[18]

Economic models are deductively accurate given the assumptions, and the economics profession thereby retains its scientific authority, while politicians and the general public are left to quibble about which assumptions offer the more insightful description with respect to how individuals will react to the tax. If the tax system were inherently harmonious with the basic economic and commercial interests of individuals and businesses, then it would only be secondarily necessary to engage in highly elaborate mathematical games about the degree to which an economically adverse tax proposal, like the GST, will affect spending patterns, compensation packages and so on. In other words, the acceptability or unacceptability of the tax would not be based upon the economists' usually less than accurate predictions about the effects of the tax on the economy.

The varying assumptions about the impact of the GST do, however, come together on the uniform view within the economics profession that the short-term effects of the GST will be perilously negative and the long-term effects will only be marginally positive. This in itself should be sufficient to reject the proposal because most agree that the GST raises significantly, at this point in time, the economic risk factors for the economy as a whole, given that the underlying broad indicators are already quite weak.

The economics profession has failed to rise to the occasion of genuine tax reform because it has not developed tax proposals, which have already been formulated to a certain degree, that would universally benefit lower and middle income Canadians, that is, lower the incidence of taxation on labour income, while at the same time substantially fighting inflation and interest rates, increasing productivity, infusing a greater degree of equity into the tax system as a whole, creating more efficient and competitive businesses and radically simplifying tax compliance and collection thereby enhancing administrative efficiency.[19]

The Report also betrays an underlying bias toward governmental interventionism in the economy when it talks about the manipulation of individual preferences (Report, p.20). Whether one prefers to save or spend earned income should be a decision made solely by the individual. There cannot be an efficient utilization of resources if individual economic choices with respect to saving and spending are predetermined, and thus usually distorted, by the tax system. A rationale often put forth for a consumption tax is that it will increase the savings rate thus making a larger pool of capital available for investment and economic growth. Investment is, however, determined primarily by anticipated demand for goods and services. There is little empirical or historical evidence to substantiate the argument that a higher savings rate in itself will necessarily lead to greater economic growth. It is, however, well known that the artificial interference by governments in individual economic and business decision-making creates a high degree of inefficiency in the economy.

It is also argued in the Report that consumption taxes are more neutral than income taxes with respect to individual decisions as to whether to save or spend. The important tax concept of "neutrality" refers to the idea that a tax is more neutral the less it impacts on or distorts individual economic choices and the decisions of business enterprises. There are many levels of non-neutrality in the GST proposal, some of which are inherent to consumption taxes and others which are peculiar to the design of this particular tax.

The highest level of non-neutrality with respect to the GST is in fact the opposite of what is asserted in the Report. Although consumption taxes tax present and future consumption equally, if the rate remains constant, they create an economic bias in the economy towards saving rather than spending or dissaving. Consumption taxes are therefore non-neutral by definition in relation to proportional taxes on earnings.

Another non-neutrality in consumption taxes relates to spending on discretionary items and on the necessities of life.[20] It is obvious that consumption taxes will affect more adversely discretionary spending than spending on necessities. Spending on goods and services which are perceived to be luxuries, such as vacations and in the area of arts and culture, will be cut back.[21] The GST is therefore non-neutral with respect to various types of spending. It will thus distort individual economic choices in relation to various industries. This in turn will necessitate different kinds of governmental intervention, such as increased subsidies to the tourism and cultural industries, either directly through grants or indirectly through tax expenditures.[22]

There are also a wide range of non-neutralities that are peculiar to the GST proposal. For example, it is universally recognized that collection and compliance costs will impinge the most on small businesses.[23] This is why special measures are being introduced to streamline accounting procedures for collecting the GST in the small business sector.[24] Such measures only increase the complexity of the tax, which further negates its neutrality, creates more inefficiency in the economy, and heightens the possibility of an increase in the rate.

The various distinctions between taxable, exempt and zero-rated supplies will produce a spectrum of non-neutralities as various businesses seek different tax status for their goods or services in order to maximize their competitive position. There is a large non-neutrality, for instance, between the export and import sectors given that exports will be zero-rated under the GST.

The zero-rating for exports is a result of the "destination principle" that is usually associated with VAT-type taxes. This principle states that a multi-stage sales tax, like the GST, should have its incidence at the final stage of consumption. Since exports result in consumption in foreign jurisdictions over which the government cannot exercise any control, they must be zero-rated. It is also argued by the government that the zero-rating of exports will produce a level playing field for the export sector of the economy.[25]

The destination principle has caused immense problems in the European Community.[26] It will probably be the greatest obstacle to true economic integration amongst European countries in the 1990s. The zero-rating of exports also violates the important cost-benefit principle of taxation since businesses which export their goods and services benefit from social goods yet they will pay nothing, either by themselves or through their consumers, on account of the GST for the provision of these services because they will receive a complete reimbursement for GST-paid through input tax credits.[27] It also means that the Free Trade Agreement between Canada and the U.S., and the important liberalizing trade principle of "national treatment", will be undermined in spirit, if not technically, since exports are treated differently from imports.[28] Even more importantly, the GST will raise unit labour costs and business administration costs in Canada, which U.S. consumers and producers will not have to bear. This will force many Canadian businesses to go south of the border in order to remain competitive.[29]

The cascading of provincial sales taxes on GST-included prices is also a non-neutrality, especially given the varying provincial rates. A reason why the draft GST legislation is being put in the Excise Tax Act is to avoid the problem of requiring the provinces to amend their sales tax laws that for the most part require the provincial retail sales tax to be levied on top of federal customs, excise and sales taxes (Report, pp.30-31). The GST will also create regional non-neutralities with respect to transportation costs. This will make it more difficult for the outlying regions to develop industries which sell in central Canada and likewise goods and services from central Canada will cost more to the final consumer in outlying regions.

There are a myriad of other non-neutralities in the GST proposal that could be detailed at length, such as the issue of tax-exempt suppliers who cannot get rebates, will move toward self-supply, the difference between basic groceries and prepared foods, the artificial organization of businesses, discrimination in favour of foreign tourists, the impact on the housing and non-profit sectors, dual-status organizations, the allocation of input tax credits amongst subsidiaries and so on. All of these complexities together seriously erode any possible claims that the GST is a neutral tax that will be very different from many of the perverse characteristics of the MST.

Another myth expressed in the Report has to do with the issue of the overall balance of the tax system (p.21). The Report takes the view that if the burden of raising government revenue is divided among several revenue sources, then no single source should be utilized to the point of generating unacceptable distortions in the economy as well as creating inequities. The assumption in this view with respect to a "balanced" tax system is that since individual circumstances differ in so many ways no one index of taxable capacity could possibly be sufficient to guarantee the overall equity or efficiency of the tax system.

Such an approach to taxation starts from the standpoint that only individuals can be taxed, that is, it relies on the position that there can only be in personam taxation. All levels of government generally focus their tax policies on taxable events engaged in by individuals. That is, when people do something it becomes taxable. We call this in personam taxation because taxes become payable or exigible when a person engages in a commercial or socially beneficial activity. For example, if you improve your house to a sufficient degree, it is re-assessed and your property tax increases. If you work over-time, you may find yourself in a higher tax bracket, and thus will have progressively less income, even though you have worked harder. And if you contribute to the ongoing commercial activity of the nation by purchasing various consumer items, you pay more to the provincial and federal sales tax systems. The incidence of taxes is therefore solely on those activities that are good for the economy and which generally benefit the community. We thus measure the taxable capacity of the individual per se, as reflected in beneficial economic and social activity as the fundamental bases for levying taxes.

A balanced tax system is only an issue, however, in relation to the flawed tax systems that currently comprise the Canadian tax mosaic. It is because the income tax system, both with respect to individuals and corporations is so fundamentally skewed with respect to the circuitous and excessive taxation of individuals and uncertain with regard to the effective incidence of taxation on corporations that a general tax on consumption appears to mitigate some of the distortions inherent in the income tax system.

It is seldom realized, however, that corporations have never been taxed in Canada because the profits or net income tax is really a tax on individuals, either as shareholders, employees or consumers. If we had a neutral proportional rate of tax on individual incomes and a single rate on the earned income of all business enterprises, that is, a tax on that part of the income of business enterprises which is used to earn income and create wealth, then a multi-stage consumption tax like the GST would reveal itself more truly as a highly counterproductive, non-neutral, and inequitable means of raising revenue for the government.

It is because the modern discipline of tax economy has not adequately articulated sound principles to guide the formulation of tax policy, that all the arguments in favour of the GST are merely relative to the present chaotic tax structure and not to an objective standard for judging how taxes should be designed. In order to situate the GST within the larger context of the discipline of tax economy, and thus illustrate the basic flaws in its conception and design, it is necessary first of all to turn to the fundamental principles of taxation.

THE PRINCIPLES OF TAXATION

The objectives of equity, efficiency and simplicity are normally understood as the basic principles of taxation in the contemporary literature on tax economics. These objectives are, however, aspects of the implementation of sound taxes which flow naturally from a more fundamental understanding of what constitutes a coherent philosophy of taxation. Stated propositionally, the unifying concept of a philosophy of taxation is the interrelation of the principles of ability to pay and cost benefit. Equity, efficiency and simplicity are conditioned by this interrelation just as the principles of ability to pay and cost benefit reciprocally complement and condition each other. The various approaches to taxation predominant in the current tax reform debate emphasize onesidedly either primarily the principle of ability to pay or cost benefit, the latter usually in the form of user fees. In and of themselves the two principles are deficient and inadequate, yet a recognition of the role of both in designing a tax is necessary in order to develop a comprehensive and harmonious system of taxation.

A onesided emphasis on the principle of ability to pay has led to a narrowing of the focus of tax thinking on the taxable capacity of individuals. A structuring of the tax system solely on the basis of the benefit principle would necessitate an impossibly strict accounting of the tax cost of all the direct and indirect expenditures of government which benefit individuals and businesses. Governments provide a wide range of social and merit goods, such as law and order, defence, education, the upkeep of parks and so on, which are jointly consumed by the population. It is extremely difficult to quantify the benefits to each individual and business of the provision of these goods. Likewise, the ability-to-pay principle has never been and can never be precisely defined. The arbitrary manipulation of what constitutes ability to pay is central to the development of an interventionist governmental policy with respect to the economy. Ability to pay as reflected in our tax laws has therefore become confined primarily to labour income.[30] In other words, the incidence of taxation is now primarily determined by the ability of the government to collect taxes from those who have the least ability to resist taxation.[31]

Benefits and privileges from the government and the community at large do, however, determine to a substantial degree the taxable capacity of individuals, business enterprises and property ownership. These benefits are both direct and indirect. They enhance the ability to pay taxes of individuals, businesses and property. The present task is to identify accurately at what point the earnings of these three taxable entities benefit from the provision of government goods and services, thus increasing their ability to pay, and thereby becoming the appropriate base for taxation to support local, provincial and federal government.

The interrelation of the principles of ability to pay and cost benefit was recognized in the history of political economy by such writers as Adam Smith and Henry George. Their writings illustrate the necessity of integrating how we go about levying and collecting taxes with how individuals and businesses conduct their economic and commercial activities. The present tax system discourages everything that is beneficial to the community and the economy, while encouraging those things which are deleterious to the socio-economic order.

The corporate net income or profits tax encourages cost inflation and inefficiency because the tax is levied on a base that only reflects a company's supposed ability to pay. The present corporate tax system subsidizes waste and encourages the flow of capital into less productive enterprises. It is also a very inequitable tax because many corporations are able to avoid it altogether while certain sectors as a whole are able to reduce substantially the incidence of the tax in that sector.[32]

According to the ability-to-pay principle, profits are to be understood as the indicator of the taxable capacity of a corporation. It is important to remember, however, that profits do not belong to a company per se, but to its shareholders. The noted economist Irving Fisher stated:[33]

It is interesting to observe that a corporation as such can have no net income. Since a corporation is a fictitious, not a real, person, each of its items without exception is doubly entered. Its shareholders may get income from it, but the corporation itself, considered as a separate person apart from these stockholders, receives none.

The profits tax is therefore fundamentally a tax on individuals, i.e. stockholders, and not on the corporation itself.[34] Although corporations and business enterprises in general are not real persons, they are distinct economic entities and organizations that contain their own synergy and dynamic. As such they directly and indirectly receive substantial benefits from the provision of governmental goods and services. Like individuals it is therefore reasonable that business enterprises reimburse government for the cost of these expenditures. Government services reduce business costs or the factor costs of production. This is why taxes should themselves be considered as factor costs.

The earnings of a business enterprise, as reflected in its cost of sales statements, are divisible into three distinct components. First, there are the expenditures made in purchasing goods and services from other businesses. Secondly, there is the income expended in employing the factors of production that have resulted in the creation of value added or the creation of wealth. Finally, there is provision in the earnings of a business for profits, or net income, which is represented by the excess of total income or earnings over total costs. We currently attempt to tax businesses on the basis of the last component. The GST does not tax businesses per se, but the final consumer. Nevertheless, because the final consumer must pay for the GST out of after-tax earnings which will in all likelihood be compensated for by businesses, it follows that the GST indirectly affects the costs of value added since a large percentage of value added is comprised of wages and other employee benefits. Business enterprises are therefore being affected by the tax system in many indirect and unnatural ways. The object of tax reform should not be to increase the indirect effects of taxes, which is what the GST does, but to clear away unnatural indirect taxes in favour of direct taxes that fall upon the appropriate component of the earnings or income of business enterprises.

We are proposing that the corporate income tax system, which yielded $11.3 billion in fiscal 1988-89 and total federal sales taxes, which raised approximately $18 billion during the same period, be collapsed into a single tax on the earnings of all business enterprises in the country. This would be a tax on businesses which is levied on the second component of total business earnings or business income mentioned above, that is, that part of a business's cost of sales which reflects its expenditures on the factors of production which are employed in the creation of value added. This tax can be called a business earnings tax. The single rate should apply to corporations, sole proprietorships, partnerships, cooperatives and all other businesses which are engaged in adding value to natural resources or goods and services purchased from other businesses.

In the tax literature this tax has sometimes been referred to as a "factor tax".[35] It bears some relation to the argument, mentioned above, which structures taxation on the basis of what is taken out of the economy because, unlike the corporate profits tax, it increases the rewards for efficiency while at the same time increasing the penalties for using scarce resources inefficiently. However, the primary rationale for a business earnings tax is that it is the only method of taxing business enterprises which conforms the most to the interrelation of the principles of ability to pay and cost benefit. The fact that this tax encourages the efficient use of a community's resources is only one, among many, benefits which flow naturally from its instantiation of the unifying principle of taxation.

That a business earnings tax, or a proportional tax on the factor costs of production, is the most logical way to tax business enterprises can be discerned negatively in terms of the inequities and inefficiencies of placing the tax on the other components of corporate or business income. The CRCT has documented extensively the panoply of criticisms of the corporate profits tax in its study Business Earnings Tax: Creating a More Productive Economy Through Positive Taxation. The fundamental unreliability of the corporate income tax system is demonstrated in the continually declining revenues raised which are accompanied by increasing compliance and collection costs. Over the past twenty years profits as a proportion of the Gross Domestic Product (GDP) have declined over 50 per cent. Much of this decline can be attributed to systematic profit disguising by many corporations seeking to avoid the profits tax. The corporate net income tax system rewards inefficient companies, displaces business decisions and management with tax decisions and planning, encourages creative accounting and the artificial inflation of costs, promotes debt over equity financing, necessitates high, and internationally uncompetitive, rates because of its narrow base and is biased towards capital intensive rather than labour intensive industries. The corporate income tax system is fundamentally flawed in design. This is the reason why the government has to resort to such ad hoc and artificial methods of taxing corporations such as the capital tax on large corporations.

It has been proposed that an alternative to the GST could be a tax on the gross revenues of companies.[36] This would be a tax on the total revenues of a business or all three components of business income mentioned above. This tax would not, however, eliminate the problem of tax cascading for it would be entirely up to the business as to whether the tax it pays on the purchase of goods and services would be passed on to its customers or absorbed into its return on capital or taken out of employees' wages and so on. Secondly, tax avoidance would still be advanced through the minimization and disguising of profits. It therefore does nothing to discourage artificial business structuring and categorization of costs. Thirdly, there would still be little advance in what should be an overall goal of the tax system - the creation of more efficient businesses and thus making them more competitive both domestically and internationally. The primary advantage of a tax on the gross revenues of companies is its simplicity. This is, however, a simplicity that is achieved at the cost of efficiency and of harmonizing the tax system with commercial and business activity.

The most logical and natural component of business income upon which to levy a tax in order to pay for the benefits the business enterprise receives from the government is the income it receives in its cost of sales statements that reflect what it has expended on the factors of production in creating wealth. It is that component of business income or earnings which best mirrors in general the direct and indirect benefits received from government expenditures and at the same time it is that aspect of the income of a business which most accurately reflects its ability to pay tax or which is an indicium of its taxable capacity.

It is the view of the CRCT that a breakdown of an analysis of the estimates of GDP for 1991 would indicate a proportional tax in the 15 per cent to 20 per cent range on all business enterprises would be sufficient to replace the revenues from both the current corporate income tax and the proposed GST.37 Although the total figures are readily available to government, the data on the overall factor costs of production, processing or assembly in the economy needs to be properly disaggregated and analyzed. These costs include overall employee compensation and benefits, or the aggregate of unit labour costs; the costs of inspection, testing and quality control; developmental, design and engineering costs; the costs to fixed capital such as maintenance and repairs; taxes; economic depreciation; advertising and promotion and so on. In other words it would include all those costs that are directly incurred in, or which can be reasonably allocated to, the production of goods and services.

The imposition of a business earnings tax would create an incentive for more accurate cost accounting and thus over time the total direct costs of adding value to raw materials and goods and services, or the reasonably controllable costs of businesses, in the economy would become more readily transparent in the financial statements of businesses, which would then be reflected in the national accounts and the macro-economic figures for the nation.

The business earnings tax is therefore fundamentally a proportional income tax on all business enterprises. The incidence of this tax would be directly identifiable in the cost of production accounts of business enterprises. It is an accounts- based tax that would completely eliminate the need for identifying each transaction for tax purposes, by means of invoicing, as under the GST. Nor would it be necessary for businesses to calculate input tax credits under the business earnings tax, since purchases of goods and services from other businesses, or what are now usually referred as "business inputs" upon which taxes are already paid, would be completely factored out of the tax base. The business earnings tax would therefore radically simplify a large part of the overall system of federal taxation, while at the same time significantly increasing equity and efficiency.

BUSINESS EARNINGS TAX VS. THE GOODS AND SERVICES TAX

The following is a point by point comparison of the superiority of a business earnings tax over the GST and the corporate net income tax. Although a business earnings tax is a tax that reflects a comprehensive approach to taxation, and which is designed to replace a number of taxes that excessively tax labour income and indirectly businesses in an unnatural and haphazard manner, we have limited this comparison primarily to the main arguments presented by those who advocate the GST. The purpose of this section is to demonstrate how a business earnings tax would achieve a wide range of positive objectives without any of the negative effects of the GST.

The Tax Base

It is argued by the government that the GST is necessary to replace the MST because it is very narrowly based. The GST does more than replace the MST, however, since it significantly shifts federal sales taxation from the manufacturing sector, which is a declining sector of the economy, to the service sector which now comprises over 70 per cent of the nation's economy. It should also be noted that the corporate income tax is also levied on a steadily declining tax base.

A business earnings tax would be levied on the widest possible base in the economy - the total direct costs incurred by business in order to create the aggregate value-added in the GDP over any given year. Since this tax would be harmonious with the efficiency objectives of businesses, it would increase total output in the economy. The very nature of a business earnings tax would therefore result in an expansion of the base upon which it is levied. It would reverse the usual tax situation, which will also occur under the GST, where rate increases are necessitated because of a relatively diminishing tax base. The extremely wide tax base for a business earnings tax would allow for lower rates relative to the current corporate income tax and the proposed GST. Tax Neutrality

The government believes that the GST ought to replace the MST because the latter distorts production and distribution decisions. However, the many non-neutralities in the peculiar design of the GST greatly erode the validity of this argument. The supposed neutrality of the GST is only relative to the MST, which everyone agrees is a hopelessly untenable tax. For this reason it is a very poor standard by which to judge the viability of its replacement.

A business earnings tax is neutral with respect to production, managerial, corporate structuring and distribution decisions. It is neutral with respect to the decisions of businesses to engage in equity rather than debt financing, since interest on debt incurred for the purpose of earning income would no longer be deductible. Decisions with regard to replacing labour with capital would be made for business reasons rather than on account of the availability of capital cost allowances and other tax incentives. Furthermore, decisions as to whether to operate through branch plants, subsidiaries, associated companies or divisions would be made for business rather than tax reasons. Uniformity, Inflation and Deflation

It is argued that the GST, unlike the MST, will greatly reduce varying tax effects on prices. The lack of uniformity in the effective tax rates of the MST results from it being applicable to only the manufacturer's selling price of the final selling price. The GST will be more uniform than the MST, although its uniformity will be relative not absolute. The GST will, however, be inflationary. The degree to which it will be so depends on any number of economic and psychological assumptions.
The business earnings tax will be uniform, but more importantly it will be deflationary. Under this tax businesses will have two good reasons to reduce costs - to increase profits and to decrease taxes. The efficiency arguments in favour of the business earnings tax are crucial to creating greater productivity in the economy as a whole and thus attacking the fundamental cause of inflation which is the lack of productivity. Tax Cascading

The arguments of the government with respect to the bias in the MST in favour of imports and the tax cascading which increases the cost of investment have already been touched upon in this Submission. The exclusion of marketing and distribution costs from the MST tax base and the artificial creation of associated companies by Canadian firms in order to avoid the inclusion of these costs is a well known problem with federal sales taxation that has contributed considerably to a decline in revenue. The words of Adam Smith are, however, apposite to these developments:38

An injudicious tax offers a great temptation to smuggling. But the penalties of smuggling must rise in proportion to the temptation. The law, contrary to all ordinary principles of justice, first creates the temptation, and then punishes those who yield to it; and it commonly enhances the punishment too in proportion to the very circumstance which ought certainly to alleviate it, the temptation to commit the crime.

There would be no tax cascading with respect to a business earnings tax since the purchase of goods and services from other businesses would simply be factored out of the tax base or rather not included in it ab initio. Likewise, the certainty and equity of the tax would be the highest achievable since all businesses would be treated exactly the same with respect to the their direct costs of production and there would be a single proportional rate on all enterprises irrespective of size or legal status. Simplicity and Administrative Efficiency

The government argues that the MST must be replaced by the GST because it is too complex. No one can doubt that the 22,000 administrative directives which govern the application of the MST are an absurdity. The Regulations for the GST have not yet been released but it is obvious from the draft legislation before Parliament that we are dealing with a replacement that also will be extremely complex, primarily because of the non-neutralities inherent in general consumption taxes and on account of those peculiar to the GST. Since the GST is an individual transaction based tax, extreme complexity will necessarily be a part of its administration. BR

A business earnings tax is a simple and administratively efficient levy. It would be based on the already existing financial statements of all businesses which now have to be filed with Revenue Canada. It would not be necessary to create a new bureaucracy to administer the tax or to have each individual business keep track of every transaction. The bureaucracy that has developed around the MST could be dispensed with. In addition, accountants would be more productively employed as cost, rather than tax, accountants in helping businesses become more efficient and competitive. Certainty

The government argues that it is necessary to have the GST because the MST is unstable and uncertain on account of court challenges to its archaic legal structure. It is obvious, however, that the complexity of the GST will also cause a considerable amount of litigation and tax planning because of the complex rules and administrative directives that will undoubtedly accompany its implementation.

A business earnings tax would secure the certainty of incidence and the certainty of liability of the tax. In other words it will be quite easy for the government to assess the liability of taxable business entities. Little will be left to the discretion of tax officials. Since all businesses necessarily incur costs, there will be little need for tax liability to be determined by the courts or the administrative discretion of the tax authorities. The business earnings tax would therefore be a single unavoidable tax on all businesses that would no longer necessitate consideration of a minimum tax on companies which manage to manipulate the tax system to their benefit and the disadvantage of other taxpayers.

CONCLUSION

The CRCT in this Submission to the Senate has shown that many of the economic rationales for implementing the GST are seriously flawed. These rationales do not conform with the fundamental principles for tax design in the modern world. The CRCT is of the view that a general consumption tax, like the GST, will do nothing to enhance the equity, efficiency and simplicity of the overall tax system in Canada. Nor will it contribute in any significant way to the growth of productivity in the nation's economy. There are very few redeeming features to the GST and these are only so in relation to the wholly inadequate MST.

The basic and unifying principle of taxation is the interrelation of the principles of ability to pay and cost benefit. All tax systems at the local, provincial and federal level should be designed in accordance with this principle. Consumption taxes in general are to be rejected as a means of raising government revenue because they fail to reflect either the ability to pay or cost benefit principles. That governments can only make consumption taxes somewhat palatable by integrating them with the income tax system is proof that they are inherently inequitable taxes.

A theoretically sound and viable alternative to the GST is the business earnings tax. This tax meets the tests of ability to pay and cost benefit. It also satisfies, more than any type of consumption tax, the objectives of tax equity, efficiency and simplicity. It is also a tax that will increase productivity in the economy thereby reducing inflation and increasing real disposable income. A business earnings tax should replace both the corporate income tax and the MST. Provinces could also use it to replace their retail sales and corporate income taxes.

A comparison of the business earnings tax with the GST reveals that it would accomplish all that is intended to be achieved by the GST without any of the negative consequences that accompany consumption taxes. It is deflationary, reliable, simple, uniform, neutral and fair.

RECOMMENDATIONS

The Canadian Research Committee on Taxation recommends that:

The Senate reject the recommendation of the Standing Committee on Finance of the House of Commons that the Federal Sales Tax be replaced by a broadly based consumption tax.
The existing Manufacturers Sales and the Corporate Income Tax be replaced by a broadly based income tax, to be known as the Business Earnings Tax, which will be levied on the factor costs of production as reflected in the cost of sales statements of all business enterprises in Canada.
The Senate request the Department of Finance to undertake immediately a comprehensive analysis of the potential tax base of a Business Earnings Tax and to report back to the House of Commons within six months the results of this analysis.
The Senate request that the analysis by the Department of Finance include in the tax base of a Business Earnings Tax the factor costs of all business enterprises in the country that are directly controllable by each business.
The Senate request the Department of Finance to find the precise proportional tax rate with regard to a Business Earnings Tax which will yield sufficient revenue to replace primarily the current Federal Sales Tax and the Corporate Income Tax, and to consider replacing any other secondary taxes on businesses.

1 See, for example, Wolfe D. Goodman, "Hail to a National Tax," The Globe and Mail, May 1, 1989; Ted Carmichael, "In Defence of the GST", The Globe and Mail, May 11, 1990, A8, and John Crispo, "The New Sales Tax: No Way Out", The Globe and Mail, August 17, 1989, A7. For a useful commentary on the view in official Ottawa that if you disagree with the GST proposal, it is because you do not understand the tax, see, The Canadian Taxpayer, Vol.XIII, No.3, January 30, 1990, pp.17-18.

2 In a study by Francois Vaillancourt of the University of Montreal, it was found that in 1986 Canadians spent $5.5 billion -about $349 for each taxpayer - in order to comply with the tax laws. A survey commissioned by Revenue Canada of 1,100 taxpayers and released in January of this year showed that 46 per cent of taxpayers paid for help to fill out their tax returns. This was an increase of 30 per cent over the previous year. Most of the money spent to comply with the tax laws went to tax lawyers, accountants and people who work at the tax preparation firms. It is obvious that overall compliance costs in the tax system will increase with the GST. This is one reason why the GST is widely supported by professionals working in the tax industry.

3 Macaulay's History of England (Popular edition, 1889).

4 Derek Coomber, "If the GST Repeats Britain's VAT Experience, We Are in For Trouble," The Globe and Mail, August 26, 1989, B2.

5 For an instructive analysis of why the time is once again ripe to consider how taxation can be justified, see, Klaus Vogel, "The Justification for Taxation: A Forgotten Question", The American Journal of Jurisprudence, Vol.33, 1988, pp.19-59.

6 See, for example, Sales Tax Reform (Ottawa, Department of Finance, 1987), pp.9-27; the GST Technical Paper, pp.5-6, and Malcolm Gillis, "Federal Sales Taxation: A Survey of Six Decades of Experience, Critiques, and Reform Proposals," Canadian Tax Journal, Vol.33, No.1, January-February, 1985.

7 Even before its implementation the GST is already collapsing into a discriminatory and ad hoc mosaic of tax provisions, especially with respect to how small businesses, which will comprise the vast majority of registrants, collect and account for the tax, see, "Visibility of GST Fades With Changes, Expert Says", The Ottawa Citizen, June 2, 1990, F2.

8 The limitations of the principle of ability to pay as the only principle in designing tax systems are examined in a number of studies produced by the CRCT of the personal, corporate and municipal tax systems in Canada. See, for instance, Business Earnings Tax: Creating a More Productive Economy Through Positive Taxation (Ottawa, CRCT, 1987) and Reforming Municipal Property Taxation by Site Value Taxation (Ottawa, CRCT, 1989).

9 See, for example, Social Spending and the Next Budget (Ottawa, National Council of Welfare, April, 1989), especially Tables 4 and 5 and The Hidden Welfare System: A Report by the National Council of Welfare on the Growth in Tax Expenditures (March, 1979).

10 Not only is it used to justify consumption taxes, but also the personal expenditure tax, which is an income tax in which net income for tax purposes would be total income minus savings.

11 It is interesting to note that the misnamed corporate income tax is biased in favour of corporate savings, i.e. retained earnings, yet this has had little effect in improving Canada's productivity over the past 10 or 15 years.

12 The emphasis on demand management comes through quite strongly in government documents, see, for instance, The Budget (Ottawa, Department of Finance, February 20, 1990), p.51.

13 It is far better to increase the national pool of savings by creating new real capital and properly utilizing existing capital through such fundamental tax reforms as land value taxation than by means of the GST and other taxes which bear heavily upon productivity and new real capital formation and investment, see, for example, Mason Gaffney, "The Role of Ground Rent in Urban Decay and Revival", The Henry George Lecture (New York, St. John's University, October, 1988), p.13.

14 See, for example, the testimony of Michael Walker of the Fraser Institute, Minutes of Proceedings and Evidence of the Standing Committee on Finance, Issue No.51, October 3, 1989, p.58. Walker states that there is no differential incidence with respect to consumption taxes regardless of income because of the fact that most people over their lifetimes consume most of their income. This assumes, however, that one has as broad a base as possible for the tax.

15 See Table 2 in the Liberal Minority Report of House Finance Committee, p.18.

16 The intergenerational shifting of tax burdens by means of consumption taxes and the redistribution of income from borrowers, or generally, the dispossessed, to those who already have wealth, and thus have a lesser need for spending, is an aspect of the debate over GST that is rarely addressed.

17 See, for instance, the testimony of Professor John Bossons, Minutes of Proceedings and Evidence of the Standing Committee on Finance, Issue No.32, September 18, 1989.

18 A good example of this is Patrick Grady, "The GST is a Good Idea - But at 5%", The Globe and Mail, June 16, 1990, B4. The analysis is totally devoid of any discussion of tax principles. It proceeds on the basis of assuming the inherent worth of the GST, primarily, it appears, in relation to the MST, and then examines the rate and various adjustments in terms of desirable economic effects.

19 Why the economics profession, as reflected in the tax literature, has narrowed considerably its focus with respect to tax reform and the articulation of tax policy historically goes back to certain developments earlier in this century in such writers as E.R.A. Seligman in Progressive Taxation in Theory and Practice (2nd rev. ed., 1908) and H.C. Simons in Personal Income Taxation: The Definition of Income as a Problem of Fiscal Policy (Chicago, University of Chicago Press, 1938). A critical analysis of these theories is provided in F. Peddle, Reforming the Personal Income Tax System (Ottawa, CRCT, 1990).

20 This distinction was examined by Adam Smith, The Wealth of Nations (New York, Modern Library, 1937), pp.821, et seq.

21 For example, see, "Travel Industry Has Gloomy View of GST", The Globe and Mail, June 2, 1990, A18.

22 It is inevitable that one form of government interference in the economy results in other interventions. The GST will obviously have a varying effect on pricing, although this will be very difficult to determine precisely because the incidence of the MST cannot be accurately calculated. A watchdog agency must therefore be created to monitor prices in the economy and so on.

23 See the testimony of the Canadian Federation of Independent Business before the House Finance Committee, Minutes of Proceedings and Evidence of the Standing Committee on Finance, Issue No.33, September 19, 1989.

24 See, "Jelinek Eases GST Collection for up to 800,000 Small Businesses", The Globe and Mail, June 1, 1990.

25 See, for instance, the Technical Paper, pp.4, 11-18. It is argued by some economists that the export sector is not overly burdened by the MST, see, Minutes of Proceedings and Evidence of the Standing Committee on Finance, Issue No.51, October 3, 1989, pp.67-68. A MST tax incidence of 1 per cent on exports is not distorting, if trade subsidies of 1 per cent are not trade distorting.

26 See, Michael von Steinaecker, Domestic Taxation and Foreign Trade (New York, Praeger, 1973), p.4. Steinaecker points out that the source of all problems in the taxation of internationally traded goods is indirect (consumption) versus direct (income) taxes. His book focuses primarily on border tax disputes between Europe and the U.S. A major irritant in these disputes is the fact that the U.S. relies mainly on direct or income taxes for its revenues, while European countries get most of their revenue from indirect taxes. Since the U.S. is by far our largest trading partner, it is inevitable that an increased reliance on indirect taxes in Canada is going to cause problems not only in the internationally tradeable goods and services sector, but also with respect to business location decisions and the movement of the factors of production.

27 One of the most incongruous arguments presented in testimony before the House Finance Committee was put forth by Professor Robert Clark. He stated that the expenses of government ought to be paid by means of a number of revenue sources, principally, personal income taxes and a broad-based consumption tax. He fails to realize, however, that the destination principle per se violates the benefit principle and the use of the community's resources principle of taxation that is invoked by supporters of the GST. What foreigners take out of the economy through their consumption of exports is free of sales tax, see, Minutes of Proceedings and Evidence of the Standing Committee on Finance, Issue No.51, October 3, 1989, pp.72-73. Professor Clark, like Dr. Walker, is also burdened with the myth that only individuals can be taxed.

28 Article 401 of the Free Trade Agreement states that neither the U.S. or Canada shall increase any existing customs duty. The latter is defined in Article 410 as excluding:

"a charge equivalent to an internal tax imposed consistently with the provisions of paragraph 2 of Article III of the GATT in respect of like domestic goods or in respect of goods from which the imported good has been manufactured or produced in whole or in part".

Paragraph 2 of Article III of the General Agreement on Tariffs and Trade states in part that:

"The products of the territory of any contracting party imported into the territory of any other contracting party shall not be subject, directly or indirectly, to internal taxes or other internal charges of any kind in excess of those applied, directly or indirectly, to like domestic products".

This GATT provision is merely an enshrinement of the status quo as it then existed.

29 For example, see, "Dow Canada Head Warns of Effects of High Taxes," The Globe and Mail, May 25, 1990, and James Gillies, "A Modest Proposal to Solve a Major Problem," Inside Guide, Vol.4, No.2, May, 1990, p.15. The importance to international competitiveness, productivity and employment in Canada of high labour costs induced by counterproductive taxation seems to be lost on Michael McCracken, who argued in testimony before the House Finance Committee that the GST complements the Free Trade Agreement, see, Minutes of Proceedings and Evidence of the Standing Committee on Finance, Issue No.32, September 18, 1989, p.36. There is now a considerable amount of data which shows that substantial tax increases over the past six years have lead to compensation packages that are raising unit labour costs to the point where Canadian firms are becoming uncompetitive in relation to U.S. firms, see, "Canadian Firms Losing Labor Cost Edge", The Globe and Mail, June 5, 1990, B1.

30 This development, and the resulting over-reliance of the government on personal income taxes, has led to call for an annual net wealth tax that is equally difficult to define and which is yet another version of the ability-to-pay principle, except that taxable capacity is no longer defined primarily in terms of labour income or wages.

31 In this sense there has been a quiet revolution going on in tax avoidance and evasion for some time.

32 For an analysis of the varying incidence of the corporate income tax by industrial sector see, The Corporate Income Tax System: A Direction for Change (Ottawa, Department of Finance, May, 1985), p.15. The financial sector, for instance, on the whole pays considerably less in corporate taxes than the wholesale and retail sector.

33 Irving Fisher, The Rate of Interest (New York, Macmillan, 1930), p.23.

34 There is substantial evidence that corporate income taxes are borne largely or entirely by the owners of capital, see, Roger Smith, "Rates of Personal Income Tax: The Carter Commission Revisited", Canadian Tax Journal, Vol.35, No.5, September-October, 1987, p.1233, and Robin Boadway and John Treddenick, "A General Equilibrium Computation of the Effects of the Canadian Tariff Structure", The Canadian Journal of Economics, Vol.11, August, 1978, pp.424-446.

35 Charles M. Allen, The Theory of Taxation, (England, Penguin Books, 1971), pp.167-170. See also, E. Nevin, "Taxation for Growth: A Factor Tax", Westminster Bank Review, November, 1963, pp.13-25. The CRCT has variously referred to this tax in its studies as a "net costs business tax", "net expenditures tax", and "net revenue tax". It has been referred to by others as a "tax on costs", "factor taxes" or a "tax on the costs of the factors of production", "production tax", and "net business costs tax", see, Richard Bird, Taxing Corporations, (Montreal, Institute for Research on Public Policy, 1980), pp.38-41; "Current Reading", Canadian Tax Journal, Vol.XXVI, January-February, 1978, pp.148-149 and Canadian Tax News, Vol.VI, No.4, August-September, 1978, pp.54-57. It is interesting to note that Donald Huggett proposed in the Canadian Tax News (Ibid.) that: "The Federal Sales Tax should be replaced by a low-rate tax on net business costs" (p.57). This tax is, however, fundamentally a tax on business income or earnings properly identified in the cost of sales statements as apportioned to the factor costs of production and which is recovered in the marketplace.

36 For a recent example, see, Kell Antoft, "How About a Brand New Tax", The Globe and Mail, May 1, 1990 where such a tax is labelled the "gross revenue tax" or GRT. While there are a number of good points in Professor Antoft's article, it is not guided by sound tax principles since it is not sufficiently discriminating with respect to that part of commercial revenues which should form the base for the taxation of business enterprises. 37 GDP for fiscal 1988-89 is $601.5 billion, see, The Budget (Ottawa, Department of Finance, February 20, 1990), p.148. Total employee benefits would be a large part of the total factor costs of production, generally around 60 per cent. 38 Adam Smith, The Wealth of Nations, p.779.

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To: The Standing Committee on Banking, Trade and Commerce The Senate

From: Canadian Research Committee on Taxation

Re: Submission on the Federal Goods and Services Tax

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