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National Growth Tax - an alternative to the GST

Note from this page's originator (Doug Anderson):

This idea was first published in a column in the author’s newspaper, the Whitby Free Press, in 1990 in the period leading up to the GST. Most Canadians opposed the GST and expressed their profound objection in more than a hundred public opinion polls over a period of a year and a half.

Many people and organizations, especially in the business community, offered constructive alternatives to the GST which they felt would be better for the Canadian economy. The author offered this alternative which, in addition to generating revenue, addresses a number of other key economic issues which continue to plague us. It has been updated and expanded many times in the intervening years but the basic concept remains unchanged.

However, I am not an economist and try as I might I have never persuaded any economist to give it more than a cursory glance. As this idea turns the current monetarist approach to the economy on its ear, it certainly needs detailed analysis.

The upside of such a 'radical' approach is that everybody hates the GST and any reasonable alternative would generate a lot of attention for the party.


INTRODUCTION: History, Geography and Economics


Canada is an extremely vast and diverse country and ever since confederation (and even before) efforts to balance the economic disparities have been a perennial preoccupation. The National Growth Tax (NGT) provides a means to address these economic disparities.

Taxes are generally regarded solely as a means to raise revenue but they can also be used with great effect as a means to bring about policy outcomes. Green taxes are a prime example. Sales taxes in particular have a direct affect on purchasing and could be used very effectively to control inflation or stimulate a stagnant economy.

In the late 1980s, inflation was rampant in the Greater Toronto area with speculators flipping properties at higher and higher prices before the original sale had even been closed. In response, the Bank of Canada was steadily increasing interest rates in order to dampen the speculative fever.

Meanwhile Atlantic Canada and for that matter most of the rest of the country was still dragging itself out from the lingering after effects of the 1982 recession. In fact, parts of the country were probably still in recession. Rising interest rates simply compounded the economic difficulties these areas were already experiencing..

Back in the GTA area, rising interest rates had only a minor dampening effect - until inevitably the whole country tipped over the edge into another full blown recession.

This scenario is by no means unique. At any given time, there are always parts of the country which are experiencing strong economic growth and parts with low or negative growth. It happens in all countries to some degree but in a country as physically large and diverse as Canada, with economies ranging from high tech in the Golden Horseshoe to subsistence in northern regions, the problem is particularly acute. Canada is the only Western economy with such extreme diversity and it seems appropriate to develop specific economic structures which will accommodate our unique situation.

WHY INTEREST RATES ARE AN INAPPROPRIATE WAY TO REGULATE THE CANADIAN ECONOMY


Raising interest rates to slow down an inflationary economy is intended to reduce the money supply. The theory is that if you make it more expensive to borrow, less will be borrowed, demand will drop and prices will follow.

Maybe! As far as consumer spending is concerned, most loans are for a fixed term at a fixed rate and while higher interest rates may be a deterrence on new loans for major purchases, existing loans are unaffected. If credit card rates were reflective of bank rates then there might be a dampening effect - but they aren’t.

The main thrust of adjusting interest rates is to stimulate or slow down business credit. But do the math. If a business wants to invest $100,000 to expand their company, they are looking for a return on that money of at least 10% after all the associated expenses - or $10,000 in this example. (Given the vagaries of the business world, if you can’t project a return of at least 10% on any specific investment, it just isn’t worth the downside risk.) So when the Bank of Canada raises interest rates by ¼ per cent, the additional cost to the business of that $100,000 loan will be $250 - an insignificant amount in relation to a projected return of $10,000. If, after successive and increasingly aggressive rate increases, there is a cumulative increase of, say, 2%, the extra cost is now $2,000. Certainly
significant, but probably still not enough in itself to prevent the business from borrowing the desired money.

What will prevent the loan is the psychology of uncertainty that the Bank of Canada creates by signalling its unhappiness with the state of the economy. It’s the psychology, more often than not, that leads to recession.
Unfortunately the psychology plays hardest in those parts of the country with the least economic optimism. The use of interest rates to regulate the business cycle markedly increases the economic disparities that already exist - and the effect is cumulative. Using interest rates to control inflation is like trying to kill a mosquito with a shotgun - you may kill the mosquito but the collateral damage is way out of proportion.

The biggest deterrent to business investment is uncertainty. History has shown that business will continue to invest in spite of high interest and/or high inflation rates as long as those rates are predictable over an extended period, i.e. reasonably stable. Investment requires that businesses be able to calculate their risk. There are always plenty of instabilities in the marketplace without adding interest rates as yet another.

The second reason interest rates are inappropriate to regulate the Canadian economy is its size and economic diversity. As indicated in the introduction inflation can exist in one part while another is in recession as it has been on several occasions. Using interest rates to solve a problem in one area simply compounds the problems elsewhere.
Since Southern Ontario is the core of the Canadian economy, the Bank of Canada tends to (indeed it has to) respond to these problems even if it is detrimental of rest of the country. This “favouritism” for the Ontario economy contributes greatly to the anti-Ontario sentiment in other parts of the country.

The third reason interest rates are an inappropriate tool is that the Canadian economy is only a tenth the size of our American neighbour and our interest rates have to remain co-ordinated to US rates in order to prevent currency runs.

A fourth reason is that for most small businesses, bank credit is not a major source of financing, with self- financing, angels and venture capital playing a much larger role.


NATIONAL GROWTH TAX


This idea was developed in the late eighties when the government was drafting “the second phase of tax reform” which became the GST.

Instead of using interest rates uniformly across the country to regulate economic activity, the National Growth Tax is a sales tax which would be applied at a variable rate from region to region. While capital markets (which is what interest rates regulate) are mobile, this sales tax would be applied on a regional basis and since sales are recorded in a specific place, the influence of the tax rate would apply in that place. Ideally there would be separate wholesale and retail taxes which would be adjusted individually and would generate quite different effects. The wholesale tax would have a direct impact on local employment levels (and hence general economic prosperity) in a particular area by allowing cheaper overall sale prices for manufactured or distributed goods. The retail tax would directly influence consumer spending and hence provide the leverage to regulate inflationary pressures in a particular area. A 2% variance in either tax
would theoretically have the same general affect as a 2% change in interest rates but the change would be far more direct and immediate and would apply only in that particular region. The tax revenue implications of such a change would be offset by minor increases in other areas.

Implementation


Just as the Bank of Canada controls interest rates at arms length from the government, a variable sales tax would have to be controlled by an independent body insulated from political interference. The NGT board would monitor and assess economic conditions in regional economies and adjust the sales tax rates accordingly. The mandate of the board would be to act only in response to actual economic data and as a result the process of rate adjustment would be entirely market driven.


Revenue Source


As it stands the GST is simply a source of revenue for the federal government as are provincial sales taxes for their governments. The actual level of revenue in each case is dependent on the state of the economy.

The NGT would also be a source of revenue but would have the additional function of market equalization. The government would set a general level of revenue that it expected to receive from the NGT in a particular fiscal year and the NGT Board would adjust tax rates to generate that revenue. If the government wanted to provide a general stimulus, it would lower its revenue expectations which would be the same as lowering the average tax rate.

Unlike the GST, the NGT could not be a value-added or flow through tax because input credits would negate any savings from buying from a lower tax region. In that respect the NGT would be similar to the old manufacturers sales tax but it would be applied on a broader range of goods and services (including imports) and obviously under different regulations in order to avoid the imbalances that the old manufacturers sales tax was guilty of. Businesses would benefit under the NGT because they would no longer have to keep track of input tax credits.

Regional Equalization


Because a lower NGT would have the effect of economic stimulation, it could largely replace existing regional development programs. If sales tax rates in the Maritimes were substantially lower than in Ontario, businesses
would have an incentive to locate there, thereby employing more people and gradually balancing economic development throughout the country without using handouts. Using a lower sales tax as a regional economic
stimulus does not have the bias and pork barrel implications that current regional economic programs are frequently accused of. It also doesn’t carry the stigma of a handout. The market would decide which ideas were good and which would fail.

Keynes would love this


Currently, whenever the Bank of Canada raises interest rates to slow down an economy which on average is inflationary, it costs the government more to service its own debt. Under the NGT, the regulatory body would raise rates only in those areas that were experiencing inflationary pressures and there would be an increase in revenue to the government. This is how Keynes said it should be - increase government revenues in good times, spend it in bad.

If the provinces chose to roll their provincial sales taxes into the NGT and set overall revenue goals without regard to provincial boundaries, it could in large part replace existing equalization programs as dollars would
automatically flow from areas of strong economic activity to areas where the economy was weak.

Additional Possibilities


The NGT would also have the potential to be applied on a micro-economic level. As an example, if a mine were to close in a one industry town, the tax rate might be dropped to zero for a period in order to attract new businesses, and gradually increased as things improved. (To do this, the board’s mandate would have to allow it to act proactively in special circumstances.)

The tax could be applied on an industry basis as well. If the auto industry was in recession but the rest of the economy was doing well, the tax on cars could be reduced (or raised if economic statistics indicated the industry was generating inflationary pressure.) Rather than making loans or grants to specific industries in rough times, the tax rate could be adjusted as a stimulus, for example to the airlines, or for the purchase of farm equipment.

Depending on how fine you want to micro-regulate the economy it could even be used to balance some of the disparities between large cities and the surrounding rural communities. On the retail level, merchants in smaller communities might be assigned a lower tax rate as a counter balance to the large shopping malls in nearby cities.

Naturally, everyone would want to see rates go down but for every rate that goes down it has to go up somewhere else in order to maintain the same overall level of revenue. In practise, since population has always tended to gravitate to the growth areas where the jobs are, a 1% increase in tax in the highest growth areas might generate sufficient revenue to allow a 5-10% drop in the poorest areas where there is far less population.

Eventually people would get used to the idea that rates varied from city to city, town to town and possibly product to product. A few years ago this level of micro-regulation would not have been practical but with computerization it is both possible and practical.

Once established and stabilized (which might take a few years), changes would tend to be minor and infrequent.
Localized changes would only occur as a region’s economic climate changed vis à vis the rest of the country. Over the long term, as economic activity gradually flowed to weaker areas, all parts of the country (with the probable exception of the north) would tend towards a single average tax rate.

The NGT would provide far more precise regulation of the business cycle on both the national and regional level.
The effects of changing rates would be felt immediately.

Meanwhile interest rates could be boringly consistent, changing only in relation to international changes. And business could get on with doing what it does best without worrying whether the economy in some other part of the country was going to cause changes in its interest rates.

SO IF IT’S THAT SIMPLE WHY DIDN’T SOME ONE THINK OF THIS BEFORE

To my knowledge, a variable sales tax has never been tried before. And that’s its biggest problem. People are not by nature adventurous - they want a track record. They want to know that somebody else has tried it and that it works.

However, there is ample existing data to indicate its feasibility. Throughout N. America, there are several examples of adjacent provinces and states with different sales tax rates. Not surprisingly, purchasing and economic growth tends to flow to the lower tax jurisdiction and these effects have been quantified in considerable depth in many border communities.

Some additional modelling would be necessary to determine the particular impacts of the NGT.


SUMMARY


The National Growth Tax would replace in whole or in part:

1. The GST
2. Interest rate changes designed to stimulate or slow the economy
3. Regional economic growth programs
4. Equalization payments
5. Provincial sales taxes
6. Direct grants to business

Economic Benefits


1. The National Growth Tax provides a market driven mechanism to regulate the business cycle on a regional basis.
It has the built-in ability to equalize economic activity throughout the country so that dollars will flow from areas of high prosperity to low.

2. It provides a stable and predictable economic stimulus in poorer areas which will encourage long term economic growth. Poorer regions will no longer have to suffer higher interest rates designed to control inflation in more prosperous parts of the country.

3. The stimulus/dampening effect of NGT changes will be far more direct and immediate than the use of interest rates.

4. Business will benefit generally from a more stable borrowing environment.

5. The NGT will continue to be a major source of sales tax revenue for both federal and provincial governments.

6. NGT revenues would increase whenever there were general inflationary pressures, unlike the additional cost of servicing the debt as occurs when interest rates are raised.

7. The NGT is relatively simpler than the programs and policies that it replaces.

Political Benefits

1. The NGT replaces a number of long standing regional irritants with a transparent market driven non-political process that will over time equalize economic activity throughout the country.

2. It reduces the need to focus economic policy on ‘Bay St.’ and thereby helps eliminate one of the main forces that has tended to pull the country apart.

3. Because economic prospects will improve in poorer areas the tendency for population migration will decline.
This in turn will reduce growth pressures on major metropolitan areas.

4. The ability to regulate microeconomies opens the door to alleviating a host of disparities on a community by community or industry by industry basis.
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