TAX NEWS - 2010

Harmonized Sales Tax: How the new tax works and why it's different

When the harmonized sales tax comes into effect on Thursday, tax rates on some items will change. Several items that were previously exempt from provincial sales tax, such as movies, restaurant meals and gym passes, will be taxed at the HST's 12 per cent.

For most items on which consumers previously paid both goods and services tax and PST, the tax rate will remain at 12 per cent. But that doesn't mean the HST is identical to the old sales tax. There is a key behind-the-scenes difference between the Harmonized Sales Tax (HST) and PST.

Economists call the PST a sales tax because it is applied to the sale price each time a product is sold. The GST and Harmonized Sales Tax (HST) are what economists call value-added taxes. They apply only to the added value a product takes on.

To help explain the difference, consider the example of a furniture maker who buys $50 worth of wood from a lumberyard and turns it into a $90 chair. With a sales tax, the chair maker would have to pay tax on the $50 of wood and charge tax when he sells the $90 chair.

With a value-added tax, the lumberyard would still charge tax on the $50 of wood, and the chair maker would still charge tax when he sells the chair. But the chair maker would receive a rebate from the government for the tax he paid on the wood.

With both taxes, the government would collect the full tax on the $50 of wood. But with a sales tax, the government also collects tax on the full price of the chair. With a value-added tax, the government receives the tax on only the "value" that the furniture maker adds to the wood -- $40.

A sales tax creates double-dipping. The wood gets taxed when the furniture maker buys it, and gets taxed again as a component of the chair's value when the chair is sold. But with a value-added tax, the wood gets taxed only once.

In other words, under the Harmonized Sales Tax (HST), most businesses will receive a refund for the sales tax they pay on their business inputs. Currently, businesses get refunds on the GST they pay for business inputs, but don't get a PST refund.

The credits mean most businesses will have lower costs under a value-added tax. So in theory, some of those savings will be passed on to consumers in the form of lower prices.

How much of those savings businesses will pass on to consumers is a source of debate among economists, and would likely be influenced by how competitive an industry is and how sensitive customers are to the price of a product.

Ontario and B.C. will adopting the Harmonized Sales Tax (HST) on Thursday.

Nova Scotia, New Brunswick, and Newfoundland and Labrador adopted the Harmonized Sales Tax (HST) in 1997.

That has given economists a chance to examine to what degree the Harmonized Sales Tax (HST) changes prices.

A study by University of Toronto professors Michael Smart and Richard Bird found no statistically significant change in overall prices in the three provinces as a result of the Harmonized Sales Tax (HST) being introduced. It led to modest after-tax price cuts on household products, health and personal care items, and alcohol and tobacco, but was largely offset by rising prices on shelter, clothing and footwear.

Another study, by University of New Brunswick professors David Murrell and Weiqiu Yu, found that after-tax prices fell in the two years after the HST was introduced: 0.6 per cent in Nova Scotia, 0.7 per cent in New Brunswick and 1.7 per cent in Newfoundland and Labrador.

But they cautioned that their results "cannot immediately be extended to consumers in other provinces" because the Atlantic provinces all reduced their tax rates on most items when the Harmonized Sales Tax (HST) was introduced. B.C. is keeping its overall tax rate on most items constant at 12 per cent.

Another difference between the Harmonized Sales Tax (HST) and the old tax regime concerns how taxes are filed. Prior to Thursday, businesses needed to file two tax returns: one to the provincial government and one to the federal government. Once the Harmonized Sales Tax (HST) takes effect, businesses will be able to file a single return.

For small businesses, this is not likely to make much difference. But for big businesses, it could have a noticeable impact.

For example, Telus spokesman Shawn Hall said the streamlined paperwork would save his company between $2 million and $3 million per year in auditing costs.