Most economists would prefer to see the federal government reduce and reform business taxes rather than continue to cut the GST because the economic benefits would be far greater.

The problem is that there’s little fiscal room to accomplish this, the economists say. The 1% GST cut that the Tories implemented in July — which doesn’t improve competitiveness or productivity — is costing $5 billion a year. And the Conservatives have promised to shave another percentage point off the GST within five years. In addition, it’s rumoured that another $3 billion a year may go to fix the federal/provincial fiscal imbalance — another Tory election promise.

Of the five experts interviewed by Investment Executive, only Jon Kesselman, economics professor at the University of British Columbia in Vancouver, thinks the GST cut will have economic benefits. He argues that it provides an incentive to work more because it increases the amount people can buy with extra income. A cut in income tax rates doesn’t have as broad an effect, he says, because it doesn’t benefit low-income people who don’t pay income taxes.

Kesselman also says the GST cut may reduce the size of the underground economy by lowering the incentive to avoid taxes by paying or being paid in cash. This should increase revenue, not only for the GST but also for income taxes.

But most economists say the only way the GST cut could have been justified would have been to tie it to a harmonization agreement with those provinces that have not yet harmonized their provincial sales taxes with the GST.

There’s general agreement that provincial sales taxes are the biggest problem in the Canadian tax system because they tax business inputs. This puts Canadian producers at a disadvantage when competing in export markets and against imports at home. As the GST does not tax inputs, harmonization in Ontario, British Columbia, Manitoba, Saskatchewan and Prince Edward Island would eliminate this problem. Quebec and the three other Atlantic provinces have already harmonized their provincial sales taxes. Alberta, of course, has no sales taxes.

The problem with harmonization is that it broadens the provincial tax base to services as well as goods and is, therefore, unpopular with voters. Provincial governments generally recognize the economic benefits; P.E.I. is the only province that definitely wants to keep retail sales taxes. That’s because it wants to tax imports, says David Perry, senior research associate at the Canadian Tax Foundation in Toronto.

Dale Orr, managing director of Global Insights (Canada) Ltd. in Toronto, believes the Conservatives will wait as long as possible before implementing the second cut in the GST — five years after the election would be January 2011 — and he thinks they should tie it to pro-vincial sales tax harmonization.

The reduction in fiscal room from the GST cut isn’t necessarily all bad, say some economists. Robin Boadway, economics professor at Queen’s University in Kingston, Ont., says it will force fiscal discipline. Orr, for example, agrees with the Tories that rationalization and constraint in program spending can free up money for more tax cuts.

Even with little fiscal room, the Tories could make some inexpensive tax changes that would increase productivity and competitiveness:

> Business Taxes. Kesselman suggests increasing the speed at which new business capital investment can be written off or bringing back the investment tax credit.

Don Drummond, chief economist at TD Bank Financial Group, also favours reintroducing the investment tax credit.

Boadway would like to see a levelling of the playing field for business taxes, along the lines of what was suggested in the 1998 Report of the Technical Committee on Business Taxation. Unfortunately, that would be politically difficult to do because the report’s recommendations were revenue-neutral; some industries would see increased taxes to offset the lowering of rates for other industries.

For Boadway, cutting the GST was a big missed opportunity: the Tories could have used some of the tax revenue to lower business taxes for all sectors to the same level.

Nevertheless, resources companies get “really favourable treatment” for no reason. The feds would be wise to do something about it. The government could do a lot by doing away with some special measures, including the deduction of royalties, he says.

Both Boadway and Perry also think more needs to be done to level the playing field between corporations and income trusts.

@page_break@> Capital Gains Taxes. Orr would like to see capital gains taxes eliminated or, at least, reduced. The Tories promised to eliminate them when the proceeds of asset sales were reinvested, but have to figure out a way to implement this that is not too expensive. Orr suggests restricting such taxes to type of asset or by putting a limit on how much is tax-exempt for individuals. He says business and individuals would be more willing to make investments.

> Personal Income Taxes. Al-though many economists would have preferred income tax cuts to the drop in the GST, they don’t put a high priority on the former, given the lack of fiscal room.

Orr, though, does expect the Conservatives to bring the rate for the bottom bracket down to 15%, a concept introduced by the Liberals before the election, from the 15.5% level to which the Tories raised it. Going into an election, the Tories can’t afford to leave a big group of voters less well off than they would have been under the Liberals. Orr also expects the Tories to deliver on their promise to raise the personal tax exemption to $10,000 by 2009.

Kesselman thinks raising the threshold for the highest income tax bracket makes sense as a way to encourage bright young people to stay in Canada.

> Savings. Kesselman favours the introduction of tax-prepaid savings plans. Opposite to RRSPs, TPSP contributions would not be tax-deductible but neither would withdrawals be taxable.

Orr would also like to see increased savings, pointing out that RRSP and TPSP money increases the pool of money available for business investment.

TPSPs wouldn’t have a big impact on federal revenue because the money going into them would be made with after-tax dollars. The idea is to encourage saving by lower-income people, for whom the RRSP tax deduction isn’t worth a lot, and to give additional sheltered retirement savings room for all Canadians.

> Other Consumption Taxes. The Conservatives could increase sin taxes; indeed, they did so in their first budget, raising the taxes on tobacco and alcohol. Raising gasoline taxes would be a political hot potato, although it wouldn’t be unreasonable.

Folding gasoline taxes into a broad environmental tax and using the revenue to cut capital and income taxes is another option, says Drummond. The idea would be to tax all forms of energy at rates that reflect their level of greenhouse emissions.

However, Perry points out, this would have negative implications in terms of Canadian competitiveness. Kesselman says it’s an idea that doesn’t yet have any political support. IE