The Canadian Century. Brian Lee Crowley
In tandem with the drive for free trade, the Mulroney Tories pursued another Laurier tenet: tax reform, both for efficiency’s sake and to regain lost competitiveness with the United States.
Laurier, we recall, wanted to avoid taxes and tariffs being higher in Canada than in the US, while also reforming the tariff to be less damaging in its effects on the Canadian economy.
While the structure of taxes evolved significantly over the intervening decades, the principles that Laurier sought to preserve and promote could not have been more apposite to the situation confronting Canada.
By the mid-eighties, federal revenues came chiefly from three sources: the manufacturers’ sales tax, the personal income tax, and the corporate income tax.51 Each was in severe need of reform.52
On the income tax front, Ottawa had allowed both corporate and personal tax loads to become uncompetitive compared with rates in the United States, and because of President Reagan’s proposed tax reforms, that lack of competitiveness risked becoming acute if Ottawa did not act.
Regarding personal income taxes, Ottawa saw that the Reagan tax reforms were going to cut taxes by at least 30 per cent across the board.53 Such a policy was in line with the advice many economists and the Department of Finance had been giving for years54—and that Laurier would instinctively have understood was right. Income taxes, especially ones that are highly progressive—i.e., where the tax rate on your income rises steeply as your income grows—fall most heavily on three highly valuable factors: effort, entrepreneurship, and productivity. As you work harder, and earn more as a consequence, your tax burden doesn’t rise in lockstep with your income. It increases faster than your income. If the country’s top rates are too high, then the reward for working harder and longer falls below what is needed to sustain that extra effort. As any economist will tell you, if you tax something, you’ll get less of it. And in Laurier’s plan, what Canada needed was more effort, more hard work, more risk-taking, more people striving to build the country, not less.
The finance minister at the time, Michael Wilson, didn’t need much convincing that if the top rate on personal income had fallen to 28 per cent in the United States, Canada could not long attract and keep its most talented workers with top rates of over 50 per cent.55 Accordingly, the 1987 federal budget outlined comprehensive personal tax reform, reducing the number of brackets to three from ten and lowering the marginal rates significantly.
Wilson’s legislation to put these changes into effect, Bill C-139, broadened the tax base for personal income while reducing the tax rates. In the place of the traditional tax exemptions, the new regime relied on tax credits while getting rid of a number of personal income tax deductions.56
The situation was similar in the corporate income tax field. Economists were increasingly coming to the view that heavy taxation of corporate profits was undesirable because, among other things, it suppressed investment, left less money available for wages, reduced income for pension plans workers would rely on for their retirement, and caused multinational companies to try to report as much of their income in low-tax countries as possible. The 1986 US Tax Reform Act put US corporate taxes on the same reform track as personal income taxes. Canada was compelled to follow suit, and for exactly the reasons that Laurier believed were decisive: we live in a competitive world, especially vis-à-vis the US, and we could never allow our tax rates to rise above theirs without paying a painful price. In fact, given the other disadvantages Canada faced, having lower rates than the US was almost compulsory.
In putting his tax reform package forward, Michael Wilson sounded a Laurier-like note:
Statutory corporate tax rates in Canada are above those in the United States and other countries, and without early implementation of significant reductions in Canada the gap would widen. If the gap between Canada and U.S. rates were not narrowed, considerable income-earning activities would shift to the United States. The gap would also encourage firms with operations in both countries to arrange their operations so as to allocate more of their taxable income outside Canada. The result of such shifts would be less economic activity in Canada and a significant erosion of our corporate tax revenues. The proposed reduction in Canadian statutory tax rates is designed to avoid these results.57
Of course, these reforms were only a down payment on what would come later, because while they reduced the gap between the tax burden borne by American and Canadian workers and companies, they did not eliminate it, and still less did they restore Laurier’s ideal: a gap in favour of Canadian workers and companies. Still, just as Laurier had to be content in the early days with tariff reform rather than the free trade in which he so fervently believed, the movement was in the right direction, even if the way station fell far short of the cherished final destination.
Perhaps even more important than this early down payment on income tax reform was the wholesale reform of federal sales tax that Michael Wilson engineered.
The chief sales tax at the federal level was the manufacturers’ sales tax (MST). A more foolish and damaging tax it would be hard to conceive. The MST was a tax that applied only to manufacturing, and even within that narrow field, taxed some activities but not others. Companies could organize themselves and their activities in such a way as to blunt or even escape much of the tax—practically a textbook definition of a poorly designed tax. Because the tax could be largely avoided with a little effort and imagination, Ottawa found its revenues from this source to be declining over the years.58
Yet leaving aside the misleadingly named MST, sales taxes per se have increasingly won approval from economists and policy thinkers because, if you are going to levy taxes, a well-designed tax on consumption is one of the least damaging. Unlike income taxes, which discourage work and effort and success, consumption taxes do not distort incentives to do these highly desirable things. And where saving is taxed—by the income tax and capital gains tax, which capture a part of the returns to savers—but consumption is not (i.e. when there is no sales tax), the absence of the sales tax also creates incentives for people to spend rather than save. Finally, a broadly based tax with few or no exemptions, and set at a low rate, means that the revenue is more reliable than under an MST-type tax, cause companies cannot escape the tax by artificial reorganization of their activities.
The highly courageous decision was therefore made by the Mulroney Tories to eliminate the MST and to replace it with the goods and services tax (GST). Unlike the MST, the GST was to be a “flow-through tax”: when businesses bought raw materials or machinery or advertising or telecommunications services, the tax they paid on those “inputs” was credited against the GST they collected from the consumers of their goods or services. The hidden 13.5 per cent MST, applied to a narrow range of goods, was abolished and replaced with a much more transparent and easy-toad-minister tax, applied to a wide range of goods and services but at the much lower rate of 7 per cent. The balance between saving and consuming was at least partially restored.
All of these good things were purchased, however, at a significant political cost. Because the new GST was so transparent and obvious, people had something quite concrete on which to focus their dislike of taxation, whereas the MST had been hidden and therefore called forth little popular agitation for its abolition. And it did not help that the introduction of the GST coincided with both a significant recession and a rise in the value of the Canadian dollar. A well-designed visible tax, even if it was replacing a badly designed invisible one, could only become a lightning rod for general economic discontent, and cross-border shopping with valuable Canadian dollars became an effective kind of tax protest.
The GST became a major money spinner for the federal government, although it was quickly forgotten that it replaced the revenue from the MST. The reception the tax received might well have been more positive had the government been able to follow through on their original plan to make it the centrepiece of a larger tax reform package that reduced income taxes and shifted the tax burden onto consumption, a highly desirable rebalancing of the tax load.59 Unfortunately, the economic circumstances of the time, including the government’s own inability to keep its spending under control, forced Ottawa to put off the planned reductions in personal income taxes until