How the United Kingdom will balance its budget

Yesterday in the United Kingdom, the coalition government of Prime Minister David Cameron released its emergency Budget. One item that caught my eye in this time of HST implementation was the change to the UK's Value Added Tax (VAT). On January 4th, 2011, the tax will increase from its current level of 17.5% to 20%. In proportion, it's similar to the increase in Nova Scotia's HST from 13% to 15%. What was particularly interesting was that this increase is expected to raise over £13.5 billion in a full year by 2014 - 2015. As well, the United Kingdom VAT rate still falls well short of the maximum of 25% allowed under European Union law.

The United Kingdom has reached the point of budgetary desperation. As it stands now, the United Kingdom is considered by many economists to be the most indebted nation in the world. Their national debt stands at nearly £924 billion. Their public sector net debt (as shown in the chart below) is projected to reach 70.3% of GDP by 2013 - 2014.

By comparison, the United States debt to GDP ratio is 88.9% and Canada's is in the neighbourhood of 35% depending on the source used. The United Kingdom's budget deficit is projected to be £148 billion for fiscal 2010 - 2011; it is hoped that the increased taxes (except corporate taxes) and reducing spending in today's budget will help balance the budget by 2014 - 2015. In today's budget, the government anticipates expenditures of £44 billion on debt interest alone in 2010 - 2011; this is projected to rise to £67 billion by 2014 - 2015. The UK had been threatened with cuts to their credit rating by two rating agencies unless the new government made major changes to their tax and spend philosophy; the UK had not balanced their budget since 2002 - 2003 and their debt growth far exceeded their economic growth.

If the United Kingdom feels that it is prudent to at least partially balance their budget deficit using an increase in their VAT, I suspect that they will be setting the trend for other jurisdictions. As I noted in yesterday's post, Nova Scotia has already increased its HST. Quebec is raising its QST in two stages from an effective rate of 12.875% to 13.925% on January 1, 2011 followed by another increase to 14.975% on January 1, 2010. In both cases, these consumption tax increases are being used to help their respective governments balance their rather frightening budget deficits. In the cases of Ontario with its net debt of $193 billion and 2009 - 2010 budget deficit of $19.7 billion and British Columbia's net debt of $29 billion and their 2009 - 2010 budget deficit of $1.7 billion, it will be very, very tempting for them to raise the provincial portion of the HST once the two year term of holding rates steady, agreed to with the federal government, has expired. Apparently, governments really do regard value added taxes as a cash cow despite their protestations to the contrary when they are trying to implement said taxes!

As an aside, here's an interesting twist on the HST story for Ontario residents who, unfortunately, don't have recall legislation. It seems that the McGuinty government has reached the point of desperation in their attempt to "sell" the HST to their electorate.

Ontario residents may be aware of this website, but I'll share it for those who aren't. It is part of the Liberal Party of Ontario website; when you click on the "Learn More" button on the opening page of the www.ontarioliberal.ca website, you are automatically redirected to the Strong Medicine for Ontario website.

It has a small Liberal Ontario logo in the upper corner and a selection of propaganda videos that you can watch which, quite naturally, do everything in their power to promote the massive advantages of implementing the HST. I really liked the column on the right side that had Twitter comments from various anonymous people with no political affiliation whatsoever (or so the Party would have us think). I particularly liked the postings by AMontgomery86 who informed me that she "Enjoyed the informative new video re: HST paid for with the Liberal's OWN money!" and "As a student, I'm looking forward to how much I know I'll benefit from the HST". Just wait until you're in the workforce and have to pay a whole pile of taxes Ms. AMontgomery86, then we'll see if you change your tune, that is, if you are a real person!

The first video on the list was released Monday; it is a video of Premier Dalton McGuinty doing a last minute, hail Mary promotion of the HST. The video is also posted on YouTube just in case you want to avoid the rest of the Liberal Party propaganda on the website:

Here's the YouTube video:

http://www.youtube.com/watch?v=4YpuzXj_ayw&feature=player_embedded

It's well worth a watch , even if just for the cinematographic value. Notice that Premier McGuinty is wearing a nice conservative blue dress shirt, but it's open at the collar so he looks a little more like "the small people on the street". If you listen carefully, you can hear the birds chirping merrily in the background; it seems that even they are convinced of the merits of the HST.

At the end of the video, the viewer is informed that the ad was "Paid for by the Liberal Party of Ontario". At least the Ontario Liberals have done that part right. I wonder if they'll do the same thing when they increase the HST in 2012?

The Hated Sales Tax

In today's National Post, Niels Veldhuis and Charles Lammam, two economists at the Fraser Institute, wrote a column entitled "Don't believe the anti-HST rhetoric" (aka The HST is good for you. Yes it is, Is too). The column was written in response to the strong anti-HST movement in both Ontario, whose residents are defenceless against the tax, and British Columbia whose residents are opposing the tax through the use of a petition being undertaken under the province's recall legislation.

In the column, these gentlemen use the argument that the advantage to a value added tax like the HST is that "only the value added by the business selling the good or service is taxed." Businesses will receive an input tax credit (ITC) for their business inputs under the HST which will allow them to claim a tax refund for the sales tax they paid on their inputs. In a perfect world, the amount of this input tax credit is then passed along to the consumer; in the case of British Columbia and Ontario, the net change in the ITC will increase by the current amount of the provincial sales tax. If that is the case, the business should pass along their new 8% savings to the consumers of Ontario and 7% in British Columbia.

The fly in the ointment for this thesis is that far more items will be taxed under the new HST scheme. In British Columbia, the government proudly touts the fact that their new HST will be the lowest in Canada, however, it will now apply to a broader range of goods that were formerly exempt. Here's a line from the B.C. government HST blog:

"And for the majority of goods (they claim 80%) you use, you won’t pay a penny more tax because of the HST."

Ah, but according to the same website, here's a list of items that will accrue additional tax once the HST is implemented:

- books, school supplies, magazines, newspapers, EnergyStar windows, thermal insulation, weather stripping, caulking, smoke detectors, food producing plants and trees, household moving services, adult-sized clothing for children, dry cleaning, used adult clothing under $100, snack foods, restaurant meals, catering and even planning services, basic cable television, local residential phone, appliance repair, repair or renovation services to property, landscaping, taxi services, domestic air, rail and bus travel originating in B.C and real estate commissions.

...and that's enough of that. It keeps on going. Yes, there are a few cases where the tax actually drops; alcoholic beverages (those will be much needed), children's disposable diapers and a 0.4% drop in the tax on residential heating and electricity.

In Ontario, here's their line about the new HST from the Ontario Ministry of Revenue website:

"In total, about 83 per cent of products and services purchased by consumers will see no new tax."

Here's the Ontario government's handy list of old versus new tax rates for some consumer items and here's a partial list of items that will see the tax rate rise:

- dry cleaning, cleaning services, electricity and heating costs, internet access, home service calls by electricians, plumbers and carpenters, hotel rooms, camp sites, taxis, domestic air, rail, boat and bus travel originating in Ontario, subscriptions to magazines, home renovations, private resale of cars (now the GST portion will be added), gasoline and diesel, new homes over $400,000, real estate commissions, massage therapy (you're going to need it), vitamins, athletic membership fees, sport and cultural lessons, tickets for live theatre with seating less than 3200 (who came up with that number?), funeral services, legal fees, hairstyling, fitness trainers and, of course, tobacco products and nicotine replacement products.

Again, the list goes on but I started to get tired. Sorry about that. Ontario seems to really have hit their residents much harder than British Columbia, likely a reflection of Ontario's huge debt which is projected to peak at $319 billion in 2016 - 2017 and their current deficit of $21.3 billion. The Ontario government is in great need of increased revenue and the HST is one of the tools in their deficit-busting arsenal.

What is particularly concerning to me when looking at the HST regime is the deal that both British Columbia and Ontario have made with the Federal Government. In both cases, the provinces have agreed to hold the HST at the 12% and 13% levels for only the first two years; after that, the provinces are free to change their component of the HST to any level they wish. Here are the details from the Ontario agreement:

"The PVAT (Provincial portion of the HST) Rate in respect of the Province may be increased, or decreased, in accordance with the provisions of this Agreement after a minimum period of two years from the Implementation Date. Following that two-year period, any change in the PVAT Rate in respect of the Province, as permitted under the provisions of this Agreement, will not occur more often than once in any twelve-month period." (my bold)

In two years, residents of both provinces can pretty much count on increase in HST unless, of course, an election is called near the end of the two year period and a reduction in HST is used to temporarily bribe voters with their own money. Of course, the federal component is also an unknown; they can raise the GST portion as well.

One need look no further than the example of Nova Scotia to see what can happen to the HST over time. In 1997 when three of the Atlantic provinces implemented their HST programs, the rate was set at 15% on more items but at a greatly reduced rate to the former Nova Scotia PST/GST combination of 18.7% (the tax eventually dropped to 13% based on cuts to the federal portion). In its 2010 budget, Nova Scotia raised its component of the HST by 2 percentage points resulting in a new 15% HST, the highest in Canada. This move was made to directly combat the province's growing deficit/debt issue. Nova Scotia residents were sold the HST in 1997 on the basis that they'd be paying less tax on a wider range of goods. Now they find that they are paying nearly the same amount of tax (if the GST was 7% as it was in 1997) that they did prior to implementation but on a far wider range of goods.

While Mr. Veldhuis and Mr. Lammam would argue that businesses passed along their cost savings because of their now claimable input tax credits, I would argue that, as a resident of Atlantic Canada, I saw little to no evidence that prices declined, in fact, by the time prices would have declined, inflation had negated any price drop. Ontario Premier Dalton McGuinty claims that in other jurisdictions that have implemented HST, it has taken up to three years to see tax savings back in the pockets of consumers by which time the HST is part of life and the pre-HST regime is pretty much forgotten. What is particularly concerning to me is that consumers have to rely on the largesse of major corporations to see any price reductions that are based solely on the refund of their input tax credits. I suspect that most companies of all sizes will simply add their savings to their bottom lines.

It is also suggested that implementation of the HST in both Ontario and British Columbia will result in job creation totalling 591,000 jobs in Ontario and 113,000 jobs in British Columbia over 10 years. I'd be interested to know how an economist can distinguish between jobs that are created through normal cyclic growth in the economy and those that are directly attributable to implementation of the HST. I would suspect that there will definitely be some job creation; it is likely that a large number of jobs will be created in the public service sector related to implementation, collection and enforcement of the new HST regime.

As far as I'm concerned, jurisdictions like Ontario and British Columbia are simply using the HST to increase their tax base to fund their tax and spend mentality. If I actually thought that provincial governments (and the federal government as well) would spend their newfound wealth in a responsible manner, implementation of the HST would bother me less. Unfortunately, we all know that that simply will not be the case.

A Harbinger of Tax Increases to Come?

It was interesting to see the new NDP government in Nova Scotia raise their HST level by 2 percentage points from 13% to 15% in today's budget despite their campaign promises of no tax increases. I firmly believe that this tax increase is a harbinger of tax increases on goods and services to come in all provinces right across Canada.

With the huge deficits that provincial governments are running in both last and this fiscal year's budgets, my suspicion is that other provinces will soon join Nova Scotia and Quebec in raising their sales taxes. In the case of Quebec, their blended sales tax is rising by 1 percentage point to an effective rate of 13.92% on January 1, 2011. For the time being, since HST is just being introduced in both Ontario and British Columbia on July 1, 2010, their residents are unlikely to face increases in HST until the next budget cycle since politicians in both provinces are well aware just how unpopular the new tax is to their respective electors. However, in both provinces, huge budget deficits are predictors of things to come. Finance Ministers in both provinces predict a return to balanced budgets within three (British Columbia) to seven (Ontario) years. This is most unlikely.

Most provincial budget deficit projections are based on faulty logic. With interest rates likely to rise from their historic lows, mounting debt, mounting debt servicing costs and possible debt downgrades, I suggest that the projections of most provincial Finance Ministers are barely worth the paper they are written on. In the case of Ontario, their projected return to a balanced budget has moved two years further out within the past year alone. So much for budget projections!

It will be very tempting for provincial governments across Canada to attempt to balance their books with an increase in taxes on goods and services. A one or two percentage point increase seems relatively benign and once the consumer adapts, it is soon forgotten. However, we must remember that in the case of HST implementation, the tax base broadens to cover far more goods and services than under the old PST/GST regime, costing consumers more. Unfortunately, repeatedly picking the pockets of the electorate allows governments at all levels to continue to spend irresponsibly. Rather than balancing budgets by cutting waste, we are allowing provincial governments to continue spending on meaningless and wasteful programs .

We must hold those we elect responsible for every dollar we "donate". If Canadian households budgeted the way our provincial governments budget, we would all be forced to declare bankruptcy.